Valeant: Goodwill Implies Salix Valued At 22x EBITDA. In What World?

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Valeant CFO Paul Herendeen. Source: WSJ

Valeant (VRX) reports Q3 earnings on November 7th. Analysts expect eps of $0.90 per share. In my opinion, the most important items are [i] how the company can justify $16 billion in intangibles for Salix and over $1 billion intangibles for Sprout, and [ii] how much in corporate costs did it cut?

Parsing Valeant’s $34 Billion Intangible Assets

Valeant has been cutting its debt through asset sales. Such asset sales also reduce the company’s remaining EBITDA.The change in the company’s business model since the days of former CEO Mike Pearson has been well-documented. The company decided to sell assets in order to pare debt. The other option could have been to simply raise equity, yet the share price could have cratered under that scenario.

Loss of pricing power and asset sales have caused the company’s EBITDA to free fall. Since Q4 2015 Valeant’s debt has been reduced from $29.7 billion to $26.5 billion – a decline of 11%. Its run-rate EBITDA has fallen from $6.6 billion to $3.5 billion – a decline of 47%. However, its goodwill/intangibles have only declined 17% from $41.6 billion to $34.5 billion over that time frame. Under Pearson Valeant grew threw acquisitions, and the revenue and earnings momentum spurred the stock. In my opinion, the underlying math needed to justify the company’s intangibles defies logic.

In What World Is Salix Worth 22x EBITDA?

In following chart I estimate the company’s $34.5 billion in goodwill/intangibles by business segment.

  • Intangibles for Bausch & Lomb are based on the company’s purchase accounting at the time of its acquisition. $4.4 billion was allocated to goodwill. $1.6 billion was allocated to the brand and was not amortized. About $2.9 billion was allocated to intangibles to be amortized over eight to 10 years.
  • Intangibles for Salix are based on Valeant’s purchase accounting at the time of the acquisition. At the time of the deal about $11.9 billion was allocated to intangibles and $8.3 billion allocated to goodwill. $6.8 billion of intangibles was to be amortized over a weighted average of 11 years. I also understand that at October 2016 Salix’s goodwill carrying value was $5.1 billion.
  • The difference between [i] Valeant’s total intangibles and [ii] the estimated intangibles for Bausch & Lomb and Salix was allocated to U.S. Diversified and Branded Rx.
  • The EBITDA by segment was based on total EBITDA and interpolated based on the company’s allocations of EBITA.
  • Corporate costs were allocated based on each segment’s percentage of total EBITDA – Bausch & Lomb (39%), Branded Rx and U.S. Diversified (40%) and Salix (21%).

Total Goodwill/intangibles are 9.8x the company’s total run-rate EBITDA. However, Salix’s $16 billion in intangibles equate to nearly 22x EBITDA. In what world could this possibly be justified? Market chatter suggested Takeda (OTCPK:TKPHF) (OTCPK:TKPYY) might have been interested in acquiring Salix last year for $10 billion or 10x – 12x EBITDA. Had Valeant done the deal it likely would have triggered billions in asset write-offs.

Another major issue is the goodwill/intangibles the company continues to apply to Sprout. Given the low number of prescriptions sold, it is unclear whether Addyi, Sprout’s libido-boosting drug – is effective. Goodwill and intangibles associated with the Sprout acquisition were over $1.7 billion.

That said, I believe it is time for management to walk investors through the largest asset on its balance sheet, how it’s valued and why it’s justified. CEO Joe Papa promised greater transparency under his regime. It is time he delivered.

Cuts To Corporate Costs

The general consensus is that Valeant’s business has stabilized. The free fall in EBITDA has subsided and debt is being pared down as promised. Corporate costs from the above chart were $132 million. The figure was $167 million in Q1 and $157 million in Q4 2016, respectively. That implies that corporate costs fell 21% or $35 million Q/Q. Rationalizing costs is exactly what management should be doing. My guess is that Valeant might not need as much corporate overhead after divesting certain of its businesses. CEO Joe Papa and CFO John Herendeen clearly understand what levers to push in order to drive earnings and value.

Management should be commended for its efforts in making Valeant more efficient. The company has gotten major headlines for paring debt. In my opinion, its ability to cut costs and continue to management customer relationships has not gotten enough attention. Other than intangibles, this will be the one metric I look for this quarter.

Conclusion

In what world is Sprout worth $1 billion and Salix worth $16 billion? Asset impairment charges could cause Valeant to miss Q3 earnings. If management cannot walk investors through how its largest asset is valued then the stock could crater.

 

 

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