Valeant (NYSE:VRX) went up nearly 16% Wednesday. The move was ascribed to the comment made by Alex Gourlay on the Walgreens earnings call in response to a question about the relationship with Valeant. There's nothing like source material so I've dug up the comment and highlighted several key phrases:
It is Alex, again, here. Yes, we are satisfied and pleased with performance in the dermatology business the volume is as we expected. And remember, we have paid for the service we provide. We're not paid on the margin mix here at all. So we're satisfied the relationship is good. We know Joe well from the past from Pagel where the group had a very good relationship with Joe and Pagel. And we are in constant dialogue with Joe and the management team. Which you see their situation and we are very willing to help them in a positive way. So it's early days a 20-year contract and from our point of view we are pleased. We want to help our partner to be more successful in market.
If the price move yesterday tells us anything, it is how little there is required to move Valeant higher. Walgreens Boots Alliance (NASDAQ:WBA) gets paid by Valeant for the service it provides while handing out the product. It is satisfied because it gets paid no matter if a profit is made on a particular sale.
Valeant, in the words of its CEO, is taping dollar bills to some of the prescriptions going out. That's why Walgreens mentions it is not paid on the margin mix of the Valeant prescriptions it is giving out. Even though it is negative on some prescriptions which is dragging margins way down, Walgreens doesn't care! It makes sense it is satisfied. The deal is great for it.
Valeant is apparently in constant talks with the company as it wants to change a few specifics of the deal so it is no longer losing money on a percentage of the products going out through the Walgreens channel, but Walgreens has very little incentive to give in.
Except for one thing.
It's not a secret Valeant is working hard to get its finances in order. The firm is overlevered and in danger of breaching covenants if it were to encounter some major hiccups. That's a problem for Walgreens because if Valeant goes into Chapter 11 the result could be worse for it than if it agrees to amend some of the terms of the deal. That's why I underlined the part about the 20-year contract. Walgreens may be thinking to ease up a bit in order to secure a great deal for the next 20 years by helping Valeant survive. It would be better in the short term to rake Valeant over the coals but it may be doing its shareholders a better service by securing the deal for the long term.
How important is Walgreens to Valeant? Probably, fairly important. The exact numbers I'm not sure of but I estimate between 5-7% of total revenue. That's a modest number but the market may have responded so fiercely because people are modeling the subpar Walgreens contributions out over an extended period of time (due to the contract lifetime) and perhaps because for Valeant every extra dollar earned isn't just an extra dollar but actually gets the company further away from default.
To me the price move response to the comments made by Gourlay, that I don't view as unambiguously positive, shows how preoccupied the market is still with a default. Fellow contributor Trent Welsh did a great job describing some of the baby steps Valeant is taking to avoid it but we'll probably have to see some non-core asset sales actually being realized before the market starts believing in a successful reorganisation without default. The reaction to the Gourlay comment appears a little bit overdone to me but it is illustrative of what will happen to the share price if Valeant successfully divests one or several non-core assets and gets back to more solid financial ground. I continue to believe that's the path Joe is taking Valeant on to improve the debt profile and it has a good chance of succeeding.
Make sure to read Valeant; Buying The Uninvestable for additional detail.
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.