Thursday, December 17, 2015

Valeant: cash EPS, GAAP EPS and various covenants

Today Valeant guided down its so-called cash EPS. You can find the press release at this link.

Lets just take the 3Q guidance as published:

Q4 2015 Revised Guidance 
  • Total Revenues previously $3.25 - $3.45 billion now $2.7 - $2.8 billion
  • Adjusted EPS* previously $4.00 - $4.20 now $2.55 -$2.65
  • Adjusted Cash Flow from Operations* previously greater than $1.0 billion, now greater than $600 million

At the low end of this range we have reduced quarterly revenue from $3.25 billion to $2.8 billion dollars. This is $425 million. [The high-end of the reduction is $750 million.]

The reduction is - at this end - $425 million on $3.25 billion of sales. The low end is thus a 13 percent revenue reduction.

Here is what Valeant said about Philidor on the October 26 call.



To quote: In Q3 2015, Philidor represented 6.8% of total Valeant revenue.

The reduction in revenue is about twice the revenue running through Philidor.

Observation 1: The revenue drop is more than just Philidor. Something else is going on. 

The bull argument to date is that Philidor is a small percentage of sales some of which will be caught elsewhere and thus can be ignored. However the drop in sales is twice Philidor (or more than twice Philidor for most points in the range). 

Second - the "adjusted EPS* drops from $4.00 - $4.20 to $2.55 -$2.65. This is a drop at the minimum end of $4.00 to $2.65 0r $1.35 per share.

There were - according to the last 10Q - 343,101,797 shares outstanding as of October 19, 2015.

So so-called cash EPS will fall by roughly $463 million at a minimum.

The fall in cash-EPS is more than double the entire revenue of Philidor.

Again something other than Philidor has been broken here.

GAAP numbers and debt covenants

Valeant tells the market about "cash EPS" - a measure that differs considerably from GAAP EPS.

The cash EPS numbers are not audited. The differences are differences you must trust the management to honestly report.

However they are not the numbers as reported in the 10-Q nor are they the numbers that are contained in the debt covenants. [See just one debt indenture at this link.]

Here is the P&L statement for the last quarter and nine months from the 10-Q.

VALEANT PHARMACEUTICALS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(All dollar amounts expressed in millions of U.S. dollars, except per share data)
(Unaudited)
Three Months Ended
September 30,
Nine Months Ended
September 30,
2015
2014
2015
2014
Revenues
Product sales
$
2,748.2

$
2,022.9

$
7,590.1

$
5,868.1

Other revenues
38.6

33.3

120.0

115.4

2,786.8

2,056.2

7,710.1

5,983.5

Expenses
Cost of goods sold (exclusive of amortization and impairments of
finite-lived intangible assets shown separately below)
634.6

545.8

1,864.9

1,619.5

Cost of other revenues
13.6

15.0

43.1

45.3

Selling, general and administrative
697.6

504.1

1,956.9

1,501.8

Research and development
101.6

59.1

238.5

186.9

Amortization and impairments of finite-lived intangible assets
679.2

393.1

1,629.8

1,113.9

Restructuring, integration and other costs
75.6

61.7

274.0

337.4

In-process research and development impairments and other charges
95.8

19.9

108.1

40.3

Acquisition-related costs
7.0

1.6

26.3

3.7

Acquisition-related contingent consideration
3.8

4.0

22.6

14.8

Other expense (income)
30.2

(232.0
)
213.2

(275.7
)
2,339.0

1,372.3

6,377.4

4,587.9

Operating income
447.8

683.9

1,332.7

1,395.6

Interest income
0.7

0.8

2.5

3.8

Interest expense
(420.2
)
(258.4
)
(1,130.7
)
(746.1
)
Loss on extinguishment of debt


(20.0
)
(93.7
)
Foreign exchange and other
(34.0
)
(53.0
)
(99.5
)
(63.0
)
Gain on investments, net

3.4


5.9

(Loss) income before (recovery of) provision for income taxes
(5.7
)
376.7

85.0

502.5

(Recovery of) provision for income taxes
(57.4
)
100.3

10.4

124.4

Net income
51.7

276.4

74.6


378.1

Less: Net income (loss) attributable to noncontrolling interest
2.2

1.0

4.4

(0.5
)
Net income attributable to Valeant Pharmaceuticals International, Inc.
$
49.5

$
275.4

$
70.2

$
378.6

Earnings per share attributable to Valeant Pharmaceuticals International, Inc.:
Basic
$
0.14

$
0.82

$
0.21

$
1.13

Diluted
$
0.14

$
0.81

$
0.20

$
1.11

Weighted-average common shares (in millions)
Basic
344.9

335.4

340.8

335.2

Diluted
351.0

341.3

347.2

341.4



Note that operating income (earnings before interest and tax) for the third quarter was $447.8 million and for the nine months was $1332.7 million.

Note that the minimum fall in so-called "cash eps" in the fourth quarter is larger than the entirety of operating income in the third quarter. This should provide some scale.

Here is the cash flow statement from the last 10-Q.

VALEANT PHARMACEUTICALS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(All dollar amounts expressed in millions of U.S. dollars)
(Unaudited)
Three Months Ended
September 30,
Nine Months Ended
September 30,
2015
2014
2015
2014
Cash Flows From Operating Activities
Net income
$
51.7

$
276.4

$
74.6

$
378.1

Adjustments to reconcile net loss (income) to net cash provided by operating activities:
Depreciation and amortization, including impairments of finite-lived intangible assets
726.4

439.3

1,768.4

1,248.1

Amortization and write-off of debt discounts and debt issuance costs
20.5

34.6

123.7

58.1

In-process research and development impairments
95.8

19.9

108.1

20.3

Acquisition accounting adjustment on inventory sold
27.2

12.4

97.7

21.9

Loss (gain) on disposal of assets, net
5.3

(254.5
)
9.2

(254.5
)
Acquisition-related contingent consideration
3.8

4.0

22.6

14.8

Allowances for losses on accounts receivable and inventories
19.6

12.0

46.4

47.6

Deferred income taxes
(91.4
)
74.6

(79.0
)
63.2

Additions (reductions) to accrued legal settlements
25.6

(0.9
)
31.9

(48.2
)
Payments of accrued legal settlements
(26.2
)
(0.2
)
(32.1
)
(1.2
)
Share-based compensation
50.5

20.2

111.4

60.6

Excess tax expense (benefits) from share-based compensation
3.9

(15.9
)
(21.7
)
(17.1
)
Foreign exchange loss
31.0

55.1

96.6

62.4

Loss on extinguishment of debt


20.0

93.7

Payment of accreted interest on contingent consideration
(7.7
)
(1.3
)
(19.8
)
(9.5
)
Other
0.2

9.7

(13.7
)
15.8

Changes in operating assets and liabilities:
Trade receivables
(347.2
)
(121.4
)
(656.0
)
(205.2
)
Inventories
(45.6
)
(41.5
)
(132.4
)
(122.8
)
Prepaid expenses and other current assets
(88.5
)
5.5

(252.0
)
34.5

Accounts payable, accrued and other liabilities
281.6

90.7

334.1

18.4

Net cash provided by operating activities
736.5

618.7

1,638.0

1,479.0

Cash Flows From Investing Activities
Acquisition of businesses, net of cash acquired
(115.8
)
(606.8
)
(14,001.7
)
(981.1
)
Acquisition of intangible assets and other assets
(0.1
)
(74.3
)
(58.1
)
(105.8
)
Purchases of property, plant and equipment
(51.1
)
(39.6
)
(163.7
)
(211.2
)
Proceeds from sales and maturities of short-term investments
32.5


50.2


Net settlement of assumed derivative contracts (Note 3)


184.6


Settlement of foreign currency forward exchange contracts


(26.3
)

Purchases of marketable securities
(24.2
)

(24.5
)

Purchase of equity method investment



(75.9
)
Proceeds from sale of assets and businesses, net of costs to sell
2.5

1,477.0

2.8

1,479.8

Decrease (increase) in restricted cash and cash equivalents


(5.2
)

Net cash (used in) provided by investing activities
(156.2
)
756.3

(14,041.9
)
105.8

Cash Flows From Financing Activities
Issuance of long-term debt, net of discount

555.0

16,925.8

963.4

Repayments of long-term debt
(29.0
)
(1,629.8
)
(1,387.2
)
(2,184.0
)
Repayments of convertible notes assumed


(3,122.8
)

Issuance of common stock, net


1,433.7


Repurchases of common shares


(50.0
)

Proceeds from exercise of stock options
7.0

3.8

29.1

10.9

Excess tax benefits from share-based compensation
(3.9
)
15.9

21.7

17.1

Payment of employee withholding tax upon vesting of share-based awards
(24.3
)
(2.0
)
(85.8
)
(38.5
)
Payments of contingent consideration
(48.4
)
(14.4
)
(129.4
)
(96.6
)
Payments of financing costs

(10.2
)
(101.7
)
(18.8
)
Other
(9.9
)
(0.4
)
(10.2
)
(14.9
)
Net cash (used in) provided by financing activities
(108.5
)
(1,082.1
)
13,523.2

(1,361.4
)
Effect of exchange rate changes on cash and cash equivalents
(9.8
)
(15.3
)
(21.9
)
(14.9
)
Net increase in cash and cash equivalents
462.0

277.6

1,097.4

208.5

Cash and cash equivalents, beginning of period
958.0

531.2

322.6

600.3

Cash and cash equivalents, end of period
$
1,420.0

$
808.8

$
1,420.0

$
808.8

Non-Cash Investing and Financing Activities
Acquisition of businesses, contingent and deferred consideration obligations at fair value
$
(108.7
)
$
(16.0
)
$
(783.3
)
$
(65.1
)
Acquisition of businesses, debt assumed
(6.1
)
(4.5
)
(3,129.2
)
(8.5
)


Depreciation and amortization, including impairments of finite-lived intangible assets was $726.4 million in the third quarter and $1,768.4 for the nine months.

In the third quarter EBITDA (defined as earnings before interest and tax and adding in depreciation and amortisation) was $447.8 + $726.4 million = $1174 million.

So so-called cash EPS will fall by roughly $463 million at a minimum.

This means that the run-rate GAAP EBITDA is $711 million or less.

Debt restrictions

Here is a debt indenture. This debt indenture places restrictions on Valeant if the debt to EBITDA ratio exceed 3.5 times. These do not cause an "event of default" but do limit Valeant's flexibility to buy back shares (they can't), incur most indebtedness or to make other investments.

Given that debt is about $30 billion and EBITDA run-rate is about $700 million per quarter there can be little question that Valeant is operating under strict loan-covenant based restrictions.

In Pearson we trust

Mike Pearson did not tell us about Philidor.

Originally Valeant stated that they did not disclose Philidor because their alternative fulfilment was a "competitive advantage". Later they declared that Philidor was not unusual - other companies used specialty pharmacies (p. 8).

Then Mike Pearson told us that the issues related to Philidor and Philidor was 6.8 percent of revenue.

Then he guided down revenue by approximately double the sales of Philidor.

Then he neglected to tell the market he was operating under covenants that restrict many of his actions. In October Bill Ackman thought that Valeant might buy-back stock at these low prices. That is not possible.

Still despite these things it is clear that most the market believes something akin to Valeant's so-called cash EPS.

The market trusts Mr Pearson for the moment.

I am a gnarly fellow however: I note the revenue fall is roughly twice Philidor - so I know that I don't know what is going on and I don't believe what I am told.

What you believe dear readers however is up to you.




John

16 comments:

Anonymous said...

Remember the covenants run off of Consolidated Adjusted EBITDA, which is allowed to include estimates around expected synergies from M&A in the last 12 mos. Salix was 4/1/15,so we have at least 2Qs of fiction left. Which is to say, they may be able to claim they're not violating those covs yet.

Anonymous said...

See Slide 18 from today's presentation. They fully explain the lower revenue. $250M in Philidor, $150M from Walgreens transition and $200M from pricing adjustments.

Selective disclosure and fear mongering isn't going to win you any fans, Johnny-boy.

http://s1.q4cdn.com/484041954/files/doc_presentations/2015/Valeant-Investor-Day-2015-Presentation-version.pdf

@bauhiniacapital said...

Nice work again John,

I noticed the Q4 forecast 'issue' immediately too. And you are choosing the most conservative look at it. My gut has been that there is going to be an inventory run-down in Q4 to 'kitchen sink' as much as they can. They won't tell you this outright if they can explain it through the $600mm number they showed on

I would note also that in 2016 guidance, the adjusted EBITDA number matches the Street's roughly $7bn number, but revenues look light vs Street and 'cash EPS' is lower than Street consensus as I see it on capIQ by some 6-7%. That means despite sharply lower margins through Walgreens Boots Alliance meaning revs drop $600mm (so EBIT drops a lot too on pro-forma basis), margins go up? I think something a bit dodgy on this but expect where they expect numbers to come through is on pure volume through WBA deal. Rifaximin (generic Xifaxan) is 5% the cost but generic not approved in US because Salix applied for IBS-D indication, means orphan drug approval for a couple of years. At which point, prices will fall 95% to generic level (Walgreen's announcement says price fall 10% to 95% for drugs through that channel to match generic). Think only way you get the 2016 guidance is through stupidly high volumes, and letting people go in 2016. But I think very tough to get revs to that level, and very tough to get EBITDA up there when margins fall sharply and GPMs already 75+%. One way to get it might be to simply cease giving money to 'charities'. Doing so would soften the hit to cash flow from lower prices.

All I can say is "we'll see." MP has probably shown for the near-term that he has 'taken the hit' in 2015, but 2016 will be fine. Main issue for VRX holders should be that IMS data will now show price falling trend because WBA channel content in that data. Means payers will want to pay less. This is a much longer-term issue and indicates existing assets are probably worth less, but I wouldn't expect a write down (there is a reason why the WBA deal is 20 years long - means auditors can't claim the drugs are worth less earlier).

Yesterday's comments on CNBC about Philidor were quite disingenuous I thought, and whole "Q&A" showed evasiveness. This AM 'better' but not great by any stretch. But I think the can has probably been kicked.

Anonymous said...

This seems a slightly biased view of earnings and the indenture - although no doubt directionally correct.

The consolidated cash flow definition in the indenture (what you are taking as EBITDA) excludes pretty much all non cash charges in net income (as well as interest and tax), which means EBITDA is likely to be considerably higher than your estimate - more like $1,385m plus potentially the stock compensation charges of $50m.

The 3.5 ratio test also only relates to incurring secured debt - I'm not sure if Valeant has secured debt it needs to refinance but it could always raised unsecured notes, and so total leverage is more of an issue depending on where EBITDA settles ($30bn-$1.4bn cash is $28.6bn over run rate EBITDA of say $1.1bn is 6.5x leverage.

Anonymous said...

What's up with Martin Shkreli?

Anonymous said...

Where you see smoke, there is fire. Looks like the big share holders are trying to keep this fire under control long enough to slowly get out with as much as possible. My personal opinion is that we are looking at a house of cards. How long can it hold up with smoke pouring out of every crack?

I put my money where my mouth is, so let's wait and see who gets burned!

Anonymous said...

"Given that debt is about $30 billion and EBITDA run-rate is about $700 million per quarter there can be little question that Valeant is operating under strict loan-covenant based restrictions."

The covenant is called the Secured Leverage Ratio - note the word "Secured". Much of the $30B of debt you cite in the sentence above is UNsecured debt, and thus does not count toward the calculation. Pretty weird that you can't even grasp such a basic point as this.

Anonymous said...

Indeed, some basic points just being missed, Worst of all, not once has John actually tried to value this. It's like he thinks $11bn of sales is worth nothing, that the Salix drug is worth nothing, that B&L is worth nothing....this is not analysis.

Anonymous said...

John,

I think you would enjoy a new challenge by applying your unique skills to icap plc.

Simple google searches will reveal the type of behavior that employees of icap are comfortable with. Try searching for fines, parties and pay attention to the wording of the ASX notices this year about the deliberate and continuing conduct (even after they knew of breaches) of the icap trading team. Linkedin searches will show the Head of Trading - Jason Howell is related to the CEO -- Brad Howell. This and many examples of bad behavior consistent with that of being over paid adolescents will be revealed as comments to your posts should you decide to take a look.

The recent sale to tullet prebon by Mr Spencer is in my opinion tantamount to admitting that he is unable to control the bad behavior and culture that has developed. Support for these comments will be made public over time.

I know there is much to be discovered about this company should you want to turn over a few rocks and given the behavior and attitudes of senior employees I'm convinced there is even more that I am yet to determine.

NB - disclaimer - I am not an ex employee, nor have I had any dealings with the company. I do have a small short position that is likely to be increased significantly pending the report of a private investigator which I engaged only recently.

Anonymous said...

Mate,

You should spend more time trying to get your long position in RR.L straightened out. Valeant deal with Walgreens/Boots is a game changer. Pearson is an innovator. You on the other hand are a blow hard talking up his book in hopes you can convince people you're smart. Fat chance.

GlobalTrader said...

John,
that's it? this was your smoking gun on the covenants? thats a pretty darn weak case to be short. same way you were wrong to talk about a $10b fine, you will be wrong to talk about these irrelevant covenants (that prevents buybacks lol)

Dan Davies said...

It's like he thinks $11bn of sales is worth nothing, that the Salix drug is worth nothing, that B&L is worth nothing.

This company has debt.

Anonymous said...

Dan, so value it. john hasn't. What are the assets worth? If you don't know that, sure, your short case might sound smart. You can say things like "it has debt" implying that the debt was taken on sport. A true analyst would value the company honestly. There's no evidence
John has done that.

John Hempton said...

I will value it. Zero.

Dan Davies said...

Here's a valuation model. $700m of EBITDA a quarter is $2800m a year. Pretend they can get away with paying no tax for ever and that maintenance capex is only $300m a year. That's $2.5bn of free cash flow.

Now let's say that the game is up for acquisition driven growth and price increases. So put it on an ex growth multiple of 11x. Enterprise value is therefore $27.5bn.

Equity value is EV minus debt, so what's the debt? Oh dear it's about $30bn. The good news is that there is limited liability so rather than minus $2.5bn the equity in that case would be worth zero.

I don't think that case is particularly pessimistic for the actual outcome for Valeant, but any outcomes worse than "ex-growth" are of interest to debt investors only because the outcome for equity value is the same.

Dan Davies said...

Note of course that my sketch valuation hasn't taken into account the possibility that it might pay a dividend before it falls apart but you really can't expect precision in blog comments.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.