Valeant: Who Can Stomach Double-Digit Revenue Declines?

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Valeant (VRX) reported Q4 earnings earlier this week. The company delivered revenue of $2.163 billion and adjusted net income of $347 million. Valeant missed on revenue by $20 million. I expected VRX to melt up like it has done over the past nine months. The stock fell over 11% on the revenue. Apparently, double-digit revenue declines were hard for VRX bulls to stomach.

Total revenue fell 10% Y/Y. Bausch & Lomb and Salix – Valeant’s workhorses – saw revenue rise in the low single-digits However, revenue from Branded Rx (ex-Salix) was off 57% while revenue from U.S. Diversified fell 16%. Branded Rx (ex-Salix) was off due to lower volumes from the Ortho Dermatologics business, and the impact of divestitures, particularly from the sale of Dendreon. The decline at U.S. Diversified was due to a loss of exclusivity (“LOE”) for a basket of products.

The problem Valeant now faces is two-fold. U.S. Diversified is the company’s highest margin business. It has a segment EBITDA margin (excluding corporate allocations) of 70% versus about 37% for other segments. The more it declines the more it hurts the company’s margins. Secondly, financial engineering is great over the short-term, but management still has to prove it can offset LOE from new product launches. Single-digit revenue growth from its two anchors might not achieve the task at hand. Of note, is that Bausch & Lomb’s segment EBITDA margin was 28%, down from 32% in the year earlier period. It implies that the segment could lose pricing power as it attempt to attain new business.

Corporate Cost Cuts

Valeant has done a yeoman’s job of cutting corporate overhead costs. Management has also been able to forgo expensive R&D projects related to divested assets; this has represented a side benefit of asset sales. Corporate allocations declined 25% from $157 million in Q4 2016 to $117 million in Q4 2016. However, Q/Q allocations only fell by 7% while segment EBITDA was off 14%. Valeant may need to maintain its current corporate overhead to run its portfolio of businesses even while LOE kicks in and Bausch & Lomb’s margins erode. This could be a drag on EBITDA.

Credit Quality

Over the past year Valeant reduced its debt load by $4.1 billion to $27.8 billion. VRX bulls have been energized that the company will survive. However, its debt/run-rate EBITDA deteriorated from 7.5x at Q4 2016 to 7.9x at Q4 2017. While debt fell by 14% Y/Y quarterly EBITDA was off by 20%. Valeant remains highly-leveraged and it could draw the attention of the rating agencies. Debt maturities have been pushed out for a few years, yet a potential debt downgrade could create negative sentiment for the stock.

Conclusion

Double-digit revenue declines could be difficult to stomach going forward. VRX trades at nearly 10x run-rate EBITDA. Until the company can grow revenue and earnings VRX remains a sell.

Mr. Coleman is best known for his role as fan-favorite ‘Tyreese’ in one of the most popular cable series of all time, the Golden Globe® nominated series “The Walking Dead” ‘and as the reformed criminal “Dennis ‘Cutty’ Wise” in Emmy® award nominated HBO drama series “The Wire.” Coleman currently stars in the highly- new, hour-long FOX comedy series, “The Orville” playing the role of ‘Klyden.’ Created, executive produced, and starring Seth MacFarlane (“Family Guy”) and directed by Jon Favreau (IRON MAD, THE JUNGLE BOOK), the comedic science fiction series set 300 years in the future and follows the adventures of the U.S.S. Orville, a not-so-top-of-the-line exploratory ship in Earth’s interstellar fleet. The first season premiered on September 10th on FOX and has been picked up for a second season. ‘

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