Valeant: Data Vacuums, Management Credibility In Addition To Investment Value

As an investor, would y'all purchase shares inwards a fellowship that is at the pump of a political too legal firestorm? What if this fellowship has a CEO who has lost the religious belief of his board too an ex-CFO who is existence defendant of shady fiscal practices? And would y'all draw  the purchase trigger if the fellowship has delayed its scheduled annual filing past times to a greater extent than than 2 months, too past times doing thence is running the adventure of violating debt covenants too existence pushed into default? And to top it all off, would y'all live a petty worried  if the largest investor inwards the stock, a good known activist amongst his reputation too wealth on the line, is forthwith calling the shots? No way, y'all say! At the correct price, I would, too that is the ground that I decided to revisit my Valeant valuation final week, half dozen months after I valued it for the get-go time, inwards the aftermath of a crisis born of hubris too happenstance. In structuring this post, I volition depict on an old-time consulting matrix, where companies were classified into stars, cash cows, dogs too enquiry marks, to illustrate the transience of these classifications, since Valeant has cycled through the entire matrix inwards a year.

Valeant, the Star

Valeant's ascension from an obscure Canadian drug fellowship to pharmaceutical star has been good chronicled too rather than drown y'all inwards prose, I intend it is best captured inwards this picture, which shows the increment inwards marketplace position value (market cap too firm value) too operating numbers (revenues too operating income), particularly betwixt 2009 too 2015:

Source: S&P Capital IQ

During a stream when other pharmaceutical companies were struggling amongst revenue growth too turn a profit margins, Valeant outstripped them on both counts, growing revenues at almost 43% a yr piece posting higher operating turn a profit margins than the balance of the sector. At to the lowest degree on the surface, the fellowship seemed to live delivering the best of all combinations: high growth amongst high profitability.

So, how did Valeant draw of this feat? In an before post on the company, inwards Nov 2015, I argued that the Valeant line of piece of work concern model was a stool amongst 3 legs: growth from acquisitions, amongst the acquisitions funded primarily amongst debt, followed past times a strategy of increasing prices on "under priced" drugs.

The unique combination of growth too profitability made the fellowship a target for value investors, making it a favored halt for investors equally various equally Bill Ackman, the activist investor, too the Sequoia Fund, a storied usual fund, too a dominant piece of work of their portfolios. In their defense, non exclusively were these investors transparent nearly their large bets on Valeant, but at to the lowest degree until September 2015, their concentration was viewed equally a forcefulness rather than a weakness. In fact, when I posted on why diversification is a necessary constituent of fifty-fifty a value investing strategy, it was these 2 investors that were held upwards equally a counters to my argument.

To encounter the allure of Valeant to value investors, allow me cash inwards one's chips dorsum to mid-year final year, when the company's line of piece of work concern model was going strong, its stock cost was higher than $200/share too its firm value exceeded $100 billion. If the intrinsic value of a fellowship is driven past times cash flows from existing assets, value-creating growth too depression risk, Valeant looked attractive on almost every dimension:

Valeant was non exclusively delivering the value trifecta, high revenue growth inwards conjunction amongst high operating turn a profit margins too generous excess returns, but was doing thence on steroids (taking the shape of depression taxes too high debt). One annotation of caution fifty-fifty then, though, was that the line of piece of work concern model was built on an architecture of acquisitions, amongst acquisition accounting playing a large piece of work inwards pushing upwards operating profitability too lowering taxes.  If y'all were unfazed past times the acquisition accounting outcome too assumed that the fellowship could cash inwards one's chips along to deliver this combination going forward, the value per portion that y'all would accept obtained for the fellowship would accept been to a greater extent than than $200/share. 

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In estimating the value, I did lower the compounded revenue growth for Valeant to 12% for the adjacent 10 years, but that translates into revenues to a greater extent than than tripling over the decade. 

From Star to Cash Cow

While many line Valeant's autumn to September too Oct of 2015, when partly because the Salix drugs that Valeant acquired (and repriced) affected to a greater extent than people (and drew to a greater extent than complaints). The Philidor revelations pushed these concerns into hyperdrive too the stock lost almost 55% of its value inwards September too October, dropping from $180/share to $80/share.

In my Nov post, I rehashed much of this story too argued that fifty-fifty if Valeant were able to endure legal too regulatory scrutiny, the fellowship would never live able to provide to its onetime line of piece of work concern model. In effect, fifty-fifty inwards the absence of to a greater extent than bad news, Valeant would accept to live run similar other pharmaceutical companies, reliant on R&D, rather than acquisitions, for (more anemic) growth. Removing the debt-funded acquisitions too the drug repricing  from the line of piece of work concern model yielded a fellowship amongst lower revenue growth (3% a year, rather than 12%), lower margins (a pre-tax operating margin of 43.66%, instead of 49.82%) too higher taxes (with an effective taxation charge per unit of measurement of 20% replacing 16.51%).

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Note that these numbers were reflective of to a greater extent than conventional drug companies too reverberate a profitable, albeit slow-growth business. With these numbers, though, the value per portion that I obtained for Valeant was nearly $77, downwards substantially from its star status, but the marketplace position price, at $82, was higher. 

From Cash Cow to Dog?

If in that location were night clouds on the horizon for Valeant inwards Nov 2015, the months since accept exclusively made them darker for iv reasons:

1. Information blackout: In Nov 2015, when I valued Valeant, I used the most recent fiscal filings of the company, from Oct 2015,  to update my numbers. Almost half dozen months later, in that location accept been no fiscal filings since, too the 10K that was expected to live filing inwards Feb 2016 was delayed, ostensibly because the fellowship was withal gathering information, too that delay has extended into April. 
2. Managerial Double talk: In the intervening months, Valeant’s managers accept been inwards the news, almost equally frequently giving testimony to Congress, equally belongings press conferences. Arguing, as they did, that they grew through R&D similar whatever other pharmaceutical fellowship too that their revenue increases came generally from book growth (rather than cost increases) was thence much at odds amongst the facts that they became less credible amongst each iteration. Michael Pearson’s hospitalization for an undisclosed illness, but before Christmas, was something that was out of the company’s command but its treatment added to the air of opacity but about the company. 
3. Legal Jeopardy: The Philidor entanglement, the master source of the crisis, did non cash inwards one's chips away. In fact, the company, after claiming that separation from Philidor would live low-cost too piece of cake backtracked inwards Jan too Feb amongst Bill Ackman increased his interest of the company inwards a bid to save what was left of his investment inwards the fellowship too to a greater extent than importantly, his reputation equally a savvy activist investor.

With the stock trading at $32, the enquiry of whether the stock is a proficient purchase forthwith looms large. Compared to my Nov 2015 estimate, the respond is an emphatic yes, but the caveat is that a neat bargain has happened to the company’s fundamentals during the final half dozen months that could accept shifted the value downwards significantly. The job that I face, similar whatever other investor inwards Valeant, is that inwards the absence of fiscal filings, in that location are no numbers to update. The solution seems simple. Wait for the delayed filing to come upwards out inwards belatedly April, early on May or later, too work that updated data inwards my valuation. That is the low-risk option, but I intend that it is also a depression provide option, since if the filing contains proficient intelligence (that revenues accept held upwards too turn a profit margins stay healthy), the stock cost volition adapt before my valuation does. The alternative is scary, but it has a bigger payoff. I could endeavour to brand a judgment on Valeant’s value now, before the data comes out, too follow through past times buying or selling the stock. In arriving at this value, hither are some of the adjustments that I chose to make:

1. The Dark Side of Debt: The debt at Valeant has cash inwards one's chips to a greater extent than burden than a help, equally it has non exclusively triggered worries nearly covenants existence violated but has opened upwards the possibility that that the fellowship volition accept problem making its payments. In fact, Value of Valeant equally Cash Cow (November 2015)
2. Value of Valeant equally Dog (April 2016)