By Richard Jennings
We last wrote about Valeant Pharmaceuticals HERE on March 7th 2017 in which we signed off with the comment – “We call it here “asymmetric skew” and at $11.56 given the points we have made re the debt profile and the likely attraction to industry players like Allergan (and a possible return of Takeda for the full entity not just Salix this time) the upside looks to be many multiples of the downside at this level. I’d go as far as to say it is one of the most attractive opportunities I have seen in the markets in my long career. This was followed by a tweet on the 21st of April in which we were specific in calling the bottom in the stock (see below) at a price of around $8.50c.
As you can see from the chart below we were literally within both hours and a few cents of the reversal with the stock making a final bottom the following day.
With the stock now up over 100% from this call we note a number of commentators this week including long time bear of the stock David Maris from Wells Fargo looking to shout out the bear story once again. In fact, Mr Maris is looking for a retrace to the $9 level which would take us back to book value. With regards to that stance we disagree vehemently.
To us, the case for remaining long VRX remains not only intact but in fact is now more emboldened. With the company paying down short term debt ahead of schedule in recent weeks, per Joseph Papa’s commitment to reduce net debt by $5bn within 18 months of August 2016, they are actually likely to significantly exceed this target once the iNova sale proceeds of $930m are received later in the year and the free cash flow for the 2nd half of this year and 1Q 2018 comes into the balance sheet. I would not be surprised to see net debt at the end of Q1 2018 around $24bn excluding any further asset sales.
We have produced below a simple divisional break down of what we believe each of the various segments to be worth in assessing a SOTP (“sum of the parts”) figure. Please note these are very conservative estimates too.
Division EBITDA 2018 Ests Multiple Factor Attendant value ($bn)
Bausch & Lomb $1.45bn X 12 $17.4bn
Dermatology $520m X 13 $6.76bn
Branded RX incl Salix $1.18bn X 10 $11.8bn
Diversified $780M X 4 $3.12bn
TOTAL $3.93bn $39.08bn
If we take these conservative figures that are in fact less than the company’s own guidance and deduct net debt that we anticipate of $24bn at 2018 Q1 end then we arrive at a target equity rump value of just over $15bn. With approx 348m shares in issue this equates to circa $43 per share. This figure may seem a long way off at present but it is simply a function of declining debt profile and realistic valuation multiples. With Bill Ackman exiting too (almost at the bottom sadly for him) and his stake in part going into strong hands at ValueAct and Paulson and Co, the perceived overhang of stock has dissipated too. If we also apply another conservative $2bn potential litigation bill for the lawsuits they are embroiled in, this still results in a price in the late $30’s. However I splice the current EV, assuming that CFO Herendeen’s guidance is believable (and his modus operandi is to surprise to the upside), I cannot get anywhere near the current stock price which equates to a total enterprise value multiple for 2018 of just 7.5 times – massively under-rated compared to peers such as Allergan.
Remember also that, reportedly, the company walked away from a bid for Salix that was mooted around the $10bn level from Takeda of Japan late last year in shoring up our divisional assesments. In our figures we have valued this division PLUS the branded RX segment at just 10 times. We thus believe we are in fact underplaying the upside should a new approach be made for the company by any number of players who enjoy EBITDA multiples at much higher levels than that which is currently being ascribed to VRX.
We would also not be surprised to see a renaming of the business later this year, possibly rebranding as Bausch & Lomb and it is worth noting that bearing in mind that the significant pay day to Joseph Papa only begins to kick in around $50 per share that if the stock moves back towards the $30 level we suspect a concerted effort to turbo-boost the re-rating by management will be embarked upon during 2018 as they look to drive growth within the company once again from surplus free cash flows and hit their own payout thresholds in turning around one of the most difficult corporate episodes of recent years.
To conclude, as we look towards quarter 2 numbers in early August, assuming there are no shocks in those figs, we anticipate this Conviction Buy Call of ours for 2017 to be one of our star performers with a price in the late 20’s/early $30’s by year end.
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