Valeant Pharmaceuticals (VRX) announced the third small divestiture this year in an effort to tackle its huge debt load. While absolute debt levels are coming down, by selling non-core assets at reasonable valuations, relative debt levels hardly come down. This comes as the business is shrinking following these sales, as organic sales are pressured from years of underinvestments into R&D as well.
Improved flexibility with the leverage situation, some recent green shoots in the core business, and divestitures taking place at reasonable valuations, make that there might be some value left for equity holders. The outlook for equity investors remains highly uncertain, but the situation is not completely hopeless. I remain neutral for now, but continue to watch the divestiture process with great interest.
Another Step Towards A More Manageable Debt Load
Valeant announced that it has sold its iNova Pharmaceuticals business to funds owned by Pacific Equity Partners and The Carlyle Group for $930 million in cash.
iNova markets a portfolio of prescription and OTC products which focus on pain management, cardiology, coughs, and weight management. The company is notably strong in Australia and South Africa as well as Asia.
The selling price looks pretty decent if you ask me. Back in 2011, Valeant bought the then privately-held group for AUD 625 million, while additional milestone payments were set at another AUD 75 million. The business was expected to post sales of AUD 200 million per annum at the time, combined with fat margins of 40%. Those margins are truly impressive, as they represent operating margins.
At the time of the original deal, the Australian and the US dollar traded around parity. As a result, Valeant probably has made a little money on the transaction in the company, on top of the earnings being retained since 2011.
Unfortunately it is impossible to find any detailed information about the revenue being contributed by these businesses at this point in time, but a $200-$250 million revenue range seems fair. If that is realistic, the assets fetched a 3.7-4.7 times sales multiple. Reports in late 2016 suggested that Valeant believed the unit could be worth a billion dollars, or even more.
Still Working For The Bondholders
This deal marks the third divestiture so far this year. At the start of this year, Valeant announced the sale of Dendreon to Sanpower in a $820 million cash deal. A day later, Valeant announced the sale of three skin related brands to L´Oreal. While sales of these three businesses came in at just $168 million, Valeant received $1.3 billion for these assets in the deal which has already closed in the first quarter.
Valeant ended the first quarter of this year with $1.21 billion in cash, while total debt has come down to $28.54 billion. This net debt load of $27.33 billion is set to fall further as the sale of Dendreon is not completed yet, as is the sale of iNova for obvious reasons. Once these deals close, net debt will fall towards the $25.5 billion region, after net debt levels peaked at +$30 billion last year.
Any debt reduction is very much needed as underinvestments into R&D and the sale of non-core assets is hurting every ¨profitability¨ metric, even a very much ¨debatable¨ metric such as adjusted EBITDA. Topline sales can not be manipulated, as total revenues fell by 11% on the back of asset sales and loss of exclusivity of some drugs.
The company now sees adjusted EBITDA of $3.60-$3.75 billion this year, at least that is the guidance as of the end of the first quarter. If I assume that the number will come in towards the lower end of the range, reflective of the announced asset sale, leverage ratios still come in at a whopping 7 times adjusted EBITDA. While the leverage ratio is high, Valeant is improving liquidity, it has swapped a lot of debt from variable to fixed rate plans, it has extended maturities and increased flexibility in its covenants.
So while absolute debt levels are coming down, relative leverage multiples remain very elevated. Note that if we annualize first quarter sales, we arrive at a revenue number of merely $8.4 billion, as this number does not even account for the three divestitures announced this year which could easily cut this number to $8 billion or less.
This lower sales base and still high relative debt ratio makes that it is highly uncertain if there is still any value left for shareholders. This is certainly the case as interest costs amount to nearly $2 billion a year, as that cost factor alone eats up over half of the reported adjusted EBITDA. In this analysis we have not even taken into account one-time costs associated with deals, financing fees or even legal repercussions from the adventure of the past few years.
Final Thoughts, Uncertainty Remains But Management Is Trying
Following the discussions above, relative leverage ratios are being rather constant, even as absolute debt levels come down quite a bit. Still, investors like the third smaller sale of a non-core asset this year at a price which can not be regarded as a fire-sale price. This is reassuring for equity investors, even as their long term outcome remains highly uncertain.
If we place a 10 times multiple on the remaining business with $3.6 billion in adjusted EBITDA, some $10 billion might be left for equity holders. If that simple back-of-the envelope calculation is anything close to being right, investors might see fair value at $25-$30 per share.
Every turn in the EBITDA multiple at which the assets are valued, provided that it exceeds 7 times, makes shares $10 worth more or less. This creates huge swings for equity holders which once more demonstrates that shares are best considered as a call option on the company´s assets.
The good thing is that management is making some progress is addressing the leverage situation, fetching reasonable prices for non-core assets, while it has some modest successes at its core business as well. The sad truth is that Valeant remains a very big hole, as management still has a lot of digging to do.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.