Valeant (VRX) reported Q3 earnings last week. The company delivered revenue of $2.22 billion and adjusted net income of $367 million. Valeant beat on revenue by $50 million, which energized bulls. However, revenue was down by 10% Y/Y. What does it mean to deliver a revenue beat when revenue is in decline? The company has been hiving assets to pare debt, which hastened the decline.
The workhorses continue to be Bausch & Lomb and Salix. Bauch & Lomb’s revenue was up 1% Y/Y, of which 6% was organic. This was pretty impressive given its critical mass of nearly $1.3 billion in revenue. Salix was up 3% Y/Y, but up 18% sequentially. Xifaxan’s 23% sequential growth carried the quarter. The segment appears to have stabilized for the near-term. However, Apriso (ucerative colitis) and Uceris tablets (mild to moderate ucerative colitis) face loss of exclusivity (“LOE). They represent about 17% of Salix’s total revenue.
Meanwhile, U.S. Diversified and Branded Rx (ex-Salix) continue to under-perform. They represent about 29% of total revenue and will likely continue to deteriorate as several of their products face LOE. Siliq and Vyzulta (expected to be launched next year) could have a tough row to hoe if they are expected to offset revenue declines from LOE. With a declining top line the question remains, “Where is the growth? The following are other key items investors should focus on going forward:
Corporate Cost Cuts
Less talked about with the Valeant story is the impact of corporate costs on EBITDA. I felt going into the quarter this was a key item and management continued to deliver. Corporate costs were $126 million, down from $132 million in Q2 and $167 million in Q1. I assumed management needed less staff to oversee operations as it got smaller via divestitures. From what I understand from the earnings call management was able forgo certain R&D initiatives associated with the divested business. Either way, the company has gotten more efficient and the gains are falling to the bottom line.
Corporate costs were 6% of revenue during the quarter and EBITDA was $926 million for a 42% margin. The EBITDA margin improved from 39% in Q2. Sans divestitures, will it be difficult for Valeant to continue to cut corporate costs and improve EBITDA at the same pace? This could be a point of contention in Q4.
The Balance Sheet
Heading into the quarter I suspected Valeant’s balance sheet, intangible assets in particular, would be a key area of focus. The CFO spent about 10 minutes on the earnings call discussing the potential impact of a hypothetical – President Trump’s proposed tax cuts – but never got around to intangibles related to Salix and Sprout. According to the company’s third quarter 10-Q Sprout has been designated as an asset held for sale and has a carrying value of $71 million; additional impairment charges could bean non-issue. The Salix reporting unit has a carrying value of $14.1 billion, an estimated fair market value of $10.3 billion and goodwill with a carrying value of $5.1 billion. Valeant does not believe the unit’s goodwill is impaired. Unless something a major event happens at Salix, such as generic versions of Uceris tablets or Apriso actually come to market, there might not be any write-downs coming down the pike.
The company reduced debt from $28.4 billion to $27.1 billion in Q2. The bigger story could be its prodigious cash flows. Through the first nine months of the year Valeant generated cash flows from operations of $1.7 billion. Management has been squeezing suppliers and collecting on receivables faster, which buoyed cash flow. From Q4 2016 to Q3 2017 accounts receivable decreased by $288 million (a source of cash) while its payables increased by $225 million (a source of cash). I expect its strong working capital management to buoy cash flow over the next few quarters also.
Despite the reduction in debt Valeant still remains highly-leveraged. Asset sales helped pair debt but it also reduced EBITDA. Its $27 billion debt load equates to 7.3x run-rate EBITDA. While management touts its debt reduction, its credit metrics still exceed 7.0x and it has increased debt from short-term creditors in the form of payables.
Of note is that Valeant also recorded a $1.7 billion income tax recovery during the quarter. Through the first nine months of year Valeant has recorded $2.8 billion income tax recoveries. From year-end to q3 2017 its deferred income tax liabilities declined by $3.2 billion. Valeant’s cumulative earnings and the reduction in this liability caused the company’s equity base to rise from $3.3 billion at year-end to $5.4 billion at Q3 2017. That’s a long-winded way of saying, “There goes my insolvency thesis!”
Conclusion
Vaeleant’s debt continues to be paid down, yet loss of earnings from divested properties and diminution in Branded Rx (ex-Salix) and U.S. Diversified continue to stymie earnings growth. The insolvency issue is off the table but headwinds from LOE remain. VRX remains a sell.
Trump And The Global Economy
The second installment of Trump And The Global Economy Town Hall took place October 24th in Fort Greene. It Featured Professor Lance Brofman, Coconut Rob (Coconut Rob Smoothies), Wuyi Jacobs (AfroBeats Radio) and Ralph Baker, author of Shock Exchange: How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead.
The event was well-received by the community. We parsed through President Trump’s proposed tax plan and [i] how it was pure economic folly and [ii] high net worth individuals could potentially game the system by shifting income around. Apparently, Kansas Coach Bill Self did this when the state of Kansas cut taxes in the past. We discussed the pros and cons of technology on workers and the economy. How will the economy and country prosper under Trump’s leadership vis-a-vis Obama? What’s behind the verbal sparring with black athletes, ESPN’s Jemele Hill and North Korea’s Kim Jong Un?
