Valeant’s unsolicited bid for Allergan part of a cheeky business model
Valeant Pharmaceuticals is a drug company that doesn’t develop drugs – it runs a serial takeover operation
The central question that Allergan and the critics raise is: does Valeant create any value at all? Nobody really knows if Valeant is doing anything that makes money, or is just engaged in prestidigitation that never gets anywhere. All serial acquirers are infernally opaque. When Valeant buys something, it incurs costs – for instance, to pay severance to fired workers. It absorbs new assets and revalues them. And it reorganises its operations. Valeant and its boosters argue that these costs are one-time in nature, while the newly-acquired operations generate revenue and profit for many years.
In the first quarter, Valeant reported a loss of $22.6 million, measured by generally accepted accounting principles. The company had negative net income in three of the four years from 2010 to 2013. Wall Street believes that GAAP net income is only for the hopelessly naive and prefers an adjusted number that more truly reflects the underlying economic reality. And in the first quarter, Valeant made $600 million on the adjusted number that Valeant and Wall Street prefers.
Ackman has experience betting against complex financial operations, and he told me Valeant is the real deal. “Superficially, Valeant has some of the indicia that are suggestive of a short, but when you study the facts, you realise that it is a great company,” Ackman said. The problem is that it’s almost impossible for an outsider to judge whether Valeant is paying the right prices for its new acquisitions or overpaying, whether it is really generating much organic growth from its products, and what its true costs are.
One question is whether the company actually generates much cash. Because it takes over companies serially, an intellectually honest assessment of its business would consider the “one-time” charges not so one-time at all.
J Edward Ketz, an accounting professor at Penn State University, took the company’s cash flow and adjusted it for all the spending from acquiring companies and paying the restructuring costs. By Ketz’s reckoning, Valeant has sent more than $1 billion in cash out the door each of the last four years and was negative $5.4 billion in 2013 alone.
Schiller, the chief financial officer, thinks that’s a silly measurement that inherently penalises any acquisition the company makes. (He also disagrees that Valeant is opaque, pointing out that it breaks out the costs of its acquisitions in great detail.) The company’s supporters argue the returns on Valeant’s investments have been steadily high, in the midteens.
But then one looks at the company’s rising debt. Adding all of its commitments, Valeant discloses that it has $23.4 billion in debt, a number that’s been rising steadily. Its operating cash flow was only $1.3 billion over the last 12 months. That’s a low 5 per cent coverage ratio. One theory why the company wants to buy Allergan is that the target has lots of free cash flow and little debt.
In its eagerness to complete the deal, Valeant is looking more and more like a summery bull market nostrum that requires too much suspension of disbelief.