Valeant: Perfect Time For An Equity Raise?

Debt Financings Have Not Improved Credit Metrics …

Valeant has engaged in what I what describe as financial engineering over the past year. It has hived off non-core assets to pare debt. In doing so, had to forgo the revenue and earnings from divested assets. While debt has been reduced, there is no evidence the company’s credit metrics have improved. Earlier this month the company priced a $2.0 billion senior note offering at 9.000% due 2025. The net proceeds will be used to repurchase $2.0 billion of notes due 2020 with interest rates ranging from 5.375% to 7.000%. Valeant will incur higher interest costs, but the offering pushed back principal payments from 2020 to 2025.

The offering gives the company more breathing room to turn things around. It also gives day traders an opportunity to speculate in the shares. At the end of the day, Valeant remains highly-indebted despite constant press releases of asset sales and debt refinancings. The company’s debt load has declined from $30.4 billion at Q3 2016 to $26.2 billion at Q3 2017. However, its debt/run-rate EBITDA was 7.2x at Q3 2016 versus 7.1x at Q3 2017. The company has engaged in a lot of activity for a seemingly uncertain benefit.

… But They Have Spiked The Stock

A few weeks ago Valeant filed an application to raise capital with the securities regulator in Quebec. That additional capital could take the form of debt, public or private equity. Valeant also reserves the right not to provide updates on its financing plans until such financing has been made. Said another way, Valeant could dilute shareholders via an equity raise without warning. The filing stoked fears of an equity raise, and in my opinion, longs had a reason to be concerned.

I have always been of the opinion that asset sales were designed to induce short-covering and spike the share price. Once the stock got to an acceptable range like $25 to $30 per share, I expected management to issue an equity raise in order to improve its credit metrics:

Management says other than the assets currently on the block that there will be no new asset sales. Who didn’t see that coming? VRX thought they could [i] spike the shares up to $25-$30 on asset sales and 85 press releases per month and [ii] then issue an equity raise at an inflated price. Now that the ruse didn’t worth they are stuck.

Now commenters on my previous article are now arguing the merits and potential pitfalls of an equity raise after the recent spike in the shares:

Commenter 1: If Valeant hit $25 per share, would it make sense to pay down $5 billion in debt by doing a secondary offering of 200 million shares? You would dilute current shareholders by about 2/3, I think. But you would also bring down debt to about $21 billion, which is a little more than the optimal debt range of $15 billion to $20 billion that Herendeen has been suggesting. What would be the net effect for the company and the share price?

Commenter 2: No …they don’t need to issue equity! VRX will earn $1.5 billion of free cash flow to equity holders (i.e. after interest) next year. At $25/share that is a 17% yield on the equity. Issuing equity is much more expensive than the 9% unsecured bond they just issued.They can pay down their obligations through until 2021 at least, so just have patience while the financial leverage works in our favor.

It could behoove Valeant to strike while the iron is hot. Any other potential catalysts could be muted by other events. The launch of glaucoma treatment Vyzulta next year could be muted by the continued loss of exclusivity on older drugs. The Allergan insider trading case could result in legal fees, a disgorgement of profits from Ackman’s Allergan trade (about $390 million) or more negative publicity. In my opinion this could be a major headwind next month and for several months thereafter.

Conclusion

If Valeant does not raise equity now it could be a missed opportunity to use its inflated stock to pare debt. VRX remains a sell as short-covering wanes or due to a potential dilutive event.