Valeant Pharmaceuticals Intl Inc (NYSE:VRX), Ackman and the Nature of Impermanence

One name dominates pharmaceutical media right now, and it’s Valeant Pharmaceuticals Intl Inc (NYSE:VRX). Well, more accurately, two names – Valeant and Ackman. The latter just reported a 25% Q1 loss on the publicly traded side of Pershing Square, Pershing Square Holdings Ltd (AMS:PSH). The former is down more than 90% on its 2015 highs. Neither have gone a day in the last few months without drawing some level of media attention, and this trend looks set to continue (and intensify) near term.

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There’s an inherent problem with situations like this attracting widespread, mainstream attention, however. Eighteen months ago, mention the name Valeant to pretty much any individual without some sort of interest, professional or personal, in the pharmaceutical space, and chances are they wouldn’t recognize the name. Never mind its industry, its roster of institutional investors and its operational strategy. Fast forward to the present day, and mainstream media coverage has afforded pretty much everyone the opportunity to learn just enough to weigh in with an opinion.

As value investor Bill Miller stated recently, Valeant is the most toxic name in the markets right now.

There’s a knowledge gap that exists, one rooted in depth of information. On one side, there are those with a superficial, media inspired knowledge of what Valeant has done wrong, and why this is bad for the company. On the other, there are those that will discount the current toxicity as impermanent, and form a valuation based on Valeant’s underlying business.

There may be an opportunity in this knowledge gap.

Let’s take the side of the latter, and consider Valeant’s fundamentals. It’s got some heavy debt ($31 billion at last count), but 80% of this derives from two acquisitions – Bausch and Lomb and Salix. Through the sale of these businesses, Valeant could unload 80%, with very little work, of its debt. Debt is being touted as one of the major bearish factors right now, but it really shouldn’t be.

The company has cash on hand just shy of $600 million, and total current assets of $5.5 billion. Total assets (which includes the value of its portfolio of IP) come in at near $50 billion. Yes, $31 billion of this is offset by debt on the other side of its balance sheet, but the company is cash flow positive. Why is this important? Because while it may not be able to generate revenues to the level it has done as late (based in the fact that it’s going to have to do some discounting on its product sales), positive cash flow allows it to service its debt going forward – albeit with a little bit more difficulty than it might have been able to previously.

The company’s current market capitalization is $8.5 billion. It’s trading at a forward PE of just 2.38. TTM PS comes in at 0.87. Valeant lost nearly 7% on Thursday as the NYT reported a few hospitals have said the company didn’t meet its promise to discount drugs. Yes, the company should be honoring its promises, and yes, it’s probably a slip up to let this sort of thing hit press at a time when your name is, to use the word again, toxic. This level of decline on a mainstream news report seems disproportionate, however. In turn, this disproportion serves to confirm the knowledge gap alluded to above.

The point here is that Valeant’s portfolio of IP, its underlying operations and its current tangible (excluding financial) assets are worth far more than its current market valuation. We’ve already mentioned him, but Miller is a value investor, and to steal his phrase from this interview, his fund is now “full up” on Valeant stock. He recognizes this latter stated fact.

Many will point to the opinions of Buffet and Munger, arguably the world’s best known value investors, as contrary to that of Miller. Yes, they have for a long time vocally denounced Valeant’s business practices, but this does not mean they don’t believe there is value in the stock. In fact, in the spirit of Buffet’s greedy when fearful, now looks like the perfect time to pick up an exposure. If not for its current public standing – toxicity doesn’t fit well with Buffet’s portfolio of family, forever brands – Valeant wouldn’t look amiss amongst the latter’s holdings.

The only thing that is certain is that negative sentiment of this magnitude won’t last forever. People move on, as new targets present. The question is, how long can Valeant weather the storm? If it can stop the flow of seemingly avoidable public facing mistakes – the hospital discount piece being just one in a string of recent examples – people will probably forget about the company by this time next year. If and when that happens, it can rebuild. We probably won’t see $200 a share realized any time soon, but if it doesn’t go bankrupt first, mid double digit billions in market cap seems far from unreasonable.

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