Valeant: Salix Sale Could Mean Major Upside

About: Bausch Health Companies Inc. (BHC), Includes: TAK
by: Orange Peel Investments

News broke yesterday afternoon that Valeant is considering selling Salix for $8.5B, plus royalties.

This could help the company delever substantially.

Equity should appreciate on lowered bankruptcy risk.

By Parke Shall

Yesterday, late in the day, it was reported that Valeant (VRX) was closing in on the sale of Salix. The potential sale was reported to be as much as $10 billion, with $8.5 billion upfront in cash, and the remainder coming in the form of revenue royalties. This represents almost a 30% discount to what Valeant paid for the company just a few years ago. It also marks the first major potential asset sale that the company would be making since it has been trying to delever itself. Reuters reported:

Valeant Pharmaceuticals International, Inc. is in talks to sell its Salix stomach-drug business to Japan's Takeda Pharmaceutical Co. Ltd. (TKPYY), according to people familiar with the matter.

The deal could raise as much as $10 billion for the indebted drugmaker, the people said, asking not to be identified because the discussions are private. There is no guarantee that the discussions will lead to a deal, they said.

Valeant is working with investment bank Morgan Stanley on the sale, the people said. Another bidder may also be interested in the Salix business, they added.

News of the talks was first reported by the Wall Street Journal.

We believe such a sale could cause the equity to appreciate meaningfully from here even with the stock at $23. We want to explain why in this article.

This move for Valeant falls in line with the strategy, but it pitched to the market on several occasions, both by the company and through board member William Ackman. For some time now, the narrative has been that the company will sell off its non-core assets and focus on its core cash-generating properties. The company also stated that it had actually reconsidered renaming itself Bausch & Lomb, the eyecare franchise that is at the epicenter of the company's core consumer business.

Speculation had been rampant over the last few months that the company was not going to be able to divest of its non-core assets in such a "fire sale". The fact that there is a meaningful bid for Salix out there is an immense positive for the company. It also is the first positive news for equity holders in a long time.

To put it simply, Valeant's equity has been priced at levels that are suggesting a complete and total collapse of the company and potential bankruptcy. The debt market had been pricing the company with significantly more confidence, but likely only because debt instruments in the capital structure are senior to equity, which is lowest in the capital structure. In order for the equity to survive, there needs to be a significant amount of relief when it comes to the company's potential bankruptcy scenarios.

For a while, we had been suggesting that asset sales and potentially a spin-off of one or more of the company's divisions could be a good way to distribute the debt and balance things while at the same time allowing equity multiples to expand. This sale, if it consummates, would do just that. It could potentially hack away at the company's significant debt load, reducing it by around 30% in one shot. This would help stabilize the business and help the company's ability to service its debt on a regular basis. All the while, the company's main cash generator in Bausch & Lomb would stay intact.

From this, we expect there to be far more price expansion if the deal is formally announced. Judging by several articles that were out last night, it looks as though only the formalities need to be finished up. Takeda's stock was halted overnight.

Two things can happen after this divestiture takes place.

The first is that equity holders will see appreciation in their investment.

The second is that the equity then becomes available for the company to use as a potential weapon to tackle more debt. Valeant would never want to go out and issue equity at prices that are suggesting the company will go bankrupt. However, if the equity catches a legitimate bid and gets back perhaps above the $40 level, the company may want to consider issuing a modest amount of equity to pay off more of its long-term debt. This in turn should have a net positive effect on the price of the equity despite the dilution.

Regardless, this divestiture would be a significant step forward in the "new" Valeant. As we wrote yesterday, we are long and plan on continuing to hold. We are also hedged slightly with puts.

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: We own VRX shares, calls and puts