May 18, 2016

Valeant stock is still risky for a bottom fishing buy

Jim Cramer clearly outlined the key risks facing Valeant Pharmaceuticals (VRX) in his column. Key among these are a possible rollback in pharmaceutical prices, coupled with a likely large increase in research-and-development costs. That could expose VRX's cash flow as having little margin for error given the requirements involved in servicing Valeant's more than $30 billion of debt.
Bill Ackman is one of the largest shareholders of Valeant
Moreover, Barron's highlighted over the weekend the lack of quality in Valeant's earnings (i.e., the wide spread between GAAP and non-GAAP reporting). The magazine concluded that on a GAAP basis, Valeant's shares are expensive -- in the stratosphere when it comes to valuations.

This is a marked contrast to recent protestations that Bill Ackman of Pershing Square (a major VRX shareholder) made on CNBC recently, claiming that the company's shares are actually cheap. "The value of the assets is much greater than where the stock [currently] trades," he said.

In an extensive interview on Mad Money last night, Jim asked new Valeant CEO Joseph Papa some hard-hitting questions that had to be asked in order to properly evaluate VRX as an investment.

Jim's accounting questions were particularly focused, but Papa deflected (he basically said investors should look at VRX's pipeline). Jim's questions regarding the need to sell assets also went unanswered. However, these questions are at the core of determining the investment case for or against Valeant.

I should add that while I'm not all that familiar with Papa's background at his former employer Perrigo (PRGO), he seems to have done a good job as CEO there. However, I though his decision to reject a generous, $26 billion bid from Mylan (MYL) for PRGO in 2015 was clearly wrong-footed. In fact, his choice to leave Perrigo in its current state and assume the Valeant CEO job seems enigmatic and cryptic to me.

The Bottom Line
Although Papa seemed like a stand-up guy in his interview with Jimmy last night, I felt the new Valeant CEO wasn't all that impressive. Papa appeared not to be all that informed (although he said he did his due diligence), and he wasn't prepared for the line of questioning that Jim delivered. Overall, he didn't really answer many of Jimmy's questions.

Now, Papa might be the tough executive that VRX needs and simply didn't want to disclose his strategy or specifically address Jim's pointed queries (which would be understandable given that it's early in the new CEO's tenure).

However, I think more questions than answers remain after last night's interview. Papa might be Valeant's savior, but his plans to right the ship and convince investors that cash flow and earnings are relatively intact remain undisclosed.

Without that knowledge, I'll continue to recommend avoiding Valeant shares. I wouldn't suggest "bottom-fishing" the stock here, even if VRX's price and valuation appear tempting to Bill Ackman.

In my view, asset sales loom ahead in order to satisfy Valeant debtholders by providing a margin of safety to service the company's sizable debt load. I also expect likely future asset-impairment charges and writedowns.

And lastly, I believe that Valeant's core earnings power will be diminished -- perhaps materially so -- relative to management's recent guidance and analysts' consensus estimates.

Position: None