This is part ten of a long series on Valeant Pharmaceuticals (VRX) - a major company in the speciality pharmaceutical space - and one that has cumulatively undertaken many billions in acquisitions.
The series was prompted by their biggest attempted acquisition to date - an unsolicited and ultimately hostile bid for Allergan (ALGN) - the maker of Botox.
If you have not been following you can review the series here: Part I, Part II, Part III, Part IIIa, Part IV, Part V, Part VI, Part VII, Part VIII and Part IX.
In my last post on Valeant Pharmaceuticals I observed that the company had blamed its earnings miss on the sale of its Facial Injectables business to Galderma. Specifically they stated that [Valeant] had built into our previous guidance $230 million of revenue and $0.50 per share cash EPS for the second half of the year from the (now sold) injectables business.
I calculated that there were 340 million shares outstanding and so for six months they were forgoing 170 million of earnings by selling that business. This is 340 million annualized and the business was sold for $1400 million.
This meant the business was sold at roughly 4 times earnings.
Michael Pearson stated on the conference call that were able to "realize the full value for these products" and so I thought there must be an error. After all Michael Pearson [the CEO of Valeant] is a clever and rational man and he would not sell at so low a price.
The post-tax and fees sales price is considerably lower than $1400 million - and so the sale looks even more insane. The 10-Q declares that there were $50 million in selling costs associated with the asset:
Divestiture of Filler and Toxin Assets
On July 10, 2014, the Company sold all rights to Restylane®, Perlane®, Emervel®, Sculptra®, and Dysport® owned or held by the Company to Galderma for approximately $1.4 billion in cash. The assets were included primarily in the Company's Developed Markets segment. The carrying values of the assets sold, which includes $622.6 million of intangible assets, $16.1 million of inventory, and a $403.1 million allocation of goodwill, were classified within Assets held for sale in the consolidated balance sheet as of June 30, 2014. In addition, the royalty obligation on sales of Sculptra® owed to Galderma of $27.1 million was classified as a Liability held for sale in the consolidated balance sheet as of June 30, 2014. The costs to sell for this divestiture of approximately $50 million will be recognized in the third quarter of 2014. As this divestiture does not represent a strategic shift that has, or will have, a major effect on operations and financial results, a discontinued operations presentation was not appropriate"
And slide 165 of this presentation assumes that $170 million in tax will also be paid on the divestiture. The net proceeds were thus $1180 million and the implied price earnings ratio for the sale was 3.5 times.
This observation of mine caused a stir - because the guidance does not look plausible.
I guess several people have asked either analysts or the company because explanations are coming out.
JPMorgan - in a note dated 6 August 2014 gave an explanation. I quote:
Management provided additional clarity on aesthetic injectables divestment.
The EPS impact from the divestiture of Valeant’s injectable franchise has been a key point of controversy since 2Q results last week. Although the injectable franchise generated $280mm in sales in 2013, Valeant had doubled its sales force on these products in January and forecasted sales to increase to $400mm in 2014 (largely back half-weighted as the sales force ramped). Further, Valeant opted to retain much of its sales infrastructure after the divestiture and, as a result, incremental margins on 2H divested revenues were extremely high.
The key explanation - highlighted - is that Valeant opted to retain much of its sales infrastructure after the divestiture. If this is true then the earnings effect of lost sales would be particularly high.
It would be a good explanation. The only problem is that this explanation is in radical disagreement with statements by the management of Valeant.
In the press release announcing the closure of the sale (dated 10 July 2014) Michael Pearson stated:
Humberto Antunes , CEO of Galderma, has embraced our commercial team and I know he will continue our efforts to build strong relationships with the healthcare leaders in this industry.
It sure sounds like the sales force went with Galderma with the products in direct contradiction of the JPMorgan broker article.
This impression is further enhanced in by Valeant's conference call where they blame a dramatic intra-quarter fall in the sales of Facial Injectable product on the sale. To quote:
As expected, the aesthetics business deteriorated in Q2. The physicians were confused as to what products we wanted them to buy: our legacy Medicis products or our soon-to-have Allergan products. The uncertain status of our MVP Program also created concern for the doctors. Our reps and management were focused on pleasing their new owners and holding back sales until they worked for the new company, and our competitors were discounting heavily and disproportionately trying to take a temporary share to demonstrate weakness in our business.
As a result, our sales dropped approximately 40% in Q2. Fortunately, these assets are now safely in Galderma's hands, and we can now focus on the rest of our business.
You see (as per the highlighted section) the injectables sales force were holding back sales, focused on pleasing their new owners. Which of course implied they had new owners.
Galderma's management are also clear that most of the sales infrastructure went with the products to Galderma. Galderma's press release states:
At Galderma people come first. We are thrilled to take on board the experienced teams from Valeant Aesthetics and, more than ever, our intent is to preserve the quality of the long-lasting relationship built with doctors.
The JPMorgan note quoted above explicitly states that the sales force stayed with Valeant. Michael Pearson however has repeatedly stated the sales infrastructure went with the new owners.
Just for kicks I have examined many profiles on LinkedIn.com - checking the movement with functions with the asset sale. It is pretty clear - the sales infrastructure went with the asset.
Analysts make mistakes (I do regularly).
I gave an early draft of this blog post to Chris Schott, Jessica Fye, Wendy Lin and Dana Flanders (the JPMorgan analysts) and expected them to come out with an explanation consistent with the statements of Valeant and Galderma management (or for that matter consistent with easily obtained data on LinkedIn).
I will print that explanation when it is forwarded to me. But without further explanation the guidance provided by Valeant continues to make no sense. And the implication is devastating. Either Valeant is just making up its guidance numbers or they sold a growing business at under four times earnings.