Valeant: A Wonderful Investment At This Price

| About: Valeant Pharmaceuticals (VRX)
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Summary

In spite of the stigma against Valeant it generates a huge amounts of FCF.

Valeant starts to refinance some of its outstanding debt.

Jeffrey Ubben replaces Bill Ackman.

Investment Thesis

Back in December I wrote my first article on Valeant (NYSE:VRX) and titled it a Great Investment to Start 2017. Since I predominantly write about under-followed smallcap companies it was a great joy to write about this more followed and contentious stock.

However, with so many article being written on Valeant every day, I did not feel that I could offer readers any new analytical edge or perspective that has not been thoroughly discussed from both sides of the argument. But since I write because I'm passionate about stocks I decided to press on regardless.

Business Developments

I don't believe there are many readers out there that don't know the superficial story of the Valeant stock. It goes a like this - Valeant's business model was to raise debt and offer shares and use that cash to acquire new business. Valeant had explosive growth through acquisitions. The stock market became truly enchanted with Valeant and its growth until mid 2015. Subsequently, the bubble burst, Valeant's aggressive accounting came out under scrutiny and made headline news all over the financial press. Now, fast forward to 2017 and the stock market is not wanting to touch Valeant at seemingly any cost.

As can be seen in the table below Valeant generates huge amounts of FCF.

Source: morningstar.com; author's calculations

The reason investors don't want to invest in Valeant is threefold. First, because of its debt burden, secondly because it is not growing fast enough to offset its huge debt burden and thirdly, because of the stigma attached to it. I will address these in reverse order.

Stigma

Many investors even without knowing much about Valeant will simply disregard any investment in Valeant simply because of its reputation. In 2016, Charlie Munger went as far as calling it a sewer. Needless to say, management has its work cut out and needs to show the Street that the new Valeant is squeaky clean.

Growth

The 2017 full year guidance is down for both its revenue and adjusted EBITDA. 2017 will be a year where Valeant will have a lot of loss of exclusivity on its drugs. However, from 2017 out to 2020, guidance appears a little better.

Source: author's calculation; earnings call 2016 Q4

On the one hand, Valeant will have declining revenues in its Diversified Products segments, but that will largely offset through the growth in both Baush+Lomb and Branded Rx. Overall, there should be a small amount growth. However, investors are so disenchanted with Valeant that they are not pricing in any growth at the current price.

Debt

Obviously, the amount of debt is huge a problem. In spite of management's commitment to bringing down its debt the reality of the situation is that Valeant will struggle to make a material dent on its debt burden.

The most it can hope to do after it has paid the $5B by early 2018 is to refinance into the future. From the press statement put out on Monday night, it appears that Valeant's attempt to start refinancing have been successful. Clearly noteholders are satisfied with Valeant's abilities to generate excess cash after it has paid off its coupon payments, giving noteholders a margin of safety. Also, on Tuesday night, Valeant says,

the amount of our debt maturing prior to 2020 will be substantially reduced [...], "In addition, the amended terms of the credit agreement will provide us with improved operating flexibility and a greater margin of safety with respect to financial covenants

Bill Ackman

When I first wrote my article on Valeant, I surmised that if Valeant was good enough for him at nearly $200 a share, it was surely good enough for me at $15. Currently it trades at $10.50 and Jeffrey Ubben's ValueAct has used the opportunity to up his investment by another 3m shares, bringing his total to 5.2% of Valeant shares.

Conclusion

The Valeant saga will continue for a little longer into the future. As often happens in the stock market things take a little longer than expected but the returns are also a little larger than originally expected, specially for investors that have the courage and conviction to buy as the stock gets cheaper.

Please remember that this article is not a recommendation to purchase shares of any of the securities mentioned. Investing in out-of-favor securities has risks that may not be suitable for you. Please do your own due diligence to reach your own conclusions. Thanks for reading.

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.