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The Current Valuation Of Valeant Indicates At Least 50% Upside
Aug. 31, 2016 9:21 AM ET|
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About: Valeant Pharmaceuticals International, Inc. (VRX)
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Summary

VRX

Medium-term growth prospects remain attractive.

Stock currently trades at discount.

Debt position appears manageable.

Leadership overstated.

Valeant Pharmaceuticals International Inc. (NYSE:VRX) has made its name through the execution of a distinctive business model that involves a combination of tax arbitrage, aggressive acquisition and rapid restructuring. VRX's business model is similar to the International Telephone and Telegraph (NYSE:ITT), the conglomerate helmed by Harold Geneen from 1950s through 1970s.

VRX too had a similar aggressive acquisition strategy like ITT and made a practice of buying disparate businesses. There was real shareholder value created by ITT's business strategy, just as real value has been created by VRX's moves.

Recently, the controversy over VRX where the company has tied up business with a pharmacy company Philidor Rx Services LLC, for the distribution of its specialty drugs. The increase in prices of branded drugs created a massive outburst among the public for which the company's share price was plummeted by 90 percent. Later, the company ended its collaboration with the pharmacy. I am hopeful that the company's value will help the company to regain its position.

Medium-term growth prospects remain attractive:

According to the report released in the last quarter of 2015 and full year 2016, the company has mentioned about sustained growth factor and the consistent cash flow generation. The company has entered a new contract with Walgreens Boots Alliance, Inc (NASDAQ:WBA). It also hinted about the probable attrition due to the discontinuation of the business with the Philidor distribution.

Recently, the company has increased investment in R&D, launching few new products. It has cancelled almost all price increases on old product brand agents. The company has invested in key functions such as financial reporting, public relations, government relations, compliance.

Source: Company financials

VRX has many new opportunities in its line. Many products do not require massive investments in expensive and lengthy trials. Examples include VRX's commitment to the launch of over a dozen new contact lens products aimed at new markets such as presbyopia and astigmatism, as well as the firm's late-stage clinical pipeline, with at least 15 branded pharmaceutical product candidates potentially slated to receive regulatory approval in the U.S. over the next 18-24 months.

Source: Company financials

VRX has become one of the fastest growing healthcare companies in the U.S. due to its investment in R&D, which has enabled it to gain approvals compared to the rest of the large cap pharmaceutical firm as measured by the number of new molecular entities (NMEs) or Biologics License Applications (BIAs) approved per each billion dollars spent on (R&D).

It is to be noted that surgical approval and contact lens approvals have not been included in the below statistics which adds to the company's success rate. VRX's success rate is due to the increased investment in R&D, compared to its competitors. The numbers below exclude product candidates that were developed by the companies VRX acquired and filed for approval prior to VRX's purchases of those companies while the numbers for all other companies in their chart include acquired brands.

Source: Company financials

Stock currently trades at a discount:

VRX's share price has been recently punished by the market relative to the shares of companies among the immediate peer group. I believe this creates an opportunity for investors, given the company's:

Increased investment in R&D. Greater investment & diversification of products. Initiation in cancelling price increases of the branded drugs.

There is always dissent on the increase in the prices of drugs, while other firms ignored this, VRX has taken the initiation with placing chain which in the long term reduces the price hike. For example, VRX recently tied up with WBA for a 20-year contract is a step towards increased investment in R&D, product innovation and commercialisation of cost effective products.

Debt position appears manageable:

The company has consistent strong cash flow generation and its debt position has few maturities in 2018 along with a probable slow rate of increase in the interest rate in the U.S. which will enable the firm in a fair position and help the firm in achieving its stated goal of reducing its EBITDA ratio to 3.5 by the end of 2016. The company's debt reduction may hold back the firm's large acquisition but the growth rate may help to increase the current share price which attributes roughly a 7x multiple on forward earnings while the firm's peer group trades at a 13x multiple. This will reduce the burden on the company's acquisition.

Leadership overstated:

In early 2016, VRX's shares were negatively impacted due to news of VRX's CEO, Mike Pearson who was hospitalised. It is to be considered that Mike's contribution to VRX is incredible but I also need to take into account the effort of the people behind this. VRX's most steadfast shareholder, the activist fund Value Act Capital personified by G. Mason Morfit, one of the two Value Act representatives on the Value Act board who were majorly responsible in the efficiency of the office of the CEO.

I think, in the absence of Mike, VRX is not leaderless. The company will continue its progress with or without Mike. I would point out to investors that Mike Pearson did establish a corporate identity at VRX that I consider creditable. Rather VRX has made clear and highly visible efforts to directly address shareholder concerns and respond proactively to setbacks.

Valuation:

The 12-month price target of $68.00 per share for VRX is driven by an earnings multiple-based approach. The mean forward 12-month earnings multiple for a universe of U.S.-based specialty pharmaceuticals and generics firms is approximately 12.5x. Applying this (with a 20% discount) to management's FY16 midpoint guidance of $6.80 EPS yields a price per share of $68.00. If investors get a position today, they can expect at least a 50% return.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.