Concordia Healthcare (NASDAQ:CXRX) just took another huge hit last Friday as the stock plummeted a near -9.4%, as Brexit fears caused heightened investor pessimism. It was the second worst performer on the entire TSX that day, and as I warned in my previous piece, Concordia would get hit extra hard if there are temporary sell-offs or if a recession occurs in the next few months.
Readers of my piece who took my recommendation to sell the company would have saved themselves a nasty downfall. There are many investors out there that believe Concordia is a safe pick because there is very little downside because the stock has already fallen so much. This is a mistake and I believe the downfall is warranted and the stock may experience even more downside, as it faced this Friday.
Concordia has a highly leveraged business model that has been compared to the likes of Valeant Pharmaceuticals (NYSE:VRX). While Concordia is not as corrupt as Valeant by hiking drug prices by unreasonable amounts, I believe Concordia actually has the worse business model. Unlike Valeant, Concordia buys off-patent drugs, which have zero barriers to entry and this breaks Warren Buffett's concept of having a moat to keep competition from stealing market share.
I believe the leverage will eventually be the downfall of Concordia, and it will inevitably sell its portfolio of old drugs, which it paid a premium for, at a discount in order to pay off its huge debt. Buying high and selling low is not a recipe for a successful company, and investors should probably cut their losses and find a business with a sustainable business model.
Concordia Healthcare has a severely flawed business model
Concordia has a flawed business model, which consists of borrowing massive amounts of money in order to purchase off-patent "old drugs," which they continue to do so in order to "drive value." But there is no value to be had here, as these old drugs are depreciating assets and will continue to see decreased sales and lowered margins, as competitors with actual R&D jump in and steal market share. Concordia has no R&D, and it can't improve its portfolio of old drugs like other companies can.
A competitor could easily steal market share by investing in clinical trials for various different therapies, which would show more promising results than those of Concordia's old drugs. I expect this scenario will inevitably play out and Concordia's portfolio of off-patent drugs will be depreciating assets that will inevitably have very little value in the long run. To make matters worse, Concordia looks to have overpaid for its acquisitions such as the AMCo deal, which racked up a $3.5 billion bill added to Concordia's debt.
It is unreasonable to expect massive growth from Concordia because its off-patent drugs have nowhere to go but down, especially once better drugs come along from its competitors. For these reasons, being a long-term investor in this stock could lose you your shirt, since as time goes by, I believe the assets lose value due to increased competition, which will kill sales and margins simultaneously.
Bankruptcy imminent unless Concordia changes its business model
Concordia is going to continue to fall by default, unless a takeover happens. There are takeover candidates such as Apollo asset management. However, I'd never advise anyone to invest in a company based solely on a takeover bid, as that's a sure way to lose a ton of money. Investors should instead look at the fundamentals of the business and ask themselves how value is being generated. With Concordia, there is no value being generated.
The business will struggle to pay back its massive debt, which will inevitably lead to asset liquidation at a discount, while the stock continues to fall into the abyss. Concordia has way too much debt right now, I believe more than it can handle, especially considering that nearly a third of Concordia's debt matures in less than five years. S&P gave Concordia a credit rating of B, which is not investment grade. I do not believe operating cash flows will be sufficient to support the company's operations in the next five years and I think the stock is headed for the same fate as Valeant.
Valuation and Conclusion
Concordia, like Valeant has an overly aggressive acquisition strategy, where it acquires new drugs and hikes prices. The only difference is that Valeant actually acquires drugs, which have durable competitive advantages in the form of a patent. Concordia on the other hand acquires old drugs, which are essentially depreciating assets, which the seller desperately wanted to get rid of. Concordia has an average net loss of -7.7% in last 12 months, with a massive 2.9 debt-to-equity ratio which is among the worst in the biotech sector.
It's negative RoE of -4.7% shows that Concordia has been unable to generate profits with investor capital, and a sign that Concordia overpaid for its acquisitions and have been unable to unlock value from them. Concordia has a decent free cash flow margin of 31.8%, all of the cash, which will need to go to paying off its huge debt bill.
For the next few years, I see Concordia pulling the breaks on acquisitions and trying to pay back its debt from sales of its old drugs, whose margins will be depreciating with time. It is truly a race against time for Concordia, and unfortunately, I don't expect the race will be finished. Investors should look elsewhere, as huge growth is not in the cards for Concordia.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.