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Valeant Hit With Downgrade Warning By S&P Which Sees "Reputational, Legal, And Regulatory Risks"

Tyler Durden's picture




 

While the negative hits to Valeant over the past month have occurred in the equity space, slamming its stock by 50% in the past month, the biggest threat may not be in the equity space at all, but from the bond market.

As a reminder, Valeant - because it is a debt-funded equity rollup - has debt. Lots of debt: over $30 billion at last check on more than 5x less EBITDA. It is also a junk rated company, in fact it is the third largest junk-bond issuer with over $18 billion in sub investment grade securities outstanding.

As such, far more than its debtless biotech peers, it is that much more sensitive to how the market views not only its equity prospects, but also its debt. And, as we first pointed out a month ago, judging by its CDS, the market was getting very concerned even before the recent revelations involving Philidor.

Since then it has only gotten worse, and currently, VRX' CDS is trading at a spread of 650bps, implying a 43% probability of default.

 

Moments ago, the BB- rated Valeant debt "story" went from bad to worse, when S&P just revised its outlook to negative citing "Risks To Growth" adding that its "negative rating outlook reflects risks to our base case expectation that Valeant can sustainably grow revenue and EBITDA, given the potential reputational, legal, and regulatory risks the company is facing."

And now that there is an incremental risk of another downgrade, ostensibly pushing Valeant into the single B category, it will make it that much more complicated for Valeant to pursue its rollups strategy.

In fact, just like Glencore, the upcoming downgrade from S&P now means that the next strategic move from Valeant will not be an acquisition, but most likely some deleveraging divestment to shore up capital, because if and when the downgrade series begins, the company's debt funding pathway will be promptly closed, leaving only suddenly very risky cash flow as a source of capital.

* * *

Full S&P warning below:

Valeant Pharmaceuticals International Inc. Outlook Revised To Negative On Risks To Growth

  • Valeant Pharmaceuticals International Inc. disclosed more details about  its financial relationship with specialty pharmacy network Philidor RX Services. Valeant has also announced another change to elements of its strategy, and does not plan to divest its Neuro business in the near term or to permanently slow its pace of acquisitions. This is the second announced strategic change in two weeks.
  • We view the Philidor relationship and marketing strategy as unconventional and very aggressive, and we expect payers  to increasingly
    push back on reimbursement, potentially reducing the viability of this channel.
  • In our view, the negative attention the company has attracted due to drug price increases and its aggressive marketing tactic increase potential legal, regulatory, and reputational risks to the company.
  • We continue to view the recent market speculation about channel stuffing and accounting fraud as unfounded.
  • We are revising our rating outlook to negative from stable and are affirming our 'BB-' corporate credit rating.
  • The negative outlook reflects heightened uncertainty relating to the financial impact from reputational, legal, and regulatory risks associated with the company's aggressive marketing and drug pricing strategies, as well as potential legal and credibility issues stemming from the lack of earlier disclosure about its relationship with Philador.

 
NEW YORK (Standard & Poor's) Oct. 27, 2015--Standard & Poor's Ratings Services affirmed its ratings on Valeant Pharmaceuticals International Inc., including its 'BB-' corporate credit rating, and revised the rating outlook to negative.

"The negative rating outlook follows Valeant's increased disclosure about its financial and operating relationship with Philidor, a network of specialty pharmacies that distributes some of its products. Valeant said this channel represents 5.9% of revenues for the first nine months of 2015, and 6.8% of third-quarter revenues," said credit analyst David Kaplan. "We estimate this channel represents a higher proportion of the U.S. Branded segment's script volumes than revenues (as cash pay products are reimbursed at lower levels, or unreimbursed in this channel, as part of patient assistance programs to increase access). As such, we estimate that this strategy likely had a meaningful impact on Valeant's reported volume growth rates on a year-to-date basis."

Our negative rating outlook reflects risks to our base case expectation that Valeant can sustainably grow revenue and EBITDA, given the potential reputational, legal, and regulatory risks the company is facing. Our base case expectations also incorporate our view that the company will manage its acquisition-driven growth strategy such that leverage will decline to 4x-5x (after adjusting for acquired EBITDA).

We could lower our rating if Valeant increases the pace of acquisitions, or experiences material operational headwinds, such that we expect adjusted leverage to be sustained materially above 5x. We could also lower our rating if we believe that ongoing investigations are likely to imperil the company's ability to maintain organic revenue growth and strong levels of cash flow, which could indicate more serious issues surrounding the sustainability of the businesses.

We could revise the outlook to stable if we gain more confidence that ongoing investigations are unlikely to harm Valeant's business. Under this scenario, we would expect to have greater confidence that the company would maintain adjusted debt leverage of about 5x or lower, consistent with historical levels.

 

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Tue, 10/27/2015 - 13:10 | 6717229 Hitlery_4_Dictator
Hitlery_4_Dictator's picture

Sorry but the S&P in no longer relavent. 

Tue, 10/27/2015 - 14:21 | 6717535 walküre
walküre's picture

With a P/E of 64 this stock is clearly undervalued.

Buy, buy, buy!

Tue, 10/27/2015 - 13:12 | 6717237 ZoroAustrian
ZoroAustrian's picture

Seriously.  More brilliant after-the-fact analysis from Wall Street.  I trust they are sufficiently renumerated in order that the talent be retained.

Tue, 10/27/2015 - 13:17 | 6717248 FlacoGee
FlacoGee's picture

Quote, " We continue to view the recent market speculation about channel stuffing and accounting fraud as unfounded.

 

 

Tue, 10/27/2015 - 13:54 | 6717404 aVileRat
aVileRat's picture

Perhaps, but then again the CEO never fully explained why 7 major vendors of VRX products, of which Philador was only 1 were all registered on the same day, from the same IP. Reviewing tax filings, you also conclude the VRX employees tend to moonlight at more than just 1 of these entities. While I may not be the smartest guy in the world, we saw from Countrywide's fake MBS program, when people are using fake identities to generate arms length invoicing we have a major issue. At the baseline VRX has a internal accounting & HR issue where sales growth is blind to reciept fraud. At the worst case we have a CEO who is fully aware and complicit in the fraud. A quick trip into 4chan & the deeps will find you a pile of circumstantial evidence that leads to the latter conclusion.

Those 7 vendors account for about 30% of VRX sales, so its no longer a '1 time event' like Michael Pearson would have insitutionals gloss over. Since VRX by Mcap was so large and the story by nature was a part of over 80% of Canadian professionally managed portfolios, everyone has a stake in keeping this house of cards afloat.

From a value side, they still did over 5b in patents so even if the company is 60% fraud, the residuals will still net you a good portfolio to sell to the next guy. Without the margin capture the VRX story will need to shift to a more normal R&D pipeline for managing product decline curves/patent expiary, which pretty much halves the TP's. How you the investor arrive at the instrinsic value requires some pencil work. So do your own dumb shit, don't trade on AVR commentary.

 

 

Tue, 10/27/2015 - 14:35 | 6717490 FlacoGee
FlacoGee's picture

When dealing with all companies I assume there is some level of fraud.    Whether it is tax fraud, insurance fraud, etc.   This is the world we function in...  

If 30% of their sales involve some level of fraud, then the particular fraud makes a difference.   Is it channel stuffing fraud and phantom sales or is it some sort of price gouging/insurance fraud?    There is a big difference...  one produces no revenue (Crazy Eddie for example) and the other does produce actual revenue with a potential for monetary damages/fines/expenses (the Goldman playbook).

Even with a potential 30% fraud/questionable sales, we still have a company turning ~$11.50 per share in earnings... in an industry that is known for price gouging, monopolies, etc.

Or there could be no Fraud at all...  a rare thing, but not impossible.

 

 

Tue, 10/27/2015 - 13:21 | 6717261 Colonel Klink
Colonel Klink's picture

Couldn't happen to a more deserving scumbag of a CEO and primary investor.

Tue, 10/27/2015 - 13:28 | 6717279 Insurrexion
Insurrexion's picture

 

 

Despite the obvious fact that Valeant is in a shithole of epic purportions,

question anyone who uses EBITDA (the over used, 1980's performance metrick).

It is not a serious financial metrick, is easily manipulated to make performance look better than it really is, and is non-GAAP.

Cashflow baby...

Furthermore, the S&P people are all docile eunuchs, serving their master since they were slapped by the U.S. .gov.

Tue, 10/27/2015 - 13:34 | 6717303 NoDebt
NoDebt's picture

Fuck EBITDA and fuck GAAP.  Cash accounting is what the standard should be.  Except most companies would instantly be insolvent these days under cash accounting rules.

Tue, 10/27/2015 - 13:32 | 6717291 NoDebt
NoDebt's picture

Ackman is so far in bed with corp management at that company it would be incredible if he didn't know about the channel stuffing.  

Tue, 10/27/2015 - 13:36 | 6717314 Id fight Gandhi
Id fight Gandhi's picture

Did he really buy 2mm shares last week as a sign of solidarity or say that, then pump and dump the option s with the volitility?

Tue, 10/27/2015 - 13:33 | 6717293 FlacoGee
FlacoGee's picture

VRX is one stock that should be massively accumulated at these price levels.

 

Thanks Citron!

Tue, 10/27/2015 - 13:42 | 6717350 CheapBastard
CheapBastard's picture

I'm guessing this is all part of Barry's robust recovery plan.

Tue, 10/27/2015 - 13:47 | 6717375 Rehab Willie
Rehab Willie's picture

But it's the short sellers fault

Tue, 10/27/2015 - 14:29 | 6717586 moneybots
moneybots's picture

"Our negative rating outlook reflects risks to our base case expectation that Valeant can sustainably grow revenue and EBITDA, given the potential reputational, legal, and regulatory risks the company is facing"

UBS kept a strong buy rating on Enron all the way down until 4 days before it filed for bankruptcy.

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