Tuesday, August 5, 2014

Valeant Pharmaceuticals Part IX: A comment on the sale of the facial injectables business

Valeant missed analyst projections of revenue and guided down their so-called "cash EPS". Regular readers know that I don't hold much regard for Valeant's non-GAAP numbers (such as cash EPS) but for the moment lets consider them.

Valeant provided the following slide reconciling previous guidance to their new lower guidance. [The slide is number 28 in this linked document.]

Valeant announced the sale of the Facial Injectables (to Galderma) on 28 May 2014 - and according to the conference call the deal closed on 10 July.

To quote the conference call:

This past May, we announced that we were selling our injectable products to Galderma. By selling these assets early, we were able to clear the major FTC hurdle towards the June regulatory approval for Allergan and realize the full value for these products. 
We closed the sale to Galderma on July 10. The $1.4 billion raised by this transaction will be used for Allergan -- for the Allergan transaction and/or other future business development opportunities.
Now according to the above table not owning the Facial Injectables business from July 10 to December 31 (ie for 174 days) will reduce annual revenue by $230 million and reduce cash EPS by 50c per share.

There are approximately 341.3 million diluted shares outstanding (as per the 10Q) so 50c per share is 170.65 million.

The implied margin after tax and all expenses for the injectable business is thus 170.65 million on the $230 million of revenue forgone - or 74.2 percent. If you allow that the business has a three percent tax rate (which is the rate that Valeant claims more generally) the margin on the business pre-tax is 76.5 percent.

There are other things you can work out. 230 million drop in revenue comes from not owning the business for 174 days of the year. If we assume no seasonality then the annual revenue of the business is = 230*365/174 = 482.4 million. And given the post tax margin is 74.2 percent the annualized forgone earnings are $358 million.*

Valeant sold this business for $1400 million - so the apparent PE ratio of the sale was - 3.9 times.

This is a very simple calculation from the guidance slide. Nestle/Galderma it seems have got a bargain. A true bargain - a business with sales growth, extraordinary margins and an unlevered price earnings ratio below four.

There is an implication here: Michael Pearson - the CEO of Valeant - let the business go for a startlingly cheap price.

That implication is clearly wrong. Michael Pearson is according to the people who know him - incandescently brilliant and in the conference call he stated that they were - and I am quoting again - able to "realize the full value for these products".

The alternative implication: the guidance slide is wrong.

I know I have put together presentations quickly - and mistakes do creep into them.

I bring this to public attention - and I await an amended corporate guidance. I will publish it when it comes.


*The way I have annualized this was roughly confirmed in the conference call. Howard Schiller - the CFO stated: "[Valeant] had built into our previous guidance $230 million of revenue and $0.50 per share cash EPS for the second half of the year." If we assume these numbers relate to only six months as per the call Valeant sold the business at 3.1 times earnings. Clearly silly. Something is wrong here.


Anonymous said...

I looked to the Organic Growth Table in the earnings press release (Table 6 in the press release) in order to determine the true revenue impact of the Injectables sales.

You can see there that in Q2 2014 "Same Store Injectables" sales were $46.8mm. The sale of the assets closed after the end of Q2, so this does give a full quarter's worth of revenue.

If you straight-line annualize that, then you get to annual Injectables revenue of $187.2mm (46.8 * 4).

That's significantly lower than the number you come to ($230mm) by using their guidance reduction slide.

I believe that my way of doing it should be correct because it uses actual numbers, and not their estimates for the rest of the year (and they would have incentive to inflate the revenue estimate for the Injectables, as it would make the reduced guidance SOLELY a result of this sale, when it may be for other reasons as well).

It's possible that it's not correct to annualize on a straight-line, but you did so also, and we arrive at significantly different numbers, so I don't think that can be the problem.

The other possibility is that the business will continue to grow throughout the year and the Injectables business will actually produce $230mm in revenue for the year.

I don't know if that is true either though: look at "Same Store Injectable" revenues for last year, Q2 2013. Sales in Q2 2013 were $80.5mm. I believe this should be apples to apples, as the Injectable assets were acquired from Medicis and so they were owned during Q2 2013 as well as the entire Q2 2014.

Did sales really decline by almost half for these assets? If so, and if annualized sales are more like $187mm, then it would seem curious for Galderma to pay $1.4bn.

Which leaves me confused. It's possibile that some number is being 'massaged' somewhere, either in the organic growth tables, or in the guidance presentation. I don't know the answer.

Dom said...

Very good analysis. One thought from my side: cash EPS excl D&A so margins calculated on that basis look higher. So i guess we need to see how high D&A is at the facial injectable business. Can't imagine them being that high. Something smells funny for sure. ..Allergan did their own analysis. Also an interesting read. Seems the annualised sales number for this business is also inflated.

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