It's the Truth: Valeant Pharmaceuticals' Debt Situation Is Worse Now Than a Year Ago
Until recently, shares of embattled drug developer Valeant Pharmaceuticals (NYSE: VRX) simply couldn't catch a break. The once high-flying stock that commanded a $90 billion valuation tumbled to a valuation of just $3 billion in recent months. In fact, Valeant's market cap was lower than its projected full-year EBITDA estimates , which is practically unheard of.
Valeant's three biggest issues
The company's issues are well documented.
For starters, Valeant's pricing practices have come under fire. After acquiring two cardiovascular drugs, Nitropress and Isuprel, from Marathon Pharmaceuticals in Feb. 2015, Valeant raised the price of both drugs by 525% and 212%, respectively. Regulators on Capitol Hill laid into Valeant for its practice of raising the prices of mature therapies without altering their formulation or manufacturing process. Now-former CEO J. Michael Pearson wound up admitting "mistakes" in Valeant's pricing practices during a Senate hearing, and the company has since lost much of its drug-pricing power.
Valeant's core operations are also struggling. Some of this relates to its reduced pricing power, but it's also a function of a somewhat unfavorable new drug distribution deal with Walgreens Boots Alliance . The deal heavily favors Walgreens, which means Valeant has been handed the short end of the stick. As a result, sales in its Branded Rx segment have plunged, while its steadier growth segment, Bausch & Lomb, has been inconsistent at best.
Of course, the elephant in the room is Valeant's debt, which stood at more than $32 billion at its peak. On top of increasing the price of mature therapies, Valeant's other source of growth had been debt-financed acquisitions. Valeant's lenders had no issue with debt-financed growth when its EBITDA was growing by a double-digit percentage. However, with its core operations suffering, Valeant's EBITDA is stuck in reverse.
Signs of relief?
Earlier this month, Valeant finally caught its break with the release of its first-quarter earnings results. Shares of the company have surged more than 50% from their recent lows, although they're still down 94% from their all-time highs set in the summer of 2015.
For the quarter, Valeant reported a GAAP diluted profit of $1.79 per share, which ended a streak of five consecutive quarterly losses. A $908 million one-time tax benefit played a key role in ending its streak. Also, its EBITDA forecast increased by $50 million on the top and bottom end of its previously estimated range.
In addition, it generated 4% constant currency sales growth from Bausch & Lomb. The company had previously forecast 5% to 7% sales growth in Bausch & Lomb for 2017, so this is a solid improvement after a 1% sales decline in the sequential fourth quarter.
However, what Wall Street and shareholders were really taken by was the company's efforts on the debt front. During the first quarter, Valeant sold three of its medicated skincare products to L'Oreal for $1.3 billion. It wound up taking $1.1 billion in proceeds from its sale and using it to pay down debt. Another $200 million in cash on hand and operating cash flow was utilized to reduce debt by $1.3 billion during the quarter. On a year-over-year basis, Valeant's debt has declined by more than $3 billion.
On top of paying down its debt, Valeant's management worked tirelessly to push out the maturity dates on its debt. Having more time to repay its obligations has Wall Street feeling a bit better about Valeant.
Actually, Valeant is in worse shape than a year ago
Though Wall Street cheered the quarter, and Valeant remains a pick of the Motley Fool Everlasting Portfolio , I referred to it as one of the greatest smoke-and-mirror shows you'll ever see.
A number of "positives" weren't actually as impressive if you dug below the surface. For example, the company would have lost money for a sixth-straight quarter without its one-time tax benefit. Likewise, sales of its Branded Rx segment dropped another 9%. Mind you, this is a segment that Valeant suggests will grow by 2% to 5% in 2017.
But the real issue investors should have with Valeant's first-quarter report is that its debt situation isn't getting any better. In fact, I'd argue that it's gotten worse from the previous year, even with the company's efforts to push out its maturity dates.
Here's the problem: Every time Valeant heads to the table to renegotiate terms with its secured lenders, it accepts fees and higher interest rates. This means that even though it's been chipping away at its debt pile, it's actually been digging itself into a deeper hole.
Data source: Valeant's quarterly earnings reports. Chart by author. Data in millions. of dollars.
Valeant's net interest expenses during the first quarter soared to $471 million, which was $45 million higher than what it paid in interest expenses in Q1 2016 despite having $3.5 billion more in debt. The EBITDA-to-interest coverage ratio, which describes how much EBITDA a company is generating compared to what it's paying to service its outstanding debt, dropped to just 1.83-to-1 for Valeant during the first quarter. That is dangerously low, even with the company having restructured its debt. If this ratio continues to fall, Valeant could still default on its debt, which would lead to a quicker repayment of what it owes.
Simply selling assets isn't necessarily the solution, either. Valeant made virtually no organic progress in paying down its debt in Q1 -- it relied almost entirely on its divestment to L'Oreal. Nor has the company been very successful in selling its assets. Its peers fully understand the issues it's dealing with and as such are mostly unwilling to pay a premium for Valeant's assets.
The only clear solution for Valeant is to improve its core operations in order to boost its EBITDA. But its Branded Rx segment is floundering, and the company's pricing power for mature drugs has mostly disappeared.
It's time to face the facts: Valeant's debt situation is worse now than it's ever been.
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