Thursday, June 12, 2014

Valeant Pharmaceuticals Part III: Assessing the one-off charges from the Medicis merger

In Part II of this series I explained how to look at Valeant Pharmaceutics GAAP and non-GAAP accounts. In particular I showed how the GAAP accounts show large and increasing losses which the company asks you to look through. Instead they prefer you look at earnings disregarding large and increasing "merger and restructuring charges", "asset writedowns" and "legal settlements".

This is a reasonable thing to do if you think these charges are (a) reasonable and (b) non-repeating.

If the "one-off charges" are not really "one-off" then the "non-GAAP" earnings (presented net of these charges) are a fraud on the gullible.

This is the central point of the series. It would be dead-easy to fake "earnings after one-offs" by putting ordinary expenses in the restructuring budget. I could make margins almost as large as I liked by telling you to ignore costs. Take an extreme example: if I called marketing expenses one-off (and put them in a bucket which I ignored) my margin would look much higher. Telling you to ignore those expenses of course is a sort of con - a Wizard of Oz trick where you tell people to "ignore those expenses by behind the curtain".

The "non-GAAP" earnings presented by Valeant however are not audited. GAAP accounting does not ignore the one-off expenses. The question is whether you - as an inventor - should ignore them like management encourages you to do.

The purpose of this post is to assess whether one-off charges as booked by Valeant are reasonable.

To assess reasonableness I looked at a few mergers where the acquired company had public accounts prior to the merger. It is against those accounts and that business said merger charges arise.

I start with the Medicis Pharmaceuticals merger.

Here, from Medicis's last filed annual report on Form 10-K here is the business description:
Medicis Pharmaceutical Corporation ... together with our wholly owned subsidiaries, is a leading independent speciality pharmaceutical company focusing primarily on helping patients attain a healthy and youthful appearance and self-image through the development and marketing in the United States (“U.S.”) and Canada of products for the treatment of dermatological and aesthetic conditions.  
Also according to that form 10-K Medicis had 646 full-time employees. No employees were subject to a collective bargaining agreement, and as seems obligatory in a 10-K they believed they had good relationships with their employees. 253 employees were in sales.

Medicis was acquired by Valeant during the year following these disclosures - and the deal closed in December 2012.

The Valeant form 10-K for the year ended December 2012 gives details on the merger including the restructuring charge. Our job in this post is to assess whether those charges are reasonable.

If they are reasonable then we can accept the "non-GAAP" earnings. If they are not reasonable then the "non-GAAP EPS" is a Wizard-of-Oz style con.

Here is what the 10K says about the charges.


Medicis Acquisition-Related Cost-Rationalization and Integration Initiatives 
The complementary nature of the Company and Medicis businesses has provided an opportunity to capture significant operating synergies from reductions in sales and marketing, general and administrative expenses, and research and development. In total, we have identified approximately $275 million of cost synergies on a run rate basis that we expect to achieve by the end of 2013. This amount does not include potential revenue synergies or the potential benefits of expanding the Company corporate structure to Medicis’s operations. 
We have implemented cost-rationalization and integration initiatives to capture operating synergies and generate cost savings across the Company. These measures included: 
We estimated that we will incur total costs in the range of up to $275 million in connection with these cost-rationalization and integration initiatives, which are expected to be substantially completed by the end of 2013. $85.6 million has been incurred as of December 31, 2012. These costs include: employee termination costs payable to approximately 750 employees of the Company and Medicis who have been or will be terminated as a result of the Medicis acquisition; IPR&D termination costs related to the transfer to other parties of product-development programs that did not align with our research and development model; costs to consolidate or close facilities and relocate employees; and contract termination and lease cancellation costs. These estimates do not include a charge of $77.3 million recognized and paid in the fourth quarter of 2012 related to the acceleration of unvested stock options, restricted stock awards, and share appreciation rights for Medicis employees that was triggered by the change in control.  
See note 6 of notes to consolidated financial statements in Item 15 of this Form 10-K for detailed information summarizing the major components of costs incurred in connection with our Medicis acquisition-related initiatives through December 31, 2012.

The first thing to note is the quote that says that the costs include "employee termination costs payable to approximately 750 employees of the Company and Medicis who have been or will be terminated as a result of the Medicis acquisition".

This is a surprising number - at the last 10-K (admittedly released about nine months prior to the merger) Medicis only had 646 full time employees. The termination of 750 people looks aggressive. If the reserves for this are unreasonable the non-GAAP earnings are also unreasonable.

Providing for redundancies for 750 employees when you bought a business that only had 646 employees sounds like over-provision to me - but other people might have a different view and there were a large number of people fired. This article from the Phoenix Business Blog that 319 people were fired the day the merger closed and that they were paid two months pay in lieu of notice. Two months pay time 319 people gets nowhere near the $275 million provision in the above quote. We need to look elsewhere.

More generally we should compare the total charges disclosed or anticipated ($275 million) to the pre-acquisition balance sheet of Medicis. If for example the pre-acquisition balance sheet contained only $20 million in plant it would be unreasonable to write off $100 million. The excess write-off would create a cookie jar which could be used to fake non-GAAP earnings. Indeed that is the central allegation we are addressing.

Here is the final quarterly balance sheet for Medicis as an independent company:


Balance Sheet as of:
Q3
Sep-30-2012
Currency
USD
ASSETS
Cash And Equivalents
130.1
Short Term Investments
629.8
Total Cash & ST Investments
759.9
Accounts Receivable
145.8
Total Receivables
145.8
Inventory
34.9
Deferred Tax Assets, Curr.
73.5
Other Current Assets
54.5
Total Current Assets
1,068.6
Gross Property, Plant & Equipment
-
Accumulated Depreciation
-
Net Property, Plant & Equipment
32.5
Long-term Investments
12.8
Goodwill
202.7
Other Intangibles
452.6
Deferred Tax Assets, LT
59.0
Deferred Charges, LT
11.9
Other Long-Term Assets
23.7
Total Assets
1,863.8
LIABILITIES
Accounts Payable
77.4
Accrued Exp.
224.8
Curr. Port. of LT Debt
0.2
Curr. Income Taxes Payable
-
Unearned Revenue, Current
11.4
Other Current Liabilities
77.2
Total Current Liabilities
391.0
Long-Term Debt
594.7
Other Non-Current Liabilities
50.2
Total Liabilities
1,035.9
Common Stock
1.1
Additional Paid In Capital
851.3
Retained Earnings
571.1
Treasury Stock
(578.7)
Comprehensive Inc. and Other
(17.0)
Total Common Equity
827.8
Total Equity
827.8


The source is CapitalIQ but it checks against their last 10-Q

This balance sheet matches the final Form 10-Q for Medicis as an independent company.

Not all of these assets are subject to write-down or balance sheet adjustment on acquisition. For instance the cash and short-dated securities are almost certainly able to be converted to cash near par and hence money-good. No write-down there. It might be true that the accounts receivable are not entirely solid, but you would think they are mostly money-good, after all the customers before the merger were roughly the same people as the customers after the merger. And it doesn't make sense to write down the tax assets - after all Valeant is claiming that these are very profitable businesses after the merger - so former tax losses are probably money good.

Writing down intangibles is a wash and has no effect on Valeant's accounts. Valeant has to work out what each of the tangible assets is worth at acquisition, and using this new balance sheet and the price they acquired they deduce the goodwill to add to their own balance sheet. They could write-off some of the property plant and equipment. I guess at the same level they could provide some liabilities, eg they could have a provision for sacking staff. However the main liabilities (long term debt and the like) are not subject to much write-up either. [Looking at a balance sheet usually the debt is a solid number!]

So lets do a (im)plausibility check - lets imagine a write-off so large it is implausible (at least if the business was worth buying for $2.6 billion. Here goes:
Suppose - and this is very nasty, 
*. that half of the receiveables are bad 
*. and half of the inventory has to be written off, 
*. and the entire net property, plant and equipment needs to be written off. 
*. And further suppose they have to sack every one of the 646 full time employees and provide $200 thousand per employee (and suppose we provide this notwithstanding that the Phoenix Business Blog suggested that most those employees were paid only two months salary). That might give us the largest plausible provision. 

So the answer is $252 million which even with these extreme assumptions is not as much at the $275 million stated in the Valeant form 10-K.

The $275 million number looks like a porky to me. It sure as hell looks like the only way that you can get to that number is to dump ordinary expenses into the one-off bucket. And if you do that the "non-GAAP cash EPS" that the bulls in the company tout is rubbish.

The alternative hypothesis is that Medicis really was awful - and the receivables were bad, and the inventory did have to be written off, and the property and plant was useless because they moved all the manufacturing. And they were so efficient they got to sack 750 of their 646 staff.

Stranger things have happened in my investing travels. Maybe it is all reasonable after all.




John



Post script. Even Valeant managed to reduce the merger-charges. The 2013 form 10-K re-estimates the provision for this merger at $250 million and gives further break-up as per this paragraph:
We estimated that we will incur total costs of less than $250 million in connection with these cost-rationalization and integration initiatives, which were substantially completed by the end of 2013. However, certain costs may still be incurred in 2014. Since the acquisition date, total costs of $181.3 million (including (i) $109.2 million of restructuring expenses, (ii) $32.2 million of acquisition-related costs, which excludes $24.2 million of acquisition-related costs recognized in the fourth quarter of 2012 related to royalties to be paid to Galderma S.A. on sales of Sculptra®, and (iii) $39.9 million of integration expenses) have been incurred through December 31, 2013. The estimated costs primarily include: employee termination costs payable to approximately 750 employees of the Company and Medicis who have been terminated as a result of the Medicis Acquisition; IPR&D termination costs related to the transfer to other parties of product-development programs that did not align with our research and development model; costs to consolidate or close facilities and relocate employees; and contract termination and lease cancellation costs. These estimates do not include a charge of $77.3 million recognized and paid in the fourth quarter of 2012 related to the acceleration of unvested stock options, restricted stock awards, and share appreciation rights for Medicis employees that was triggered by the change in control.
I wonder where in the P&L the difference between 250 million and $275 million appears. Whatever, both numbers seem very large to me.

So far the buy-case for Valeant looks weak.

However this is a single acquisition, Medicis, and the main products of that company Valeant are selling to Nestle. I would like to do this more generally but as a later post shows that becomes increasingly more difficult after the Medicis merger because the one-off charges are not sufficiently broken out by acquisition.



John

PPS. Someone on twitter is saying that - like the jobs - many of the restructuring expenses to do with the Medicis merger could have taken place in the pre-Medicis Valeant. I will try to address this in future posts.

34 comments:

  1. Nice job John. Great for the younger analysts.

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  2. Yes, but your thesis is kinda falling apart at the seams.

    If GAAP earnings is kosher and legit, then logically M&A-related charges is not fudged. Hence, that is why management would want to highlight non-GAAP earnings.

    If GAAP earnings are not kosher, then logically M&A-related charges are minimised. In this case, mgmt would still prefer non-GAAP earnings if non-GAAP earnings put mgmt in a better light.

    So, at the end of the day, is GAAP earnings kosher or not?

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  3. Might could be some patent problems, specifically vs agn, with some of this garbage they're going to offload to nestle. McKinsey wins again!!!!!

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  4. hmmm…..

    Where's Andrew Fastow these days?

    http://en.wikipedia.org/wiki/Andrew_Fastow

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  5. Speaking of the Medicis & Truth in Accounting..

    https://www.bostonglobe.com/ideas/2014/06/07/the-vanished-grandeur-accounting/3zcbRBoPDNIryWyNYNMvbO/story.html

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  6. "and contract termination and lease cancellation costs"

    ?

    Maybe there's a few mil for cancelling the leases, and R&D JVs? Hard to see the full $250m there, but easy enough to see $25m. Maybe there's bank fees for debt restructuring? Maybe if there's penalty clauses etc. there might be a bit more?

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  7. John - Really appreciate the blog. When you have a moment, please elaborate on your comment: "The 2013 form 10-K re-estimates the provision for this merger at $250 million and gives further break-up as per this paragraph."

    VRX did not take such large a provisional charge (of $275mm) in Q4 '12 beyond the $85.6mm expense highlighted in note 6. Of the $85.6mm in the Q4/annual P&L, $77.98mm was paid out in cash during the period. This would only leave $7.6mm for a cookie jar (assuming none of which is paid off in subsequent quarters).

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  8. Fellow readers:

    I may presume too much in anticipating where the author's posts may lead.

    The debate here is not one of GAAP vs. less-than-GAAP accounting. We all know that both have their shortcomings when it comes to the valuation of a given security.

    Nor is it about the efficiency or future of R&D. That $VRX capitalizes R&D expenses, through M&A, that other companies would or have expensed should be fairly obvious. After all, what is $VRX buying if not previously successful R&D?

    So what is the real question?

    I would posit: let us examine the cash flow of the assets purchased, not last quarter with the genius CEO's projected synergies, but those purchased 4 and 8 quarters ago. Let us not ignore the precipitous decline in certain of those assets nor the leverage incurred to purchase those assets.

    Then and only then can we begin to discuss what multiple, if any, the equity warrants.

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  9. I have been long VRX for a while and have been quite thorough in tracking the various restructurings (how could you be long if you didn't). A couple of points from my notes around that acquisition

    -Restructuring charges were roughly $100m severance, $130m of contract terminations (leases, IT, but vast majority was exiting/ partnering R&D projects), and $50m tax, prof fees and other. (It initially surprised me how much restructuring goes towards terminating R&D projects, but I did a lot of fact checking and was convinced.)

    -Medicis had 900 employees at the time of the acquisition. The 2011 10-k employee count was actually wrong because it did not include employees from Medicis' acquisition of Graceway. Medicis confirmed this

    -Valeant let go half of the combined Valeant derm/ aesthetics and Medicis employees, which was about 750 employees. More came from the Valeant side because they liked to Medicis salesforces better

    I would argue that the transparency they provide around restructurings in both their 8-k's and in conversations with management is unparalleled. One other thing to note is that over time cash restructuring and expensed restructuring has matched very closely.

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  10. In the 10Q the estimate is 200 M of which 109,2 M employee termination cost (see table p 15 - http://www.sec.gov/Archives/edgar/data/885590/000088559014000039/valeantq12014.htm). As this restructuration is now finished the average cost per employee sacked would be 146K which will be roughly in line with the B&L average though here too doubts arise.
    The filing does mention the termination of 750 employees of the Company and Medicis as a result of the acquisition (dito for B&L).

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  11. "750 employees of the Company and Medicis" So Valeant cut employees from pre-existing employees at the company as well as Medicis employees. I don't see a problem there.

    I do agree with your point that 250-275MM in integration costs seems high.

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  12. The commentator who said that the Graceway acquisition was not included is wrong. That acquisition closed in 2011...

    http://globenewswire.com/news-release/2011/12/02/462958/239854/en/Medicis-Announces-Close-of-Graceway-Acquisition.html

    Now this is interesting because if the Medicis people (meaning Valeant) confirmed that it did not include Graceway to the anonymous commentator (as the anonymous commentator makes out) then they are telling porkies.

    But whatever.

    John

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  13. It's not true that Nestle is buying the main products. At least in 2011 the acne products drove twice the revenue of the cosmetics.

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  14. Full time employees at Dec 2010 was 679. And 646 at end of Dec 2011. So perhaps there is no employees for Graceway or the combination of the two also resulted in some form of redundancy of workforce?

    But interestingly, Medicis states that the increase in SG&A for 2011 was due to an increase in headcount.

    Also, interestingly, SG&A as a % of revenue is almost 50% in 2011. For the 9 months ended 2012, it is over 60%. In Ackman's presentation, VRX SG&A is 22% versus big pharmas of 29%.

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  15. Talking about the number of employees at Medicis prior to the acquistion by Valeant. Medicis 2010 10-K states that they had 679 employees. 2011 10-K says it's 646. Capital IQ estimates the number of Graceway employees at ~200. It looks pretty credible that Medicis' 2011 10-K failed to include Graceway employees, unless they fired all of them and then some.

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  16. Found something which you may be interested in from pg36: https://www.sec.gov/Archives/edgar/data/859368/000119312512218847/d348533d10q.htm

    "The increase in personnel costs was primarily due to an increase in headcount (excluding research and development personnel) from 561 as of March 31, 2011 to 721 as of March 31, 2012."

    So excluding R&D headcount, it is 721 employees.

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  17. The thing that bugs me a bit about "anons" $130m for exiting R&D partnerships/JVs is that partnerships of this size are the sort of thing that you announce to the market. Suppose there are $130m of cancellation fees - at most you'd commit to a couple of years of expected future expense as a cancellation fee, so this makes it a say $65mil/year expense.

    But all that said John all I think you've shown is that the numbers sound a bit toppy. Which is a distance from the substantial accounting fiddle that you're alleging.

    The other thing that gives me big pause is that Sequoia is very very long. Insanely long. And they're not dopes. To implicitly state that poppe, Goldfarb, etc are dopes - well it's a bit call. So best of luck. I will be watching this very carefully.

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  18. There are a number of others besides RUANE, CUNNIFF & GOLDFARB who has a substantial % of their stock portfolio in VRX, including SQ advisors under Lou Simpson, ValueAct (but they may be reducing).

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  19. I was just thinking about the durability of VRX's products. They claimed 85% of their revenue are durables which in their definition seems to be the product are not reliant on patents. Wonder you have any comments on that? Do you think their products are really durables like how it suppose to perform like any consumer staples business as advocated by Bill Ackman?

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  20. Brian

    The end margin selling toothbrushes is under 20% even if you have scale - see P&G. You sell at two times sales.

    $VRX is priced at 10 times historic, 8 times forward sales. If it is a consumer good company as per P&G it will trade at sub $20 a share one day. Debt is over two times sales.

    J

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  21. John, After reviewing it is really looking like you didn't do your homework on this. The most recent disclosure on restructuring costs are far lower than the originally estimated (and also conservatively estimated) $275m - actually $coming in at 183m. The $275m was never actually expensed (just "guided" do), so no way they could use the delta to juice future earnings. The $110m in actual severance expense for 750 employees seems high if it's truly 2 months of comp...but that's a dubious assumption anyway, ignoring the benefits, lawsuits, and the various termination bonuses that the more senior execs are "entitled" to. Seems entirely reasonable (even "cheap") expense relative to the headcount reduction if compared to other big restructurings in the sector

    In addition, you are evidently wrong about the Medicis employee count. Putting aside the fact that the employee counts in 10-K's are almost never "accurate" - some companies adjust for part time workers, some do not, some adjust for outside contractors, some do not, the numbers are not audited, etc - you appear to have missed the Graceway acquisition.

    In this case it looks like you are promoting a poorly researched trade

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  22. I think it's absurd to claim that if Valeant's revenue profile is the same as P&G, it should trade at the same multiple.

    "P&G trades at 2x sales so that's where Valeant should trade..." yeah, if Valeant had a 50% gross margin like P&G instead of 80%, if Valeant had a 25% effective tax rate like P&G instead of 5%, if Valeant had an inefficient capital structure like P&G instead of one optimized to produce high ROE, and if it had a ho-hum management team like P&G instead of a relentlessly shareholder oriented management team...then yes it should trade at the P&G multiple (which by the way is 3x sales, not 2x sales)

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  23. The mental gymnastics that are being used are pretty amazing. You make allegations about the quality of the accounting and then proceed to refute your argument. Wittingly or unwittingly, I don't know.

    In the post-script, you quote the Valeant filing that said that total costs of $181.3mm have been taken (relative to the original $275mm and revised $250mm).

    Then you say "I wonder where in the P&L the difference between 250 million and $275 million appears. Whatever, both numbers seem very large to me."

    So they thought the "one-time" costs would be $275mm, then they revised them down to $250mm and now they're only supposed to be $180mm. It isn't like they're bleeding out a reserve - charges are taken as costs are incurred so fewer than expected costs are being incurred and hence LOWER charges.

    Ironically enough - and this is the proper usage of ironic - your point supports a more conservative view of VRX's accounting than what you're alleging.

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  24. SEQUX appears to have sold out completely: http://www.sequoiafund.com/Reports/Quarterly/Mar14.htm

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  25. Derek Lowe on Valeant:

    http://pipeline.corante.com/archives/2014/06/12/valeants_misleading_case.php

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  26. Where do you see the SEQUX sold out? Not in that filing...

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  27. Anon above asks:

    "So, at the end of the day, is GAAP earnings kosher or not?"

    Yes - the GAAP earnings are kosher.

    It is HUGE GAAP losses.

    If you believe the GAAP earnings this company is on the path to bankruptcy.

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  28. Bluntly Anonymous asks this:

    Yes, but your thesis is kinda falling apart at the seams.

    If GAAP earnings is kosher and legit, then logically M&A-related charges is not fudged. Hence, that is why management would want to highlight non-GAAP earnings.

    If GAAP earnings are not kosher, then logically M&A-related charges are minimised. In this case, mgmt would still prefer non-GAAP earnings if non-GAAP earnings put mgmt in a better light.

    So, at the end of the day, is GAAP earnings kosher or not?


    ==

    I aruge the GAAP earnings are clearly kosher. If they are the beginning and end of the story - then Valeant is on a RAPID path to bankruptcy court. They have HUGE and INCREASING losses and 17 billion in debt.

    Management wants us to ignore the GAAP earnings. They argue some charges are one-off.

    The question is whether those charges are one-off.

    I do not think they are. Others differ.

    John

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  29. Bluntly Anonymous asks this:

    Yes, but your thesis is kinda falling apart at the seams.

    If GAAP earnings is kosher and legit, then logically M&A-related charges is not fudged. Hence, that is why management would want to highlight non-GAAP earnings.

    If GAAP earnings are not kosher, then logically M&A-related charges are minimised. In this case, mgmt would still prefer non-GAAP earnings if non-GAAP earnings put mgmt in a better light.

    So, at the end of the day, is GAAP earnings kosher or not?


    ==

    I aruge the GAAP earnings are clearly kosher. If they are the beginning and end of the story - then Valeant is on a RAPID path to bankruptcy court. They have HUGE and INCREASING losses and 17 billion in debt.

    Management wants us to ignore the GAAP earnings. They argue some charges are one-off.

    The question is whether those charges are one-off.

    I do not think they are. Others differ.

    John

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  30. employees let go from Medicis may be as low as 319 December 2012.

    The link is to a document that was dug up by a couple of different AZ journalists. This was a very big deal in AZ

    http://assets.bizjournals.com/phoenix/pdf/Medicis%20Employee%20Termination-Retention%20List.pdf

    Since Medicis closed Graceway on December 2 2011 they would have to include all employees in the 2011 10k. They don't have employee numbers in the Qs. Blogs discussing the bankruptcy buy of Graceway indicate Medicis made deep cuts in sales reps and some management at the time of the acquisition. So I would not be inclined to add 200 employees to the Medicis 10K count. If the document re: terminations is anywhere close to accurate, then VRX is overstating firings.

    BTW Medicis buying Graceway was insane and a total waste of cash. Medicis is lucky Valeant was there to bail them out. In turn Valeant got a load of rubbish in the Medicis deal. The best part of that acquisition was turning around and getting $1.4 billion for Dysport and Restalyne the only drugs Medicis had that were worth anything.

    Medicis' main money maker was Soladyn and they tried "valiantly' to create a market for useless dosages when Soladyn went ex-patent. They spent millions jury-rigging 5 mg increments for a drug that doesn't need that level of accuracy. Needless to say, Soladyn was lagging badly by their last quarter and the end was near. Not quite the derm empire we are led to believe was formed with the Medicis acquisition.

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  31. John,
    Always enjoy your blog. I can piece together 1 large bucket of restructuring. On Page 93 of the proxy they detail the golden parachute comp for the top 5 Medicis execs - see here: http://www.sec.gov/Archives/edgar/data/859368/000119312512450354/d411935ddefm14a.htm Anyhow, the total expense is $62.2mm (cash + pension / nqdc + pension / benefits); the rest probably gets swept up into the pre-close stock comp related charges. If you assume the remaining 745 people let go earn $150k per year and are given 2 months severance, this amounts to an additional $18.6mm for a total cash severance payment of $81mm (of which $62.2mm is verified and $18.6mm a guess).

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  32. P&G is growing faster than Valeant. Please don't insult P&G by comparing it to Valeant.

    P&G organic sales grew at 3% in the latest quarter - Valeant's organic sales growth was 1% in the latest quarter

    http://www.pginvestor.com/file.aspx?IID=4004124&FID=23316973

    http://ir.valeant.com/investor-relations/news-releases/news-release-details/2014/Valeant-Pharmaceuticals-Reports-First-Quarter-2014-Financial-Results/default.aspx

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  33. The author doesnt understand accounting for business combinations. You dont "write off" or impair assets when purchasing a company, you allocate purchase price. Also, there is no provision recorded in purchase accounting for restructuring charges (i.e. you didn't purchase that reserve), it is recorded after the combination.

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  34. "The author doesnt understand accounting for business combinations. You dont "write off" or impair assets when purchasing a company, you allocate purchase price."

    You write assets and liabilities up (or down) to fair value which is used to allocate purchase price. The remaining unallocated balance goes to goodwill. What you missed and the author did not miss is the future expenses can be captured in liability provisions you write up on the balance sheet as part of the purchase price allocation. These are in essence, write offs.

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