Pershing Square, led by Bill Ackman (Trades, Portfolio), recently held its earnings call. Ackman highlighted why one particular holding, Valeant Pharmaceuticals (VRX, Financial), is attractive right now.
I usually get a lot of flack for my bullish position on this fallen angel, but I am aware of its checkered past and its debt load. Please be aware it is a highly leveraged company that would probably qualify as an equity stub discussed in Greenblatt’s classic "You Can Be A Stock Market Genius." Pershing also owns board seats, which means they cannot discuss all aspects of the business freely as they may be privy to sensitive information.
Pershing’s analyst touts the sequential revenue improvements as opposed to the deterioration of revenue on a year over year basis. For what it is worth, this is a fairly important point as it is the first quarter in a long series where Valeant did not lose on a sequential basis. Pershing’s analyst made three very important points:
1. Valeant said it will still be compliant with its debt covenants even with its reduced guidance.
2. Valeant will implement a zero-based budgeting initiative that should save $150 million on an annual basis by 2020. Zero-based budgeting is a cost-saving program that other Pershing portfolio companies have successfully implemented as well. It is gaining traction with the investment community and I even own small activist targets, like Ballantyne Strong (BTN, Financial), where it is being implemented. As the $150 million per year falls straight to the bottom line, it is an important consideration.
3. Management reiterated it wants to decrease debt by $5 billion on a short-term timeframe. As I have argued before, it should preferably be done before 2018.
Ackman chimed in with a couple of very interesting comments. He said the company operates in three distinct segments:
- Durable growth companies (which include Bausch & Lomb)
- Specialty pharmaceuticals (which it calls Branded Rx)
- The diversified segment
Ackman likened the diversified segment to cigar butt assets that are near the end of the lifecycle. It is here where Valeant has been aggressive in raising prices and squeezing as much value as possible out of them before they go off patent and cash flow severely diminishes. That is a very interesting way to think about them. Currently, Valeant derives ~19% of revenue from these assets, but it will quickly fall to about ~10%.
That means Valeant’s growth rate should start to improve around 2018 merely because the headwind created by revenue from this segment falling off is dissipating.
Ackman believes the durable growth assets are worth 14x to 15x EBITDA and the specialty pharmaceuticals are worth 9x to 10x EBITDA.
Below is an overview of Valeant’s long-term debt, which is quite problematic given its EBITDA of $4.25 billion:
Source: Company filing
Pershing, which is on the board, emphasizes the asset disposition program. Ackman calls pharma an M&A-intensive industry and thinks there are multiple potential buyers for the assets, of which he believes the company will realize their fair value.
The company identified $8 billion of noncore assets it would like to sell for the right price.
Ackman also draws attention to the inbound interest (that means people called the company instead of them reaching out) for Salix. Salix is part of the assets the company regards as core, but Ackman highlights a comment on the last earnings call by the new and very impressive Valeant CFO:
"What people don't often think about is the disposition of owned assets. I'd say part of our job is to know the value of assets we own, and if we believe in an asset may be worth more in someone else's hands and they'll pay us more than what may be worth in our hands, we should sell that asset.
Here comes a bombastic statement, as I often like to do that, when someone labels an asset as strategic, it means they want to buy it and can't justify the price or they want to keep it even though someone offers them more than it's worth in their hands. In a nutshell, if someone offers us a value that exceeds, even by a little, the value of the asset in our hands, we should sell that asset. It's simple. Now let me be clear, our preference is to keep the businesses we identify as core but not at all costs. This is a requirement for us as a management team and as governed by our board that we be responsible in thinking about the value of what we own and whether we can achieve more value by selling it or by continuing to run it. I'll stop there."
Ackman then suggested thinking about Valeant as if $8 billion of noncore assets were sold, including Salix. Valeant bought Salix for $14.5 billion and bids are rumored to be a little bit lower, so say that gets us to $12 billion. That means about $20 billion of asset disposals would eliminate two-thirds of the outstanding debt. Valeant would still own its highly cash flow generative Bausch & Lomb business and dealing with two-thirds of the debt would suddenly give it a lot more runway to take care of debt with internal cash flow.
Note that Valeant bought Bausch & Lomb for about $8 billion while its current market cap is $6 billion. The slides from the latest quarterly presentation show Bausch & Lomb represents 32% of current EBITA while Branded Rx, which includes Salix, represents 48%:
However, Salix is only about half of Branded Rx revenue:
This proves Valeant would still have sizeable revenue and cash flows even if it were to sell a core asset like Salix.
If a Salix sale were to take place at a $10 billion plus valuation, just a couple of billion in additional asset sales and a little bit of growth would completely transform Valeant from an equity stub to a healthy pharmaceutical company. Growth seems a bit of a stretch given the bad year over year quarters the company has been reporting, but keep in mind Bausch & Lomb is still a segment that is showing growth and 53% of its high-growth portfolio would still be intact after a Salix sale. In addition, the quickly deteriorating segments will see their impact diminish as they decrease in size over the next year, which will have an increasingly positive impact on consolidated growth rates.
Disclosure: Author is long Valeant.
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