Bausch Health: Valued Significantly Below Sum Of The Parts And Generating Activist Interest

Feb. 23, 2021 12:47 AM ETBausch Health Companies Inc. (BHC), BHC:CA84 Comments21 Likes
Justin Dopierala profile picture
Justin Dopierala
2.67K Followers

Summary

  • Bausch Health is significantly undervalued based on a sum of the parts analysis, DOMO Capital believes shares should be closer to $80 per share.
  • Numerous well-known activists (Paulson & Co., ValueAct, Glenview, GoldenTree Asset Management, and Icahn) own approximately 30% of the shares outstanding.
  • DOMO Capital Management, LLC has been a shareholder since 2017 and BHC currently has the largest weighting of approximately 27% in our DOMO Capital Concentrated All Cap Value Composite.
  • The current market environment is handing management the opportunity to unlock value on a silver platter and the lack of action is puzzling.
  • The timing of the increased share purchases by activists is not random as the annual shareholder meeting is approximately two months away.

Summary

Other Seeking Alpha authors have done a fantastic job of providing the background and history of Bausch Health (NYSE:BHC) previously known as Valeant Pharmaceuticals (VRX). In particular, we found Brett Jensen's article found here to be a fantastic overview of the operating segments, history, new approach, important drugs, debt profile, and balance sheet.

If you are new to BHC - We recommend you start there.

This article will be focused on valuation and the need for timely management action.

DOMO Capital initially started a position in BHC in January of 2017 around $14 per share, increasing our position close to the maximum 20% size in April of 2017 at under $10 per share shortly after the fall-out from the Ackman exit. We sold approximately half of our shares near the end of 2018 as the stock soared over $26 a share (in order to materially add to one of our most well-known positions), and we were shocked when we were able to reload BHC back to a full 20% position last March when the shares fell under $12. After significant appreciation in the portfolio, due to one of our most well-known positions, we were able to increase our position back to 20% in the mid-$20s and BHC now has a 27% weighting in our portfolio due to share appreciation.

Sum of the Parts

In August of 2020, BHC finally announced that they would be spinning-off their eye care unit known as Bausch & Lomb. After initially popping on the news, the stock started to sell-off when it appeared that management was dragging their feet and needlessly prolonging the spin-off as management put out a timeline that showed the spin-off wouldn't happen until late 2022.

We believe this plan, rightfully so, received a lot of backlash and is likely why management recently surprised the market stating:

... what we are doing today is we're going to get everything done we need to get done from an internal point of view to be ready to do this in the third quarter of 2021. So all that activity will be ready.

BHC plans to spin-off Bausch Health but leave the international segment within the remaining company that includes the Salix, Ortho Dermatology, and Diversified segments.

Given the timing of the spin, we'll use 2022 EBITDA estimates in our sum of the parts analysis.

Segment

2022 EBITDA Estimate

Average Peer Multiple Implied EV with Peer Multiple
B&L 925M 30x 27,750M
International 230M 10x 2,300M
Salix 1,400M 6x 8,400M
Ortho Derm 330M 9x 2,970M
Diversified 750M 5x 3,750M
Total Implied EV 45,170M
Less Debt 18,900M
Equity 26,270M
Shares 359
Price per Share $73.18

Source: DOMO Capital Management, LLC

Our 2022 EBITDA estimates are not at the high end compared to other analysts like JP Morgan or Cowen; however, our sum of the parts analysis has two main differences.

First, other analysts are valuing B&L closer to 17 to 20 times EBITDA which gives them a bull case closer to $48 per share. We believe the analysts are using this multiple simply due to a well-known secret about sell-side analysts. It's OK to go against the herd, but don't put yourself on an island. In other words, analysts can put their estimates at the high end or the low end but they are very unlikely to have estimates that significantly deviate from other analysts. No analyst has any incentive to put out an $80 price target when all the other analysts are at $30 to $45.

DOMO Capital believes that the market would significantly re-rate a standalone Bausch & Lomb. As Joe Papa recently mentioned:

For example, if you look at B&L peers, we looked at some of the Alcon multiples outcomes trading at 30 times 2020 EBITDA, Cooper’s around 25 times, 26 times 2020 EBITDA, Zeiss near almost 40 times 2020 EBITDA. So our peers are trading at some significant EBITDA multiples.

B&L's business is slightly different from the business of Alcon (ALC); however, we believe that warrants a premium not a discount. A standalone B&L would have an EBITDA margin of 20% compared to around only 17% for Alcon; therefore, we believe a 30x EBITDA multiple for B&L is appropriate.

Second, other analysts such as JP Morgan are subtracting anywhere from $2 to $3 billion from the equity value due to expected asset sales. We think they are confused. Asset sales will unlock value, not decrease it.

In the next section we are going to highlight two imminent asset sales, but we will include our conclusion here.

We believe that BHC will soon raise over $4 billion from asset sales within the International and Ortho Dermatology segments. We believe the 2022 EBITDA of the international segment is around $100M and that the 2022 EBITDA of Solta (within the Ortho Dermatology segment) is around $80M. That values the international segment at around $1B and the Ortho Dermatology segment around $720M using our multiples above. At $4 billion these two units would fetch an additional $2.28B compared to our above estimate. Therefore, the sale of the units, would actually increase the equity and result in a per share value of $79.53.

Additionally, BHC also has a product for sickle cell that is starting Phase II clinical trials. Joe Papa recently commented:

We have a product for sickle cell disease. There are sickle cell companies out there with a $2.5 billion market cap, and that's embedded within our Salix business. That's another example of places where we think we can unlock some value.

To be clear, this drug currently has no revenue and due to the costs of the clinical trials would actually be EBITDA negative, but could be valued at billions within a couple of years.

Imminent Asset Sale Opportunities

Once Bausch & Lomb is spun-off, the remaining company would consist of International Rx, Salix, Ortho Dermatology, and Diversified.

The market has consistently underestimated how much Bausch Health would be able to sell off individual business units, and since 2017, Bausch has consistently sold segments off at higher levels than the market was anticipating.

In the near term we see two immediate opportunities.

DOMO Capital believes that a sale of Amoun, an Egypt-based pharmaceutical company that Bausch acquired in 2015 for $800M is now worth over $1B. When Bausch acquired Amoun in 2015 the revenues were only about $165M. According to the last 10-K, the unit now totals 3% of total revenue which allows us to approximate that in 2019 it achieved about $260M in revenue.

Unfortunately, Egypt significantly devalued their currency in 2016 (by 50%) which significantly lowered the value of future cash flows to a company like Bausch. Impressively, this means that growth from $165M to $260M is not 58% growth, but actually growth of 215% over 4-5 years after taking into account the currency depreciation.

The incredible growth rate aside, the currency devaluation would be less of an issue for an acquirer like the Abu Dhabi sovereign wealth fund (ADQ) or the Saudi Arabia's Public Investment Fund. Bloomberg recently highlighted that both funds may be fighting over the asset. Additionally, these country-sponsored funds are not simply looking to make money.

The asset would be a strategic purchase to help prevent future global supply disruptions as the Amoun facility is one of the largest and most sophisticated production centers in the Middle East and North Africa region and produces a significant amount of antibiotics that are in high demand throughout these regions. We believe that the Amoun facility would be of national interest to both Saudi Arabia and the United Arab Emirates, and that the final sale price could top $1 billion as neither country will want to risk losing this strategic asset to the other.

The second near-term catalyst will likely be the sale of Solta. We've detected two key changes in management's tone over the last several months.

Here is Joe Papa speaking on December 1 at the Evercore ISI 3rd Annual HealthCONx Conference:

Now, if someone were to come to the table and were to offer a fair price for Solta, they didn't want to own it, and I don't think there is anybody else there that is looking at Solta and saying, that's worth a couple of billion bucks

On January 13th, at the 39th annual JP Morgan Healthcare conference Bausch CEO, Joe Papa, made these comments:

And then all the other comment and question me about Solta business. Once again, I'm not going to comment about Solta, but Solta is a very strong business. It grew by 55% in the third quarter of '20 and about 45% I think in the total 2019 time frame. So clearly, we think that's a great business. And based on other speculation out there, I'm sure that's a business that's worth several billion dollars.

At the first conference, he fielded several questions about Solta. At the second conference, he refused to comment on it further. At the first conference, he mentioned it could be worth a couple of billion bucks. At the second conference, he highlighted a surprising growth rate and stated the business is worth several billion dollars.

From the sell-side research we have seen, we think Solta might double expectations, and sell for over $3 billion.

Lastly, Ortho Dermatology President, Will Humphries, resigned in November and officially left the company at the end of 2020. As he has not yet been replaced, it's possible that Bausch is currently shopping the entire Ortho Dermatology segment.

Activists

Four of the top five shareholders in Bausch Health are considered by FactSet to be High to Very High for activism with the fifth largest having a Medium ranking.

According to the latest 13F/13D filings:

Icahn Capital LP owns 7.8% of outstanding shares

Paulson & Co., Inc owns 7.28% of outstanding shares.

ValueAct Capital Management LP owns 5.05% of outstanding shares.

Glenview Capital Management LLC owns 4.63% of outstanding shares.

GoldenTree Asset Management LP owns 3.15% of outstanding shares.

Additionally, Glenview recently wrote a scathing letter to management that states they now own approximately 6% of shares outstanding which represents a material increase from the end of 2020. It was unknown that Icahn had any ownership in Bausch Health until he filed a 13D on February 11th.

Robert Hale, a partner at ValueAct, and John Paulson, President of Paulson & Co., already have two seats on the board, but represent less than 20% of the 11 board seats.

If management does not address shareholder concerns on Wednesday's earnings call and fails to act promptly, we believe that there is a very high probability of a proxy battle within the next couple of months.

Ken Squire of 13D Monitor may be onto something in this CNBC article he wrote in regards to Carl Icahn's intentions and the potential use of SPACs:

Icahn will certainly want to make sure that shareholders get full value in the separation, which could mean a sale of the business instead of a separation. Who knows, maybe optimal value would be derived by selling the eye care business and/or other Bausch businesses to a SPAC? With the number of SPACs being launched these days, it is just a matter of time before they have to look at subsidiary businesses of public companies.

The sale of BHC assets to one or more SPACs is an intriguing theory that has a lot of merit. Taking this a step further, another intriguing potential outcome could be the creation of a SPAC by a conglomeration of the current shareholder activists. They could pay fair value for specific operating segments of BHC and then combine them with assets from other companies to create a combination that would have even greater value. In this way, they would double-dip by having their investment in BHC appreciate considerably while also using the SPAC to unlock even greater value and the total cost would be less than a spin-off while also preventing the costs associated with a proxy battle.

Conclusion

In conclusion, DOMO Capital believes that shares of BHC are worth closer to $80 per share, a 150% premium to the current share price of $32.

Management has the ability to sell several assets to unlock value for shareholders and the spin-off of B&L should generate a much higher multiple, closer to peers such as Alcon, compared to what sell-side analysts are modeling. Even at the multiples being used by sell-side analysts, shares should be valued closer to $50 per share (a 56% premium).

BHC may able to use SPACs to unlock value at significantly less cost.

If management does not act urgently, shareholder activists will take action within the coming months.

This article was written by

Justin Dopierala profile picture
2.67K Followers
Justin Dopierala is President and Founder of DOMO Capital. He received his Bachelor of Science from Concordia University, Wisconsin (2005), graduating summa cum laude and recognized as the most outstanding undergraduate student of his class. He completed his MBA at Concordia the following year. Justin has been the portfolio manager for DOMO Capital Management since the portfolio's inception (2008). His years at DOMO has been enhanced by corporate experience with Harley-Davidson, Case New Holland, and FedEx Services. His work as an auditor in the areas of Information Technology, Plant Operations, and Finance honed his analytical skills and enable DOMO's sophisticated financial models. Investing began at an early age for Justin, when he convinced his parents to place a trade for him at age 15 using money he'd saved from mowing lawns. This interest found a focus and structure when a college professor encouraged him to read The Intelligent Investor, the principles of which remain a critical component of the DOMO philosophy to this day. Justin describes his interest in investing as a combination of a passion for competition, desire to do well for himself and clients, and the intellectual rigor of the discipline. A college football Hall of Fame inductee, Justin attributes his athletic and scholastic success as early validation of the same elements that drive the DOMO discipline: Hard work digging deep into the details, combined with an uncanny ability to stay on course by remembering the big picture. These disciplines enable him to meet the greatest challenge he believes a portfolio manager faces; filtering out short term noise in order to remain convicted in longer term investable ideas.
Follow

Disclosure: I am/we are long BHC. 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.

Additional disclosure: BHC is currently one of the largest positions in the DOMO Concentrated All Cap Value Composite. More information on the composite can be found at our website. DOMO Capital Management, LLC ("DOMO") is a Wisconsin-registered investment adviser. Justin R. Dopierala is the President and Founder, and a registered investment adviser representative, of DOMO. Additional information about DOMO is disclosed in our Form ADV, which is available upon request. All information contained herein is for general informational purposes only and does not constitute a solicitation or an offer to provide investment advisory services in any jurisdiction. The investment strategy discussed herein may not be suitable for everyone. Investors need to review an investment strategy for their own particular situation before making any investment decision. We believe the information obtained from any third-party resources to be reliable, but we do not guarantee its accuracy, timeliness or completeness. The opinions, estimates, projections, comments on financial market trends and other information contained herein constitute our judgment and are as of the date of the material, are subject to change without notice at any time in reaction to shifting market conditions and other factors and should not be construed as personalized investment advice. DOMO has no obligation to provide any updates or changes to such information.

Recommended For You

Comments (84)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.