Events: Quick Thoughts
November 7, 2015
- NYSE: VRX
- Recent PPS: $81.78
- Shares Out: 351 million
- Market Cap: $28,705
- Debt: $30,883
- Enterprise: $59,588
When I started this blog I stated up front it would not be a smooth, buttoned up operation with pristine write-ups, research and decision making. That has more than proven correct, but is particularly true at present as I sort thru the VRX situation.
I have tried to tone down how much I document my real-time thoughts via Twitter, as it can become overwhelming as a follower to have mental diarrhea dominating your stream – so I have confined a lot of my real-time thoughts of late to the Trading tab. The VRX situation is a mess, and frankly embarrassing, so it would be easy to hide my thoughts behind the Trading tab. But within reason that is the exact wrong move, IMO. So like it or not, here are my real-time thoughts on VRX after this week…
I puked. Plain and simple. The hit to returns had been limited due to reasonably good risk control; so the vast majority of the ‘puke’ was MENTAL.
Perhaps I am wrong – but after further discussion with fellow investors re biz model, the high volume annihilation to materially below $88.50 on virtually no news is greatly concerning to me.
Perhaps the ‘short’ thesis will ultimately be proven correct; but at present, the two key drivers of VRX’s stock price liquidation are 1) an extremely concentrated ‘stuckholder’ base, and 2) uncertainty around future organic growth. It appears VRX’s business model was/is legitimate, but extremely aggressive; and when taken in the context of the extreme stock price liquidation, I believe the market is ‘telling’ us something. Maybe all is well and I just missed the home run buying opportunity I’ve been looking for down here – but I suspect the market is ‘telling’ us that the revenue base needs to be materially adjusted, and the valuation work needs to move to a more extreme downside scenario…
- Forget 2016 estimates – start with 2015 sales base of $11.8B
- Take off 15% for specialty pharma and repricing of Neuro (should be 20%, but give benefit for 2016 Salix) – $10,030
- 45% EBITDAM, down from 50%+ for increased R&D, price deleverage, etc – $4,514
- PF leverage 3X: $13,541
- Required issuance: $17,342
- Shares issued ($50 PPS): 347 – 698 PF
- Intex (5%): 677
- D&A: $250
- Net Income (27% tax rate): $2,619
- EPS: $3.75
I fully acknowledge that when a long time bull on something finally capitulates, usually it is time to take a look at the capitulated asset. I also acknowledge that it would be difficult to take this valuation work seriously given that just last weekend I was talking about a simple blip in the outlook, and largely a return to status quo…
…I do not care. Everyone should take everyone’s analysis with a fat grain of salt and weave it into their own investment mosaic. I am simply outlining my current thoughts. And always helpful to keep in mind is that the information backing up a particular set of thoughts is not always appropriate to publicly disclose.
Like I said – perhaps I am dead wrong and the stock will rally hard into the next earnings report; but there are simply too many questions I cannot answer in order confidently ‘fight the tape’. Chief among them – what happens to Mike Pearson? And if he leaves, what happens to the biz model? Is the above valuation work even conservative enough?
No strategic is going to buy this pig assuming anywhere near the margins VRX currently runs with. 15 times the $4,514 EBITDA calculated above works out to a $105 stock price; 20X, $169.
Who knows – all I know is that for me to get involved again I will need a much larger margin of safety against a reasonable downside scenario.
The original post was written with the numbers off the top of my head, and I was wrong on the 2015 sales base figure of $11.8B – Company guidance is for $11.1B. Let’s adjust this 2015 base up by $500 million to account for Salix channel inventory – so $11.6B – then re-base it by 15% to account for an overly aggressive specialty pharma segment and Neuro pricing. The new sales base is then $9,860; and in order to be less aggressive on the downside, I up the EBITDAM and leverage target, as well as raise the issuance price a bit…
- EBITDA @ 50% EBITDAM: $4,930
- PF Leverage @ 4X: $19,720
- Required Issuance: $11,163
- PF Shares Out @ $70 PPS: 510 million
- Intex @ 6%: $1,183
- D&A: $250
- EPS @ 20% Tax Rate: $5.49
I believe this a bit more reasonable as a downside earnings power analysis. There are many puts and takes, with the EBITDAM the most critical, IMO. With Pearson gone, I have a tough time believing someone will come in and operate VRX anywhere close to how Pearson has thus far; as such, a 50% EBITDAM could be far too aggressive.
It is extremely difficult to zero in on the appropriate sales base given the nauseating lack of clarity from management on the specialty pharma distribution network; but I believe somewhere around $10B is a reasonable starting point given the information currently available. And while it may be too harsh, the generous EBITDAM and equity issuance price assumptions help to offset this, IMO.
At Friday’s closing PPS VRX trades for 14.9 times ‘normalized’ EPS. Were VRX under new management with a cleaned-up balance sheet and buttoned down operating strategy, the current valuation would be worth considering; but given the uncertainty, I do not believe anywhere close to a rock-solid margin of safety exists at the current quote.