Valeant’s Big Shock is Not Over as Bankruptcy Looms

Valeant Pharmaceuticals has recently taken a near-deadly blow in the financial markets. Since its peak in August 2015, Valeant’s security lost more than 87% of its value because of emerging reports from Citron Research unveiling Valeant’s unethical business and price gouging practices, and on Monday the security dropped sharply, (by more than 50%) because of announcements on possible loan default, downward revisions to its forecasted earnings figures, and recently, a $600 million typo on in a press release^{[1, 2]}.

In April of 2014, we questioned Valeant’s financial strategies, and our predictions of Valeant’s risk profile have been precise, given the recent revelations and outcomes. The biggest concern (especially for creditors), however, involves the notion that Valeant will inevitably file for bankruptcy.

Valeant: a Hedge Fund Disguised as a Biopharmaceutical Company

Valeant is not a biopharmaceutical company. Pharmaceutical companies put up a significant amount of investment in R&D in order to create a novel therapeutic. Valeant is a hedge fund in disguise that leverages M&A and drug price hiking strategies to generate a profit. 

According to the company’s 2014 10K, Valeant’s M&A strategy involves ‘milking’ medical products, as a significant number of their products have no meaningful patents or exclusivity rights, or have protections that expire in the near future.  This strategy has left Valeant vulnerable to competition from R&D organizations introducing innovative therapies and generics.

Below is a brief comparative analysis that evaluates Valeant against a typical biopharmaceutical company, such as Pfizer.

According to Table 1, Pfizer invests an average of 14.12% of its revenue in R&D compared to Valeant, which has averaged 0.67% from 2010-2014.  Moreover, Table 2 demonstrates that Pfizer is a much more profitable and stable enterprise than Valeant.

Valeant has Weak Financial Footing

Valeant’s pure focus on M&A is not a good business and financial strategy.  As outlined in our previous analysis, Figure 1 delineates that Valeant has very low operating income compared to the revenue it generates, and this profit fluctuates in a volatile fashion despite massive increases in revenue growth.  There have been significant legal and ethical concerns arising from reports^[4] suggesting that Valeant has been ‘booking’ more sales through funneling unsold products to Philidor Pharmacy (and others) in an effort to alter its financial results.

Figure 2 further illustrates that despite annual revenue growth, Valeant’s operating income ratio continues to decline.

Extreme Measures, Extreme Debt

As indicated previously, poor ethical business decision-making appears to permeate Valeant, including its inability to properly manage its ballooning debt. Figure 3 delineates that Valeant has recently taken extreme statistical measures in increasing its debt/equity ratio compared to previous quarters. 

Table 4 further demonstrates that Valeant is having trouble in its ability to pay off its debts, as Valeant’s average Quick Ratio (the ability to pay its debt if it liquidates) is 0.93.  When comparing Valeant’s Quick Ratio to Pfizer’s at 1.67, Valeant is less fit to paying its debts compared to a typical biopharmaceutical company.

It’s a Matter of Time before Valeant Goes Bankrupt

The aforementioned financial data paint a grim picture for Valeant’s financial future.  Hence, we built a financial model as to what that future can possibly look like for Valeant, and evaluated the risk for bankruptcy using a stress test*.  

Figure 4 shows that Valeant exhibits significant risks in its ability to repay its debts due to the relative volatility of the Acid Test Ratio (which evaluates debt repayment potential) compared to the changes in revenues; in other words, Valeant is susceptible to significant declines in the Acid Test Ratio with small fluctuations in revenue growth.

Moral of the Story: Poor Ethics Leads to Collapse

The biopharmaceutical industry has distanced themselves from hedge funds disguised as pharmaceutical companies. In October 2015, PhRMA condemned Valeant and Turing Pharmaceuticals by indicating, “much like Turing, Valeant Pharmaceutical’s strategy is more reflective of a hedge fund than an innovative biopharmaceutical company… Valeant isn’t merely a pharmaceutical company, but rather a ‘platform company’ that systematically makes acquisitions in order to increase its own value.” ^[

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The most unfortunate bystander of this story are the patients who suffered from price gouging.  Valeant not only faces the potential for financial collapse, but, also legal ramifications stemming from its unethical practices.

* Stress test assumes (a) M&A growth rates and activities remained constant (b) any missed opportunities in revenue were allocated towards an increase in current assets and inventories (in other words, any assets that have been acquired and were not sold remained in current assets and inventories).

References:

[1] http://www.wsj.com/articles/valeant-slashes-guidance-1458037706

[2] http://www.bloomberg.com/news/articles/2016-03-15/after-a-600-million-typo-valeant-s-ceo-is-back-on-the-hot-seat

[3] http://www.usatoday.com/story/money/2016/03/17/ackman-sells-assets-after-valeant-plunge/81900844/

[4] http://www.citronresearch.com/wp-content/uploads/2015/11/Valeant-last-word-final-a.pdf

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