Valeant Pharmaceuticals Intl Inc (NYSE:VRX) turnaround story depends on transforming from an acquisition-based ‘platform’ company into an R&D-driven traditional drug company.
A conventional pharmaceutical business depends on leveraging research and drug discovery into commercialized drug products. The cash flow from these products is then used for more R&D to continue the process.
R&D is slow and expensive. Taking a drug candidate from pre-clinical development to FDA approval can take over a decade, and success is not guaranteed. The process costs hundreds of millions. And it is little surprise that Valeant, one of the biggest firms to abandon this strategy, recorded breakneck profitability and a soaring stock price.
Valeant let other company’s ‘waste’ their money on R&D only to swoop in and purchase them when they were proven and profitable.
Now, Valeant’s old business model is discredited due to public pressure on pricing. The pharmaceutical roll up is trying to transition into a regular drug company that doesn’t rely on price hikes and acquisitions to create value for shareholders. But Valeant’s growth strategy is simply not realistic.
Valeant’s Growth Drivers are Weak
Valeant’s R&D has historically been used to push late stage drugs across the finish line into commercialization. Most of Valeant’s high profile ‘growth drivers’ (Siliq and Addyi) were developed by companies before Valeant acquired them – this may be the case for Valeant’s entire late stage pipeline.
But what is the market potential for Addyi and Siliq? In the case of Addyi, there are well-known problems with efficacy. And competition from Rekynda – another female libido booster from Palatin Technologies – is on the horizon.
Even if Addyi’s sales quadrupled from $10m to $40m, they wouldn’t make a dent in Valeant’s EBITDA declines – especially because expanding the sales force and marketing of this drug will cost money.
Siliq’s situation may be even worse. While the dermatology drug shows superior efficacy over some competitors, psoriasis is a crowded field with intense competition. Siliq will struggle to compete, especially considering its REMS program and suicide indication warning.
Valeant’s management has guided adjusted EBITDA from its FY2016 figure of $4.03b to $3.5-3.7b for FY2017. This is essentially an admission that Siliq and Addyi will not be able to make up for the continuing declines in Valeant’s top line. The easy solution would be to increase R&D expenditure, but Valeant doesn’t have the cash flow to pull this off in the face of its huge debt obligations.
Valeant Doesn’t have Room for R&D
Valeant spent around $425m on R&D for FY2016; this is up from $247m in 2014 – a paltry sum for a company of Valeant’s size. Valeant’s R&D expenditure totals a little over 4% of revenue.
Similar pharmaceuticals like Allergan, for example, spend over 17% of revenue on R&D. To put this in perspective, we are talking about $2.5b in 2016 for Allergan.
If Valeant spent 17% of its $9.67b in revenue on R&D, the sum would total around $1.64b.
Unfortunately, Valeant has no way to meaningfully increase its R&D investment while so much of its EBITDA is needed for debt repayment. Valeant is in a tough situation because, while debt paydown is good, it also represents a huge opportunity cost – money that could have been used to build up the company’s portfolio.
Valeant is in a lose/lose situation because its transition from an acquisitive platform company into a traditional R&D-driven drug company will depends on expanding R&D expenditure. Valeant is in a poor position to expand R&D because of its debt obligations.
Valeant’s growth drivers, Siliq and Addyi, are also problematic. Addyi has efficacy concerns and a strong competitor on the horizon. Siliq, while scoring well on efficacy, has restrictive labeling and competes in a crowded field against giants like Johnson and Johnson with stronger sales forces.
Valeant’s poor growth prospects are a major reason why the firm is so unattractive from an acquisition perspective, and further downside can be expected in the stock price.