By Parke Shall
Valeant (NYSE:VRX) has paid off a very small portion of debt and is looking to restructure billions more, a move that we think has both positive and negative impacts for the company. Today, we wanted to briefly discuss the good and the bad of this transaction as well as why we may take a small speculative position in the company again and what we think the company can do to unlock a significant amount of value at anytime they want. We simply don't understand why this company has not spun off Bausch & Lomb into a separate public entity, loaded it with some debt, and use what would be a tremendous multiple expansion to raise a little bit of equity and steady to ship even further.
Anybody who has followed even one second of the Valeant story for the last year or two understands that the biggest key variable is the company's debt load. Buried under a mountain of $31 billion plus in debt, VRX is now tasked with the objective of trying to carefully manage its cash flow stream and keep the balance of operations steady long enough to start to make meaningful progress on paying down debt.
Of course, there have been some challenges along the way that have made this far more difficult. Aside from the initial allegations of channel stuffing and fraud, many of the assets that VRX paid for in the past have looked to only be worth a fraction of their value in terms of cash generation that they are expected to produce. The balancing act is going to be a lot more difficult than anybody could have imagined two years ago and making progress on the company's debt is the number one item that is going to move the equity from distressed levels to a more reasonable multiple. If William Ackman and VRX can pull off this balancing act and steady the company's cash flow stream, it is easy to predict that VRX will appreciate severalfold from levels here at $13.
News broke this morning that the company had made some progress on its debt issue. Seeking Alpha reported,
- Valeant Pharmaceuticals is up a fraction premarket on light volume on the heels of its announcement that it has paid down its senior secured loans ~$1.1B following the close of the sale of skincare assets to L'Oreal.
- The company is also seeking to refinance and amend its existing credit agreement, borrow new Term B loans under the agreement and issue new debt securities. The aim is to extend the maturity date of the credit revolver and Term B loans that mature prior to 2022, repay all of the Term A loans, remove the maintenance covenants from the Term B loans, modify the maintenance covenants under the revolver, modify certain other provisions of the Credit Agreement and repay a portion of its outstanding 6.75% Senior Notes due 2018.
- The refinancing is expected to close this month, although it adds that there is no assurance that all of its objectives will be met.
The positives here are obvious in that this does pay down a small amount of debt and gets some of the company's near term liabilities dealt with. Pushing out maturities will benefit the company as it gives them a longer time to stabilize their cash flow stream and basically just gives them a little more leeway in terms of how soon they need to come up with the money.
There's also an obvious negative to any refinancing and that is usually that the terms of the debt get substantially worse. In a rising interest rate environment, amending and pushing out billions of dollars in debt with tougher covenants and requirements may not exactly be what the doctor ordered for a debt distressed company.
However, we do view this small transaction as a small net positive, as it establishes that the company is trying to make strides at what is the most important factor for its business and it does chip away at a very small piece of debt. If we were Valeant, we would be focused on getting our leverage ratios to a relatively bearable spot and then look to refinance from there.
This has been a much more difficult balancing act than we could have ever predicted and we want to be the first to admit we have been wrong about Valeant thus far. We had been long VRX at various times from prices near $50 all the way down to near $15.
The narrative remains the same: if VRX can get its debt situation under control, the equity will likely return multiples of what it is worth today. If the company cannot, there is a large case for a bankruptcy restructuring that would wipe out common shareholders. With William Ackman as one of the company's largest common shareholders and also having board representation, we still find it relatively unlikely that the company is going to give in and restructure.
However, at this time, an investment in VRX should be viewed as extremely speculative and essentially a call option on the future of the business. VRX will be here in a few years, the only question is whether or not it will be with the current capital and share structure. We still believe that with a couple of decent able-bodied common shareholders and hopefully the worst of the company's PR narrative behind it that the common still may have a chance. While today's debt restructuring news is a small move in the right direction, it carries with it downside as well.
We have consistently argued that spinning off Bausch & Lomb into a separate public entity and loading it with some debt will help Valeant achieve the multiple necessary in order to generate real capital. Once Bausch & Lomb has been spun off, we should see huge multiple expansion as the entity sits alone and there should be a huge generation of value. Until then, you have a Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) style company tucked into what is otherwise a toxic company with a toxic name.
If VRX continues to make new lows this week, we plan on reestablishing a speculative position.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VRX over the next 72 hours.
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.