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Short-Term Headwinds Faced By Valeant Create An Excellent Entry Point For Long-Term Investors

|Includes: Bausch Health Companies Inc. (BHC)

Summary:

Valeant more than doubled its stock price in less than one year and recently passed RBC to become the most valuable company in Canada.

Recent deals and healthy organic growth, together with its well-diversified product portfolio, put Valeant in good stead for long-term value appreciation.

The debt used by Valeant in its acquisitions has hiked its leverage to a risky level compared to its peers, which worried investors, along with the recent sell-off of healthcare space.

Investment Highlights:

Valeant had consistently delivered great financial results thus far. On July 23rd, Valeant posted amazing second-quarter results, with total revenue growing by 34% compared to second quarter last year. The management raised the 2015 total revenue guidance from $10.4~10.6B to $10.7~11.1B. Cash EPS guidance was raised from $10.9~11.2 to $11.5~11.8. Stock reacted to the better-than-expected results by jumping over 6%.

Valeant is highly diversified from both product type and geographic market point of view. It manufactures well above 1,000 products that are sold in more than 100 countries. Although its top 20 brands contribute to roughly 30% of total revenue, Valeant is not overly reliant on single product. Additionally, what makes its product portfolio attractive is that it primarily consists of smaller products that are less exposed to generic pressure. After the Salix deal, the U.S. market is clearly an emphasis of Valeant, which is poised to reap the benefits from the U.S. economy rebound.

Valeant is an acquisition machine with successful deal-making history. Bill Ackman, founder of Pershing Square, recently drew an interesting comparison between Valeant and Berkshire Hathaway; both have done a great job at acquiring portfolio companies. Since 2008, the company has employed around $40B in more than 140 acquisitions. The acquisition strategy is to focus on companies that deliver above-average growth and margin. Valeant's most recent takeover of Salix is a case in point where Salix posted higher than expected sales and boosted Valeant's gross margin.

Valeant's management team has strong healthcare background and extensive M&A experience. Valeant's management team, led by CEO Michael Pearson, former head of global pharmaceutical practice at McKinney, is experienced in making deals and quickly realizing synergies. Specifically, Valeant is famously known for its aggressive cutoff in unnecessary admin workforce and consolidation of R&D function after acquisitions. Also, management's compensation is aligned with shareholders' value. Michael Pearson's compensation over the next five years, for instance, is mainly determined by the stock performance during the same period.

Valeant's unique corporate structure enables it to take advantage of low tax rate. Valeant, a Quebec-based company, is taxed territorially thanks to Canada's tax law that allows acquisitions to be completed in low-tax jurisdictions. As a result, Valeant only paid about 5% on tax for most of its acquisitions, thereby maximizing shareholders' value.

Healthy double digit organic growth is expected in the long run. In the past, Valeant has been criticized for its weak organic growth. Since 2014 Q3, however, Valeant has been able to consistently deliver double digit growth. The management confirmed its confidence in Valeant's 10% organic growth for the rest of 2015 due to its strong late-stage product pipeline and potential to increase pricing.

Acquisition risk and high post-deals debt load jittered investors. In the short run, the company is faced with challenges of mitigating acquisition risk and further realizing synergies since only five out of 19 largest deals it did have achieved full payback. Meanwhile, Valeant is highly levered as its Debt/EBITDA ratio is at 4.6, much higher than the average comparable multiples of 1.2. The debt risk is augmented by the looming rate hike by Fed.

To sum up, although Valeant is faced with short-term headwinds such as acquisition risk, debt risk, and interest risk that led to the recent share price decline, it is still an attractive long-term investment for investors to consider given its well diversified product portfolio, healthy organic pipeline growth, sound acquisition strategy, and experienced management team.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.