Valeant Pharmaceuticals (NYSE:VRX) stock jumps after the company sold Dendreon for hefty gains.
Shares of Valeant (NYSE:VRX) jumped more than 14% in pre-market trading yesterday, after the Canadian drug maker announced its long-awaited asset sale plans. The stock later gave away some of its gains after Moody's released a report stating that the asset sales will not impact its credit rating or outlook, though Valeant's bond prices jumped by 4.5%. Valeant is a classic example of a shareholder value destroyer. Once the darling of Wall Street, the stock has lost more than 90% of its value since its peak in 2014 and is down by more 80% in the last one year. The stock has dragged portfolios of the likes of Bill Ackman and Prof. Aswath Damodaran. However, the asset sale provides a ray of hope for Valeant's shareholders.Valeant Is Still On The Brink Of Bankruptcy
While there were many reasons for the incredible value destruction, one of the main reasons was its wrong growth strategy. The company sought to grow primarily through acquisitions. This strategy resulted in the company taking on mammoth debt. As of Q3, Valeant had more than $30 billion in debt while its shareholder's equity was around $4.1 billion, resulting in a debt to equity ratio of 7.4. Such high leverage is very risky for any company, especially for those with low cash positions and negative earnings. Cash balance at the end of Q3 came in at $658 million. For perspective, the net interest expense in the quarter was $467 million and the operating loss of $860 million. The company has $800 million in debt coming up for repayment in 2017 and more than $8 billion due in 2018.
Such a high level of debt, negative growth rates and mounting losses were pushing the company to the brink of bankruptcy. Valeant's Altman Z score, one of the most reliable indicators of bankruptcy risk currently stands at 0.2. A rating below 1.81 indicates that the company is facing serious default risk. This measure has predictive value in the range of 80% -90%. With mounting losses, declining revenues and increasing bankruptcy risk, the only option for Valient is to pare down its debt through asset sales.Asset Sales A Good Begining For Valeant
The announced asset sales, while just a beginning, are a move in right direction. The planned sales of skin-care brands to L'Oreal SA for $1.3 billion and its Dendreon division to Sanpower Group Co. for $818.9 million will garner $2.1 billion for the company. While the number is still very small compared to its $30 billion debt, it is still good news. For a start, it's a move in right direction and shows the management's strong intent and ability. The repayment will also help the company abide by the covenants in the debt agreements.
Another reason to cheer this deal is the valuations Valeant was able to get for the assets. Valeant had bought Dendreon two years ago for $400 million. The sales price of $818 million shows more than 100% profit for Valeant. As for Valeant's skincare brands, the expected 2016 revenue is about $168 million. So the valuation of $1.3 billion translates to a sales multiple of ~7.7x. Many analysts were skeptical about Valeant getting a good price for its assets, as everyone knew that the drug maker was in a desperate situation. Analysts expected bidders to bargain hard. The premium valuation has proved many skeptics wrong. According to BMO’s Gary Nachman, Valeant has received “a solid price” for its assets. To quote him:
"We think that is a good price and demonstrates Valeant’s willingness to part with some core assets if the valuation makes sense. We view that as a smart business decision given the urgency for Valeant to pay down its significant $30bn debt level more aggressively…", "There is still more to go with asset sales, but we view this as a good start for Valeant."
The company plans to pay off $5 billion in next one and a half years. Valeant's CEO Mr. Papa said on CNBC that the money is going to come from asset sales as well as company's operations.
"combination of asset sales — additional asset sales of our noncore assets — plus the operation results of our company. It's the combination of both of those that we think will get us that $5 billion over the next 18 months,"
But many analysts are questioning the company's ability to pay off a significant portion of debt using its cash from operations. The problem is that assets sales, while reducing the debt, will also impact its revenues and profit. Valeant needs to maintain a balance between asset sales and retaining strong assets for its future operations. (Also read: Can Gilead Sciences Inc Turn Around Its HCV Sales?)Valeant stock Is A Risky Bet
The planned asset sales have been received well by the market, evidenced by the strong performance of company's stock and bonds in yesterday's trade. But the company still has a long way to go. The company needs to sustainably reduce its debt burden over the next few years. The stock is still not completely out of the woods. But the current attractive valuations provide an opportunity for risk seeking investors. The company is trading at a price to sales ratio of 0.57 and Forward PE of 3.15. The consensus price target for Valeant stock is $23.97 a share, representing an upside of 44%.