Valeant - It's Not About This Quarter Or The Next Quarter

| About: Valeant Pharmaceuticals (VRX)

Summary

Valeant disappointed the market with its earnings call.

To quote the American Poet Ogden Nash: "Some debts are fun when you are acquiring them, but none are fun when you set about retiring them."

Valeant and its shareholders are in the decidedly non-fun stage.

Can the company make it through 2020?

The simplest and most secure way for Valeant (NYSE:VRX) to improve its outlook is by decreasing debt through asset sales. The latest debt schedule from the 10-K looks like this:

(in millions)

2017

$

-

2018

3,738

2019

2,122

2020

7,723

2021

3,215

Thereafter

13,371

Total gross maturities

30,169

Unamortized discounts

(323

)

Total long-term debt

$

29,846

Source: 10-K

The company has $2 billion incoming from asset sales that have been announced but haven't closed yet. Management said they were in the process of divesting certain businesses in non-core geographies like Vietnam, Indonesia, and Brazil. Perhaps that could get them another $500 million.

Until 2020, there are no hard to navigate maturities. As long as the company doesn't violate covenants it should make it through. That's based on the existing asset sales, minor additional sales and by directing free cash flow towards prepayment, which has the added benefit of lowering the chances covenants will be violated.

Post announced divestments adjusted EBITDA should come in at something like $3.20 billion to $3.35 billion for 2017, which should leave the company close to a billion per year to pay down debt (initially a bit less). Once some organic growth materializes, the diversified segment runs off and as debt gets paid down free cash flow will go up quite a bit near 2020. Reuters has six analysts projecting a mean of $1.63 billion of FCF end of 2019.

By 2020 things will get really critical. Without further medium-sized sales they could be $3-$5 billion short. I don't believe it is very realistic to expect Valeant to make it through 2020 without another medium to large divestment. A lot depends on how organic growth will look in the next few years. In the more favorable scenarios the company could roll over debt, but in less favorable scenarios it may be forced to do away with assets at less than ideal prices.

Management is clearly aware of its window of opportunity and seizing it by ramping up the Salix sales force hard after failing to sell the asset. They are also ramping R&D although admitting being limited due to the financial position they are in. As per CFO Herendeen:

We look at the capital markets all the time for opportunities to improve both our financial and operating flexibility, and also to extend maturities. I can assure everyone on the line, this is something that myself and my Treasurer, Linda LaGorga and her team, we think about it every day. And we look out at 2018 and the maturities in 2018, look out at 2020. Certainly, there are (47:40) maturities in 2019 as well, and those are things that need to be addressed. And I can't get specific, more and more specific with respect to timing or what we intend to do. But I can assure you that keeping an eye on the capital markets and moving quickly to address some of these issues is very high, very high on our list.

This may have scared the market, perhaps rightfully so, into accounting for a possible equity raise. It's not something I think they will be doing, but management obviously has a lot more insight into the avenues it explored as far as asset sales go. If they don't see much potential to get deals done before 2020, they may be better off raising some money now compared to waiting until the last minute.

It seems unlikely as asset sales so far occurred at attractive levels and the M&A market is very strong. They could have made far worse deals before I would be cheering equity raises instead. The R&D ramping and sales force expansion don't point to equity raises either. So I'm thinking we won't hear much for a while and will see another one or two weak quarters. Depending on how sales ramp up with the increased sales force in place, management will get more decisive about asset sales.

Summary

  • Expect one or two weak quarters without much divestiture news.
  • Expect sales of the diversified segment to crater pretty hard over the next two years.
  • The important thing to watch is how sales of the durable business lines develop given the investments into the sales force. If these develop well, Valeant's options start to open up.
  • After the next two quarters, I'm expecting decisive action or inaction depending on the trend in sales for the durable businesses.

For the FY 2017, Reuters tracks 20 analyst estimates and their mean estimate for EPS comes in at $4.17. For the end of the year 2021 there are only three estimates, but these analysts have a mean of $7.15. Because the sample is so small the high and low are actually much closer together compared to the estimates for 2017, which is obviously impossible.

I think about the range for end of 2021 in terms of $0 (if they hit Chapter 11 along the way) to $10 (if really lucky). Shares are about $14 after rebounding some today, and given that price I view Valeant as an attractive situation that will likely result in a binary outcome. Given the positive skew it's acceptable to brick this one, two out of three times or so.

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.

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Tagged: , Drug Delivery & Accessories, Canada, Earnings
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