Valeant Biting More Than it Can Chew

Kanak is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

While the debate goes on whether increasing output by acquiring new businesses through mergers, acquisitions and takeovers is the right way forward, the biopharmaceutical industry continues to be marked by M&A. Valeant Pharmaceuticals (NYSE: VRX) is one such company that is known to swear by the philosophy of aggressive growth-by-acquisition. Last month, the company announced a mega-deal, the biggest acquisition yet by the company at $8.7 billion, to buy Bausch & Lomb.

Mergers, acquisitions and takeovers are not new to the industry, but can Valeant afford this acquisition?

The deal

Bausch & Lomb is a private American company and credited with the invention of soft contact lenses. It is also one of the world's largest suppliers (currently the fourth largest in the world) of eye health products, including contact lenses, lens care products, medicines and implants for eye diseases. The company operates in three segments – pharmaceutical, vision care, and surgical.

It is an all cash deal instead of a share swap transaction. Out of the $8.7 billion, Valeant will pay $4.5 billion to private equity firm Warburg Pincus, and the balance goes to retire Bausch & Lomb’s outstanding debt.

What's in it for Valeant?

On completion of the transaction, Bausch & Lomb will most likely become a part of Valeant’s ophthalmic division. The acquisition marks a major shift as the company is largely focused on dermatology. Bausch & Lomb’s EBITDA in 2013 is expected to be in the region of $720 million over revenues of approximately $3.3 billion.

With the acquisition, Valeant is evidently eyeing the growing demand in emerging markets, particularly China, and betting on its aging population and increase in the incidence of diabetes. According to Valeant’s CE Michael Pearson, the acquisition allows the company entry into China and is an opportunity for expanding its dermatology business.

Eye care is a high growth business. Valeant will now compete with Novartis’ (NYSE: NVS) Lucentis. Lucentis is used for treatment of age-related wet macular degeneration and diabetic retinopathy – vision impairment in diabetic patients. Revenue from Lucentis grew from $1.5 billion to $2.4 billion in 2012.

Regeneron (NASDAQ: REGN) also has a drug for age-wet macular degeneration, Eylea, which was approved in November 2011. In September 2012, the company got FDA approval for Eylea injection for treatment of macular edema following CRVO (central retinal vein occlusion) and is now being tested for use in diabetic macular edema. In first quarter of 2013, Eylea accounted for revenue of $314 million out of total revenue of $440 million. Riding on Eylea’s approval and another drug for metastatic colorectal cancer (Zaltrap) developed in partnership with Sanofi, Regenron has returned almost 100% to investors in one year.

The market has taken the acquisition positively, and Valeant’s stock price surged 13% on May 24, 2013 when the news of the merger surfaced, from $73 to $84.

Where is the cash?

The CEO of the company has been quoted as saying that with this acquisition Valeant will be a worldwide leader in both dermatology and eye health. The question is: at what cost?

Valeant will finance the acquisition by issuing fresh equity of between $1.5 and $2 billion. For the balance amount it will issue new debt.

Valeant’s annual revenue for the financial year ended December 2012 was $3.55 billion, and the company reported a loss of $116 million. For the quarter ended March 2013, it reported revenue of $1.07 billion and a loss of $27.53 million. Its trailing twelve month EPS is at negative $0.43.

However, what I find interesting is that Valeant’s long term debt as of December 2012 stood at above $10 billion. The Bausch & Lomb deal is not only going to dilute shareholder value but also increase Valeant’s debt by almost $7 billion.

While the acquisition will contribute to Valeant’s revenue from day one and is likely to result in an a large cost saving by 2014, it must also be kept in mind that Bausch & Lomb’s net annual income is an estimated $720 million, and the $8.7 billion valuation by Valeant represents 12 times the target company’s EBITDA.

An industry marked by mergers, acquisitions and takeovers

Biotech is a complex industry and is difficult for those who do not belong to the industry to understand it fully. Small biotech companies do a lot of hard work for discovering, improving and developing alternatives for existing drugs and new candidates for unmet medical needs, but a large number of them fail to carry their hard work to its natural conclusion and end up selling themselves to large pharmaceuticals.

Those who manage to retain their independence end up succumbing to money power. Large pharmaceuticals invest heavily in small biotech companies and manage to become the ultimate licensees in a large number of cases.


I am slightly conservative in my outlook. My concern is that Valeant is currently valued by the market at $25.88 billion, and its total long term debt will be almost $18 billion on completion of transactions relating to the Bausch & Lomb acquisition. If we turn the clock back just 15 days, Valeant was valued 13% less or $22.52 billion. In January 2013, it was 44% less than what it is now.

While $3.3 billion addition in revenue and $720 million of net income is indeed a big positive for the company, in my opinion, the market is reading too much into this acquisition, as well as that of Obagi Medical Products Inc. (April 2013) and Natur Produkt International, JSC (February 2013). In addition, we have an impending dilution of shareholder value.

I would wait for a correction in the stock price – a substantial one at that – before I think of buying Valeant.

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