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This Guru Loves Valeant; Should You?

Hedge funds' final 13F forms for 2016 were published last week, and as usual, the data has been scrutinized by the financial media. There were a few surprises in the figures, including Warren Buffett ( Trades , Portfolio )'s new favorite position, Apple ( AAPL ), and the general rotation away from tech toward financials.

One position change that stands out, however, is not Buffett's move but that of Francis Chou (Trades, Portfolio). Chou's Chou Associates is a traditional value fund, and Chou is well known in the value community for his investing style.

Since inception, the Chou Associates Fund has achieved an average annual return for investors of around 12% by following Chou's value style. Before purchasing distressed securities, he asks the following questions:

  1. What would be left if the company was forced to liquidate?
  2. How competent is the management?
  3. Is the underlying business strong enough to generate consistent cash flow?
  4. Does the company have a strong enough balance sheet to make it worth the risk?

He's looking for a company with strong management that's fallen out of favor with the market, that's cheap and not going to go out of business anytime soon. With these investment criteria in mind, some might wonder why Chou Associates increased its position in struggling pharmaceutical company Valeant during the fourth quarter.

What's with Valeant?

Chou has not been a Valeant ( VRX ) supporter for long when compared to the likes of Bill Ackman (Trades, Portfolio). The fund first started buying the company in the first quarter of 2016 after the stock had more than halved in price from its $250 per share high. Chou continued to buy in the second quarter, adding 470,000 shares to his existing basket of 980,000 shares acquired during the first three months of the year. For the final quarter of 2016, Chou increased his position further by 36% or 514,000 shares. Overall, the stock now accounts for 9.4% of Chou's overall portfolio, the third-largest position after JPMorgan ( JPM ) and Berkshire Hathaway (NYSE:BRK.A).


The big question is, what should investors make of this buying by Chou? Does his buying signal there's value on offer at Valent?

Value on offer?

Interestingly, Chou is one of the only fund managers to own Valent. Jeff Ubben's ValueAct Capital and Ackman are the only other managers to own substantial positions in the firm. This either means Chou sees something most don't, or he's lost it, which is what most people tend to think when a manager takes a nonconsensus position.

Even though Chou is the only hedge fund manager buying the stock, Valent isn't as unloved as most believe. In a substantial vote of confidence for the company, management is also becoming one of the company's largest investors. Last year, while Chou was adding to his position management acquired over $5 million of stock for itself, a strong signal that it believes the company can return to health.

But even if management is optimistic about Valent's outlook, the one thing that's certain about the company is that its financials are a car crash and an accident waiting to happen. Even though the current management team has managed to lock in $2.1 billion of acquisitions, debt remains high at $30 billion. Another $8 billion of acquisitions is currently in the cards. The company is dependent upon the kindness of capital markets to keep the lights on. If creditors get spooked, there's no chance the group will be able to meet its obligations, and that's a big red flag for value investors.

Still, the company is not a total basket case. Indeed, JPMorgan analyst Chris Schott and team are expecting the group to report solid earnings figures this year, making the stock look cheap on a forward basis:

Disclosure: The author owns no stock mentioned.

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This article first appeared on GuruFocus .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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