What The Bond Market Is Saying About Valeant

Random Itinerant profile picture
Random Itinerant
332 Followers

Summary

  • Valeant's bonds are trading at non-distressed levels, and have done so throughout the past year while the stock has sold off ~90%.
  • The bonds are currently trading at the same level that they were before the March earnings report, while the stock has sold off by almost 70% since then.
  • The bond market does not believe the negative message that the stock market has been sending about Valeant.
  • The B3/B- rating of Valeant's bonds implies a 27% chance of bankruptcy over 10 years. I show that the share price ~$23 is pricing in a 67% chance of bankruptcy.
  • This is done using a comparison with peers based on EV/revenue, which shows that Valeant's shares should be trading at ~$70 in normal circumstances.

The Valeant (NYSE:VRX) saga is familiar to anyone who has been following the financial news over the past year: issues regarding its business practices in the latter half of 2015 led to a huge selloff in the stock, which was followed by an even larger selloff after a major deterioration in Valeant's business performance was revealed in the two most recent earnings reports. To date VRX is down around 90% from its 2015 high.

Valeant's growth by acquisitions strategy resulted in a substantial debt load. The deteriorating business performance over the past half year has raised questions about whether Valeant will be able to continue managing its debt load in future. EBITDA is currently pushing up against the limits allowed by the debt covenants. While the situation is manageable at present, any further major deterioration in business performance will likely push Valeant over the edge and make its survival unlikely. Thus, Valeant currently has its back up against the wall. The key question now is whether the bottom is in for its business or whether further declines await.

In situations like this, where the company's continuing ability to manage its debt is in question, it makes sense to pay close attention to what the bond market is saying. It is also interesting to compare its message to the one coming from the stock market. Bond investors are regarded as 'smart money', so a less negative message from them may indicate an overreaction in the stock price and hence a buying opportunity based on mispricing of risk vs. reward.

When a company is considered to be in danger of bankruptcy, its bonds signal this by becoming "distressed" - the bonds sell off to the extent that the yields reach distressed levels. In practice, a bond is considered to be distressed when its yield is more than

This article was written by

Random Itinerant profile picture
332 Followers
Mathematician/theoretical physicist by training and profession, currently taking a break from that to develop other interests including financial markets. Itinerant too, have never lived more than 6 years consecutively in any one country. (Currently in Asia.) DIY retail investor.

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.

Additional disclosure: I have no position in any of the other stocks mentioned, and no plan to initiate one.

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