I am long VRX. It has been a painful ride, but I continue to believe they will work through their challenges without any major asset sales or dilutive capital raises, and especially without bankruptcy. That "work it through" path will create the most value for VRX shareholders over the long term. In this note I intend to explain the impact of what could be their backup plan if the reality is worse than management is reporting, as some commentators on Seeking Alpha claim. That backup plan could be to sell Bausch & Lomb, arguably the crown jewel of Valeant. This action would solve their debt problems and likely lead to c. 100% returns for current shareholders over the next year.
B&L had $1.37bn of EBITA on a GAAP basis in 2016, which was a bad year. To be conservative take off $200mn for their 1/3 share of corporate overhead. Publicly listed companies in the Household & Personal Care industry (i.e. B&L's classification) have on average EV/EBITDA at 14.6x and EV/EBIT 17.6x (Source: Factset). Call it 17x for an EV/EBITA multiple.
PE firms have a mountain of cash to deploy at the moment, and B&L is a great, steady state business for them. Most PE sponsors would be very happy to buy a large asset at the same multiple as publicly listed companies trade, as they don't need to pay an additional "acquisition premium", which can often be 25-30%. Over 3 years such a deal with conservative assumptions (5% annual EBITA growth and 7x debt at 7% interest) would generate a 15% IRR over 3 years for the PE sponsor, which is very attractive given the $12bn equity check (which would likely be split amongst a consortium).
If we use 17x as the purchase price then selling B&L would generate $20bn (17 * 1.17bn = $19.9bn). If VRX used this to repay $20bn of debt, we include the $2bn from sales already announced and another $1bn from FCF for the first 9 months of 2017, then by Q4 17 VRX will have $8.5bn of debt, instead of the current $29.5bn.
Against this they would have approx. $2.15bn of EBITDA, calculated as 2017 guidance of $3.55bn less $1.2bn sold of B&L and $0.2bn sold from CeraVe and Dendreon. Debt would be 4.0x EBITDA and this would be very manageable, especially having already taken the profit hit from the LOEs per management guidance for 2017.
2018 would likely be another down year for this slimmed-down Valeant, call it $1.9bn EBITDA in line with management guidance on LOEs given during the recent earnings call. However from that lower base Valeant could grow again as it is mainly the Dermatology & GI businesses. Management have claimed 8-10% growth, but even at 5% EBITDA growth this firm would justify a 9x EBITDA multiple at least, so an $18bn EV assuming $2bn of EBITDA in 2019. This leaves $9.5bn of equity value, and with 350mn shares it gives a $27 share price.
To be clear, this is not my base case. I think Joe Papa will continue to work through Valeant's challenges without selling a core asset like B&L. But the option to sell B&L and solve Valeant's most pressing problems is there, and I think this makes bankruptcy highly unlikely. VRX will continue to be a volatile stock, but I will be buying on dips.
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.