Valeant Pharmaceuticals Update II

2) Valeant logo 12052016

Several large institutional shareholders have announced a reduction in their shareholdings in Valeant recently, with some exiting totally.

The latest being the highly respected Sequoia Fund, who also announced a new self imposed rule that they will not have any single investment making up >20% of the fund in future.

Other prominent shareholders who have capitulated recently include T.Rowe Price who was once the 3rd largest Valeant shareholder. They’ve sold 90% of their stake. The manager, Taymour Tamaddon, was one of the largest bulls on Valeant, having recommended Valeant since his days as a junior analyst way back in 2005. For some time he was right and looked incredibly smart. Then it unraveled.

Brahman Capital, who was one of Valeant’s largest shareholders, having held shares for 7 years, also completely exited Valeant by selling 8.12 million shares in 1Q2016.

Let’s consider this: These large institutional investors are exiting Valeant despite a latest earnings guidance for Q1 of $2.3-$2.4 billion of revenue, with earnings of $1.30-$1.55.

For the full year, the guidance is for $11-11.2 billion of revenue, with EPS of $9.50-$10.50.

Now, if we use the bottom of the range for the earnings, we’d have $9.50 EPS, and at the current share price of around $27, that’s a PE of 2.84! Which is ridiculously cheap for any company.

These institutional investors who have exited Valeant in the previous quarter would either be very right or very wrong about Valeant.

Why is the market discounting Valeant so heavily? Sure, these figures are non-GAAP. But this is the norm for most pharma companies. Many report and use non-GAAP earnings too. On top of that, the bulk of the non-GAAP vs GAAP discrepancy comes from M&A costs. As Valeant is very likely to cease any acquisitions in the short to mid term (partly because their debt does not allow for that anyway), I’d expect this discrepancy to narrow.

For these institutional investors to be right about exiting now, Valeant would likely have to miss their earnings guidance for this upcoming Q1 results. 

Valeant has just recently reaffirmed their latest guidance, which is supposed to be released before June 10th. Even if they meet just the bottom end of the earnings guidance, I believe the valuations currently are too ridiculously cheap to justify such a share price. On top of that, I continue to like companies who generate tons of cashflow. As I mentioned earlier, it takes continued catastrophes for a FCF generative business to really go south.

I’ve added to my position in Valeant in the past quarter, mostly at prices between $25-$28

This is what I see happening in the short term:

  • Valeant releases earnings report on or before June 10th
  • Earnings approximately in the middle of their guidance ($9.50-10.50)
  • Sales of non-core divisions generating modest cash to retire debt ($1bil or so)
  • Share price corrects meaningfully with the completion of the above 3 points, definitely well above the current $27.

Investing in Valeant right now is as contrarian as it gets.

It is in situations like these where the risks and rewards are the greatest.

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6 comments

  1. I blog often and I truly appreciate your content. This great article has truly peaked my interest. I am going to take a note of your site and keep checking for new information about once a week. I opted in for your RSS feed too.|

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    1. My thoughts are still the same.
      I think the mispricing is quite crazy now, and personally I’ve underestimated how extreme the sentiment can get.
      Most of the sentiment is dictated by the negative analyst reports that keeps coming out each time there’s any significant development.
      Maris and Irina are the most obvious bears. Yet, these same guys were the ones churning out “strong buy” reports when the share price was $200.
      The debt restructuring is a good thing for the company, yet the analysts are flipping it around as a way of “kicking the can down the road”, BK is certain blahblahblah.
      I wished I haven’t initiated a position that early, cos if not, I would then do so now.
      My thoughts haven’t changed a bit, they may when the data tells me otherwise, but not when some analyst decide to wake up on the right side of the bed.
      I think VRX will continue to pay down debt in 2017. Management is executing their previously stated plans thus far. from $34bil or so 5 quarters ago, the debt is now at $28.5bil after the divestures.
      Even if there are no more divestures in 2017, CF generation itself would get rid of another $1.5bil each year. And that’s taking into account LOEs and competition from generics.

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        1. Thank you for your comment.
          VRX is incredibly hard to have conviction with the daily barrage of negative sentiment out there. I try to just look at the data and ignore everything else.
          The picture will be clearer over the next 2 quarters

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