Sequoia Fund: About Valeant $VRX
Sequoia Fund comments on Valeant Pharma ($VRX) from its 2015 annual letter released this week:
The underperformance of the portfolio vs. the S&P 500 in 2015 was driven in large part by the negative return from Valeant, the Fund’s largest holding. The ten holdings listed above constituted nearly 70% of the Fund’s assets under management on December 31, 2015. At year-end, the Fund was 94% invested in common stocks, 1% invested in corporate bonds and 5% invested in cash and Treasury Bills.
Valeant experienced considerable earnings growth in 2015, but also found its business model and corporate ethics under severe criticism. Organic growth should be about 10% for the full year despite substantial disruption in the dermatology business during the fourth quarter as an affiliated specialty pharmacy, Philidor, closed after health care payers stopped reimbursing it
for prescriptions. Adjusted EPS should be up more than 20%, to around $10.25 before any unusual charges.
The closure of Philidor will significantly impact Valeant’s business in the short term, but we are optimistic that the transition of Philidor’s dermatology program to the more ubiquitous and respected Walgreen’s will be successful. Our conversations with dermatologists indicate that they want to prescribe Valeant’s brands and intend to direct their patients to Walgreen’s.
Valeant closed several acquisitions during the year, of which Salix was the most notable. That $15 billion purchase was Valeant’s largest to date. The acquisition was unusual as the portfolio is concentrated in drugs with limited patent lives, a departure from Valeant’s strategy of acquiring longer duration assets. Salix has a strong niche in gastroenterology, a market-leading sales force and opportunities for bolt-on acquisitions. We are encouraged by the growth of Salix’s brands, especially Xifaxan.
Looking forward, growth will be driven by prescription drugs such as Salix’s Xifaxan (hepatic encephalopathy, diarrhea and irritable bowel syndrome) and Jublia (toenail fungus); new treatments for acne, psoriasis, glaucoma and constipation; over-the-counter products such as contact lens solutions and moisturizing creams; and a strong emerging markets business. Valeant’s business is currently well diversified both geographically and by therapeutic category. U.S. government reimbursement is limited to around 15% of total sales.
Valeant’s $31 billion debt remains high, but we believe Valeant could pay back about $3 billion of debt in 2016 while also making contingent payments of $925 million tied to prior acquisitions. Cash available for debt repayment should grow in 2017 as the business grows and contingent payments decline. In the absence of large acquisitions or other uses of cash such as to pay fines or penalties, we estimate Valeant could pay back its debt in six years. We expect Valeant will adopt a more conservative financial position but after two or three years of paying down debt may be in position to make major acquisitions again.