Will Ebiefung

About the Author Will Ebiefung

Will Ebiefung studied finance and accounting at the University of Tennesee. He works as a freelance investment analyst focusing on equities with market caps below $100 million. In addition to writing, Will is a full-time investor focusing on web properties and debt-based securities.

How Should Investors Value Valeant Pharmaceuticals Intl Inc (VRX)?


Valeant Pharmaceuticals Intl Inc (NYSE:VRX) stock has lost over 25% in 2017 alone. Yet, is the struggling pharmaceutical giant undervalued or still overvalued at $11 per share? Let’s dive in to see where the stock headed in the next twelve months:

Valuing Valeant: Market Cap or Enterprise Value?

In most cases, it’s perfectly fine to value a company by its stock price. The stock price is a proxy for the market-cap – the current price of the stock multiplied by the number of shares outstanding.

Market cap is a good valuation metric because it represents the amount someone would have to pay to buy all the shares outstanding and take control of the board – with all other factors held constant.

Valeant’s market cap is only $3.7 billion, and this would suggest undervaluation for a company that makes almost $9.7 billion in annual revenue and over $3.5 billion in adjusted EBITDA. But Valeant’s debt-heavy capital structure makes its market cap and stock price virtually useless from a valuation perspective.

Valeant has $30 billion in debt, so its enterprise value – roughly the market cap with debt added and cash subtracted- is a more reasonable estimation of the cost to purchase the company.

Unfortunately for Valeant hopefuls, the company’s enterprise value is astronomical in light of its debt-dominated capital structure.

Instead of saying Valeant’s stock price is low because the debt makes the company risky, investors should realize that the debt makes the company overvalued because it inflates its enterprise value and forces the market cap (stock price) to drop as compensation for the overvaluation.

This dichotomy is the key difference between Valeant bears and Valeant bulls. The bulls look at the stock price while the bears watch the enterprise value. In this case, the bears are right.

Why Valeant is Overvalued

Pharmaceutical cash flows are typically analyzed by EBITDA instead of revenue because EBITDA considers the expenditures required to maintain and grow the cash flows.

Valeant’s EBITDA is expected to come in around $3.5-3.7 for the full year of 2017. And this is a drop of at least 7% from the prior year.

As a declining business with poor interest coverage, Valeant is clearly a distressed pharmaceutical asset. And according to many in the sector, distressed pharmaceutical assets are worth around 4-7x EBITDA from an acquisition perspective.

At $11 per share, Valeant’s market cap is clearly distressed, and if the company were debt free, it would be currently trading for around 1x EBITDA and only a fraction of revenue.

Buyers would be tripping over themselves to purchase the company at this price. But buying Valeant means buying its debt, and the debt is not cheap.

With a little under $30 billion in long-term debt, Valeant has an enterprise value of $33 billion. With $3.5 billion forward EBITDA, the company has a forward EV/EBITDA of 9.4x – not a distressed multiple, and certainly not attractive from an acquisition perspective.

Undervaluation for Valeant would probably start at an enterprise value of 5x EBITDA. And at $3.5 billion in EBITDA, such a multiple would imply an enterprise value of $17 billion – around $15.5 billion lower than the current enterprise value of the company.

To make matters worse, Valeant’s entire market cap of $3.75 billion could decline to near zero, and the company would still remain overvalued because of its debt-dominated capital structure.

Conclusion

Company valuation can seem opaque and confusing to retail investors, and it’s tempting to only focus on stock price when making investment decisions. However, when a company has such a large amount of debt, its stock price and market cap cannot accurately value the company.

Valeant’s debt inflates its enterprise, and this will keep the stock overvalued even if the stock price falls to near zero.

So what do Valeant’s $3.75 billion market cap and its stock price of $10.70 represent? Valeant’s stock is a bet that the company will be able to reduce its debt load and allow equity to take up a greater percentage of its capital structure.

However, with continuing declines in Valeant’s cash flows and weak forward guidance, Valeant’s chances of paying down its debt look slim. Valeant’s stock price is falling in the near-term and will continue to decline for the foreseeable future. The stock is still overvalued and should be avoided no matter how cheap it looks.

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