Analysis: 5 takeaways from Valeant's messy earnings report
Valeant's Q1 earnings and guidance came out Tuesday, and the results were messy. That's hardly a surprise, given the ongoing investigations into the company's financial practices and drug pricing, along with its heavy debt load. Here are five takeaways from the company's quarterly report and analyst call:
1. Valeant's new executives are still looking for land mines. New CEO Joseph Papa was brought on board in April to straighten things out. He's still sifting through the company, although he laid out some points of a "stabilization plan" on a conference call Tuesday with analysts.
"We have a stabilization plan and we will execute on this plan. We've hit a few speed bumps in certain business that we need to address, but we also have an important catalyst for later this year and next year and we are generating strong cash flow," Papa told the analysts. Still, he acknowledged that the "past year has been tough on everyone."
The money questions trigger secondary problems. For example, Papa said slower-than-expected growth of Xifaxan, an irritable bowel syndrome drug, could be traced in part to turnover among Valeant's sales staff. That makes it a reasonable assumption that some of Valeant's best salespeople surveyed the landscape and decided that things looked better (or at least safer) elsewhere.
2. The company wants to sell some assets. Papa drew a line Tuesday between what he labeled "core" and "non-core" assets, and made it clear he'd consider selling the latter. That's a statement he's been making since shortly after he took over the post.
"We want to refocus R&D dollars into investment for core assets of ophthalmology, dermatology, GI, and consumer," Papa said Tuesday. He declined to specify the non-core assets that would be targeted for sale.
3. The market doesn't trust Valeant. For a while Tuesday morning, the stock was down more than 20%. We're talking about a stock that already has fallen from $250 to below $25 in less than a year. Tuesday's news was bad, but was it 20%-haircut bad? It arguably was if there are ongoing trust issues.
The company substantially cut its profit guidance Tuesday for the second straight quarter. Add in Valeant's $30 billion debt load, and investors are naturally jumpy about what is going on.
Barron's reported Tuesday that the Sequoia Fund, once Valeant's largest shareholder, cut its stake from 30.3 million shares at the end of March to 16.1 million shares at the end of May. In fact, Valeant's stock price is now so low that there's an argument to be made it's below the company's break-up value.
"Unfortunately, negative external attention continues to adversely impact the business and our reputation with patients, physicians, and all of you, our shareholders as well as our distracted organization," Papa said Tuesday.
4. It's still dragging in a lot of cash. Valeant's revenue was $2.37 billion — up $200 million from Q1 of last year and slightly ahead of analyst estimates. But the company's debt and internal issues — not to mention the remnants of the whole Philidor mess that helped accelerate so many other problems — make that revenue story less attractive. The downward guidance also supports that negativity.
5. Gaming the pharma business is not for the faint of heart. Valeant had relied on a strategy that has become popular among pharma giants: Use a lot of debt to buy up smaller companies that have developed a promising drug or ones that have a drug niche stranglehold, slash costs, raise prices and hope to reap big profits. That's a considerable change from the old-school way: Spend millions or billions on R&D and the staff needed to support it, then push to bring drugs to market, typically with big hits and misses along the way.
The New Yorker had a fascinating article in April, in which it compared Valeant's strategy to the "moneyball" approach used by some professional sports teams. In that strategy, a general manager looks at how other teams evaluate players, searches for inefficiencies in those methods and then tries to use them to acquire better players for less money. Eventually, though, the other teams catch on and the inefficiencies dry up.
You can make an argument that this is precisely what happened to Valeant — and that when things didn't work out, it turned to some questionable accounting practices to create a misleading profit picture.
Consider the questions an acquisitive pharma company faces: When do you try to buy the targeted company? What happens if a drug fails in testing and you have paid an astonishing sum for an empty vessel? How do you scale the offer so that success is rewarded and failure doesn't bury you in debt? How do you handle the blowback if you hike drug prices? What do you do when the regulators come to call?
The buy-with-debt strategy requires a lot of correct answers. If it gets some of those answers wrong, the acquiring company is stuck with the equivalent of a relief pitcher with a worn-out arm. And that's not worth much of anything.
Follow Randy Lilleston on Twitter