By Scott Tzu with Thom Lachenmann
First things first; we are not just saying Valeant (NYSE:VRX) can triple arbitrarily.
If you recall, we wrote an article when the stock was about $35 stating that we thought it could double from there. With no real negative changes to the fundamentals since then, we still believe VRX is eventually capable of capturing about $75 per share as a market value and, from today's prices, that would just about be a triple.
Things have moved along positively since Mr. Ackman has been on the Board of Directors. Semi-famed CEO Joe Papa, who has extensive and almost overwhelming experience in the industry, is now heading up the new VRX and is being paid accordingly for his services. Mr. Papa's compensation will extend him compensation into the hundreds of millions of dollars if Valeant can make a recovery that puts its stock back into triple digits. So much for addressing the "tone at the top", but the news is still good for those buying up VRX shares down here at what we believe to be the bottom.
Valeant had been dragged down from the low $30 range to the mid $25 range on a series of news items that didn't really have much to do with the company's fundamentals. First of all, short-seller James Chanos made negative comments about the company during his appearance at the Sohn Investment Conference. Mr. Chanos went on record saying that he is still short the company and that he thought that debt was still a major issue. This was just days after Charlie Munger, one of the most respected investors in the world, came out and called the company "a sewer". Not a great headline for the 22,000 employees that work at Valeant and had nothing to do with any of the inappropriate conduct that happened during their employ.
Some people are calling these comments a certain death sentence for the company. We're calling it "the bottom".
We have heard everything that anybody who is anybody wants to say about Valeant. It has been opined on in the business news cycle just as much as Mr. Trump has been opined on in the political news cycle. We understand it; most people have negative things to say about the company and most people have negative things to say about Mr. Ackman. We understand that the company was abusing the healthcare system and made some incredibly poor decisions when it came to pricing. These decisions have cost them dearly, as the company has lost about 90% of its equity value. Shareholders have been punished. Executives have been called in front of Congress.
But the stock market is a forward-looking machine, not a backward one, and we are tasked with trying to find where the peak hatred for Valeant may have come in.
Having Munger and Chanos out bashing the company on live television may have been it. And it's not like we don't understand the short case to the company, because we do. The short case revolves around the completely irresponsible amount of debt that it has on it. Very much like SunEdison (SUNE), The company was starting to feel a little bit death spiral-ish over the last week or so.
Hopefully, Mr. Left's revelation that he is now long will be a game changer. Regardless, it shows his versatility and his vision, as he will likely comment on national TV today that he's long for the same reasons that we are.
The truth is that anytime you have a company as leveraged as VRX, the question is always what the future cash flow streams will look like. Another reason investors have began to panic with VRX is because nobody seems to know what the future cash inflows are going to look like for the company. Valiant made a number of revisions downward in its guidance in its 10-K, and then filed an extension for its 10-Q filing. Investors want to see these numbers as soon as possible. We believe once the market sees a couple of quarters of steady cash, that will alleviate some pressure on VRX and the extremely low multiple will again have some room to expand.
Valiant is trading at bankruptcy levels right now. At $27 per share, the market is really giving the company no benefit of the doubt for future survival. The equity is priced as though the company's cash flow streams will drop out from underneath them or the company will go bankrupt. If you believe any other scenario is plausible, you almost have to be a buyer of VRX here. Granted, you must understand the risk associated with investing in a company that is as leveraged as VRX is.
What Mr. Left is going to argue is likely going to be similar to what Joe Papa said in his first television appearance about the company. He stated,
"We are generating cash, we are generating EBITDA, we've got over $10 billion of sales," New CEO Joseph Papa told CNBC's Jim Cramer last week. "So, I do think the footprint is in place."
Mr. Papa realize, as we do, that the only real important thing right now is the company's cash inflows. As long as cash continues to come in the door and VRX can begin to stabilize itself, the equity has a real chance of appreciating seriously from here.
This also does not account for several "wild card" scenarios that may also happen over the next few months. These include,
- Another potential activist investor or well-known investor gets involved on the long side. VRX is so cheap, it is difficult for us to think that this has not been on the desks of several investors.
- The company could potentially deleverage by selling or spinning off its most well-known brand and cash generator Bausch and Lomb.
- Within the confines of the company's debt covenants, VRX may even choose to allocate a small amount of capital for a share buyback or debt buyback, depending on how the company's equity and debt are priced. This would all depend on the company's future cash flow streams and numerous liquidity ratios that need to be kept intact for the company to not default on its bonds. This one is just a maybe, but it wouldn't surprise us if it had already been looked at.
In addition, the company could move forward with Mr. Papa as CEO and establish partnerships with other well-known pharmaceutical companies, giving it a little bit more clout and credibility, which it desperately needs at this point.
Let's take a very quick look at the valuation. As it stands today, the company is trading with a price/sale multiple of 0.85x and an EV/revenue of just 3.81x.
Analyst estimates have been revised lower over the last 90 days, from $16.10 in EPS next year to now $10.49. The company is expected to earn $8.54 this year. VRX trades at about 3x this year's estimates and about 2.7x next year's estimates. If this company survives, you could cut both of these earnings estimates in half and the company would still be extremely undervalued. Most of the gusto from our "triple" scenario comes from the market finally recognizing how depressed these multiples really are. Once VRX clears the air with investors, these multiples should be able to breathe and expand.
It is for these reasons that we believe Mr. Left is now long the stock. It is also for these reasons that we continue to own VRX here and we believe the stock could eventually triple for patient investors going forward. We think under the guiding direction of Mr. Ackman and CEO Joe Papa, Valeant does not go bankrupt, is able to manage its debt, and eventually turns itself back into a semi respected company with a semi respectable multiple.
Disclosure: I am/we are long VRX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.