3.17.16 | Forbes
By Steve Brozak
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It’s not often that we see the collapse of a large pharmaceutical company in real time. In Lehmanesque fashion, shares of Valeant Pharmaceuticals International, Inc. were cut in half on Monday when management, after what was already an abysmal year, revised projections drastically and seemingly changed them even during the conference call. As confidence in management dropped, so did its stock price.
Most biopharmaceutical companies have a balance of R&D and M&A. Bristol-Myers Squibb is a perfect example. Over the last several years Brisol-Myers Squibb has made a series of very smart acquisitions that yielded it a slew of immunotherapy assets like Yervoy and Opdivo. At the same time, the company developed assets internally and slimmed down in other areas that weren’t working out, divesting assets in HIV and diabetes. Unlike the standard pharma model, Valeant’s business model relied almost exclusively on a Borg-like M&A strategy, acquiring companies with approved drugs it considered undervalued, obliterating the target companies’ operations and R&D, and then raising their drug prices almost immediately. A more cynical read of Valeant’s model is that the company was actually acquiring patients and treating them as commodities–like barrels of oil or cattle.
To recap for those who haven’t been following the Valeant story, the company came under intense scrutiny last year when members of Congress began criticizing the company for its pricing practices. A major industry organization declared Valeant a pariah and banished it to the same leper colony it sent Martin Shkreli to. This all happened just as a short seller began calling attention to Valeant’s unusual relationship with Philidor, a third-party company that distributed Valeant’s drugs. Valeant revealed it had an equity interest and right to acquire Philidor. Bill Ackman, whose hedge fund Pershing Square Capital Management has a large stake in Valeant, stepped up to defend the company and his investment. Amidst all of this, the CEO of Valeant was hospitalized for pneumonia and was sidelined for months. Several marathon teleconferences and a Congressional hearing later, the CEO returned to the company and made major revisions of how he expected the company to perform in 2016. Keep in mind that during this period of time Valeant’s stock price fell from $262 a share to $31.20 on Monday. For all intents and purposes, Valeant has decompensated.
So where does Valeant go from here? It seems as if it is headed toward a workout situation out of which several different outcomes may emerge, including a de facto break up of the company. Management has several pathways, but it must make a series of decisions that give the company the greatest chance of surviving its current crisis. With $31 billion in debt and $12 billion in market cap, Valeant management must first work with creditors to amend its debt covenants to give it the time it needs to stabilize its operations. Broadcasting any such agreements to the market in a transparent manner will be critical to regaining investor confidence as management begins to transform the company. Management must also begin to consider options for selling assets to raise cash and settle as much debt as it can. If the company is in breach of debt covenants even as it is able to service its obligations, it could cost the company dearly in further equity price erosion.
Currently Valeant operates in four major segments. In 2014, Valeant experienced $3.5 billion in pharmaceutical revenues, $1.6 billion in medical device revenues, $1.2 billion in branded/generics revenues, and $1.7 billion from over the counter (OTC) product revenues. Its OTC revenues are largely derived from eye care and cosmetic products. In 2013, Valeant acquired Bausch & Lomb for $8.3 billion from private equity company Warburg Pincus LLC. Ironically, $4.2 billion of that deal was used to pay off debt owed by Bausch & Lomb. Divesting itself of its OTC business line could be a very quick route to cash. As painful as it might be for the company, it could also sell its cosmetic and device businesses, slimming down the company considerably around its specialty pharmaceutical and branded generics cores. Of course, valuing any of these assets would require the final, final 2015 numbers, which have already been negatively affected by the setbacks and distractions of the previous year.
Another option is to break the company up into several pieces from the get-go, separating the good assets from the bad assets. We’ve seen this happen many times since the financial crisis, and it could be possibility here, but it’s a tactic that would be reserved as a measure of last resort. There is the possibility that creditors will refuse to work with management, but that would be unlikely as in such a scenario debt holders would have great uncertainty and quite a bit to lose.
The best way forward is for management to bring all stakeholders to the table and work out the situation while raising the confidence of investors and creditors. Simply having investor representatives appointed to the board of Valeant isn’t enough to instill such confidence. With a lot riding on this investment (and a lot already lost), this could be Bill Ackman’s opportunity for a major comeback as he and his advisors demonstrate their financial prowess. For those who doubt Ackman, he might be down, but don’t count him out. Keep in mind Ackman made up to $2.6 billion when he and Valeant failed to take over Allergan.