Valeant stock plunges anew on dismal 3Q results; behold another pharma Sisyphus

geralt / Pixabay

After an already noisy year, Valeant Pharmaceuticals International Inc. (Laval Québec) once again took investors off guard–this time, on Election Day–as new management cut the annual profit forecast to well below estimates and suggested there may be more bad news on the way, according to Bloomberg.

“There could still be some surprises yet to be discovered,” CFO Paul S. Herendeen told analysts in his first quarterly earnings call since joining in August. “I’m not trying to alarm anyone or walk away from our revised guidance. I’m just letting you know that as time passes our confidence in our forecast and our guidance will improve.”

The stock plummeted 22% Tuesday to $14.98, after earlier falling to $13.77, the lowest intraday price in more than six years. The bonds also dropped: The company’s $3.25 billion of 5.875% notes coming due in May 2023 plunged to a low of 75.75 cents on the dollar earlier in the day.

@Valeant catches investors off guard--on #ElectionDay--as new management cut the #profit forecast Click To Tweet

Moody’s Investors Service promptly downgraded six of its seven ratings on Valeant, including its corporate rating and probability of default rating, by at a notch. The agency downgraded its rating on the company’s unsecured bonds one level to Caa1, a level that indicates very high credit risk.

Moody’s said Valeant’s rating outlook is negative and predicted that at least through 2017, the drugmaker’s debt will remain at least seven times as high as its earnings before taxes, interest and write-downs–an unusually high ratio, according to Yahoo Finance.

Valeant now has $30.4 billion in debt, up slightly from the start of the year and roughly three times its annual revenue.

“With higher financial leverage, Valeant will become more vulnerable to any significant operating setbacks or legal liabilities arising from government investigations,” Moody’s wrote.

Investment bank Wells Fargo advised investors to sell, warning the shares are too risky.

Valeant’s dismal results stemmed from declining sales at some of its key prescription businesses and a bleak outlook for its generic unit. Herendeen’s comments underscored the major challenges CEO Joseph Papa faces regaining confidence from shareholders who had already seen a 90% crash in the stock over 15 months, as Valeant became the focus of outrage over skyrocketing drug prices and a plethora of government investigations.

Papa, who joined in May after former executives testified before Congress and federal authorities started investigating the drugmaker, is now contemplating divesting businesses to reduce some of Valeant’s $31 billion in debt. During the conference call, he declined to provide an update on talks to sell assets such as Salix, which makes top-selling stomach and intestinal treatments.

The third-quarter net loss reached $1.22 billion after Valeant took a $1.05 billion goodwill impairment charge to write down the value of some US businesses including Salix, which has been considered one of the drugmaker’s crown jewels. Sales at Salix fell (pdf) 5.4%, while dermatology sales tumbled 50%, dragged down by lower prices and higher rebates.

Excluding the write-down and other items, profit was $1.55 a share last quarter, the company said Tuesday in a statement, missing the $1.76 average of estimates compiled by Bloomberg. Revenue dropped 11% to $2.48 billion, short of the $2.52 billion average prediction. The shortfall was mainly driven by declining prescription sales.

The company lowered its 2016 earnings guidance to $5.30 to $5.50 a share, excluding some items, from $6.60 to $7.00 previously. Analysts anticipated $6.49, on average.

“Ugly quarter, and even uglier guidance cut; not investable,” Piper Jaffray analyst David Amsellem, who rates the stock the equivalent of sell, wrote in a note to investors.

Evercore ISI analyst Umer Raffat wrote to investors that the revenue guidance indicates Valeant expects sales in the fourth quarter to decline 8% from the third quarter, to nearly $2.3 billion.

In 2017, Valeant will face both the loss of exclusivity on some of its neurology brands and stiffer competition for its generics drugs. CFO Herendeen told analysts that 2017 will be a “down year” for the generics business, sending shares of other generics makers falling.

“We will not crawl all the way out of that hole,” Herendeen said.

Papa replaced Michael Pearson, a former McKinsey & Co. consultant who jacked up share prices and scaled back on research and development. Pearson and former CFO Howard Schiller are the focus of a criminal probe against the company as authorities build a fraud case related to hidden ties to a specialty pharmacy that Valeant secretly controlled, people familiar with the matter have said.

Valeant is also facing investigations from Congress and the US Securities and Exchange Commission over its accounting and drug pricing.

Steve’s Take:

I must admit I chuckled when I heard Valeant was holding an earnings call on the morning of the most contentious US presidential election in recent memory. Now why would anyone do that? Does it perhaps contain news you want to get lost in the din of an unprecedented media circus?

If that was the strategy, Valeant’s third-quarter report still managed to disappoint investors in a serious way. Valeant stock plunged 22% as the drugmaker slashed its guidance for the rest of 2016, even with less than two months left in the year.

It’s the second time this year that Valeant has had to cut its earnings forecast. Last time it did so, in March, Valeant’s stock lost half of its value in a day. Valeant shares are down 85% this year, and 95% since their peak price in summer 2015, as accounting errors have led to a criminal investigation of its practices and its drug-price increases have come under fire with regulators.

Even with a new CEO and management team at the helm, Valeant was forced to lower its 2016 expectations again as it faces slow sales of certain products, greater competition, and new problems including a recall of irritable bowel syndrome drug Librax as well as an FDA warning about one of its manufacturing facilities.

But Valeant was not short of external excuses for the poor results, says Fortune Magazine. The company also blamed negative press, the devaluation of the Egyptian pound, and even back-to-school shopping, which the company had expected would hike sales of its dermatology products a lot more than it did.

A time comes in a possible death-spiral scenario that no matter how hard a company like Valeant tries to shake its troubled past, it is still operating amidst the aftermath of a failed business model. After years of buying up companies then raising the prices of their drugs–a strategy that rapidly augmented Valeant’s revenue and stock price–Valeant is now struggling to grow by other means, while dealing with the consequences of its previous actions. Indeed, Valeant indicated that it now expects its revenues and profits to decline further in 2017.

The real problem, though, is that Valeant can no longer rely on either of the two pillars of its former growth strategy. It can’t afford more M&A deals because it can’t take on any more debt to fund them. And it’s already in the hot seat over its drug price hikes, so it can’t raise prices much further without risking another scandal.

CEO Joe Papa has pledged to increase the price of a drug by no more than 9%, and to keep Valeant’s overall price growth rate lower than the pharmaceutical industry’s average. (Valeant’s prices have risen 2% as a whole so far this year, lower than the 2.5% increase in the Consumer Price Index, Papa said.)

That leaves Valeant in quite a different situation than it was at its peak last year. As Valeant’s share price soared in 2015, it went on an acquisition spree, spending more than $11 billion for gastrointestinal drug company Salix and then $1 billion for “female Viagra” drug Addyi a few months later, racking up more than $30 billion in debt in the process. But Valeant’s stock soon came crashing down as the company was besieged by scandals, leaving it with less brute cash and too much leverage to continue its M&A binge, even if a severely contracted one.

Compounding this downward spiral, both Salix’s business and Addyi have fallen short of Valeant’s sales expectations, and Valeant has had to swallow hard and admit that it overpaid for several of its acquisitions: Its third-quarter loss of $1.2 billion was largely due to a $1 billion goodwill write-down–translation from accounting parlance: the amount Valeant spent for those assets has far exceeded what they are currently worth. That’s the main reason why Valeant is in discussions to sell certain businesses including Salix, reportedly for less than what it paid to acquire it.

In his review of Valeant’s businesses upon joining the company, Herendeen said he found that the “units were running at an unsustainable pace,” says Fortune. The CFO said that Valeant would now consider any acquisition offer for its assets that exceeded their current value “even by a little.”

That admission is a big setback for shareholders. Both Valeant’s CEO Papa and hedge fund manager and board member Bill Ackman previously asserted that the company would not sell any of its core assets.

The obvious answer is for Valeant to fill its pipeline with drugs it creates in-house. Valeant spent $101 million on research and development in the third quarter when it “could have put that on hold,” Papa said, and used that money to pay down debt instead, or save it for other problems, perhaps legal, that Valeant may face. The company’s R&D spending was flat compared with the same period last year, though Valeant says its investments have increased 38% in the first nine months of the year over that period in 2015.

Still, Valeant is already seen as a distressed seller and is rumored to be considering letting Salix go for around $10 billion, a major discount, says Max Nisen at Bloomberg. These trends and Valeant’s woeful quarter seem unlikely to increase the company’s negotiating leverage or drive a bidding war.

If Salix is disappointing, then other parts of Valeant’s business outside of Bausch & Lomb are catastrophic. Excluding Salix, branded drug sales declined 36% from a year earlier, and sales of older treatments dropped by 16%.

Valeant already expects those losses to outweigh any growth its other units can hope to produce next year. If things continue to get worse and this guidance doesn’t hold–a real possibility, given pricing trends for the company’s products and its recent execution–Valeant may once again risk violating credit covenants. It’s negotiated looser terms from creditors twice already. Another such round will be tougher and more expensive.

So the company is stuck in a vicious cycle, trying to climb out of the hole it’s in while caught between violating its credit agreements and being forced to sell one of its few attractive assets at a discount for survival cash, thereby essentially assuring itself a growth-free future.

Steve's Take: @Valeant is stuck in a vicious cycle-sell assets, pay debt, face growth-free future Click To Tweet

One thing’s for certain. After Tuesday, Valeant won’t have the circus atmosphere and tumult of a presidential election to try to deflect investors’ attention away from some really ugly news. The attempt didn’t succeed, in any event.