Valeant's New Strategic Direction: Clean Break Or Simply A Paint Job?

Insisting it was now a "new" company – or at least on its way to becoming one – Valeant Pharmaceuticals International Inc. on Aug. 9 unveiled plans to reorganize its business, reaffirmed its 2016 full year guidance and vowed to aggressively bring down its $30bn in debt by renegotiating its terms and selling off noncore assets.

"We are setting the company on a new path with new strategic imperative, changes to the management team and structure and new business segments and a new direction," said Valeant CEO Joseph Papa.

The company has been plagued by scandals in the past year over significantly hiked up drug prices and its questionable relationship with the specialty pharmacy Philidor Rx Services Inc. (Also see "Valeant: Another Fine Mess" - Scrip, 2 Mar, 2016.)

"Valeant will be embarking on a new vision and mission," Papa told investors and analysts during the company's Aug. 9 second-quarter earnings call. "We want to be a trusted health care partner and to improve people's lives with our health care products."

But skeptical Wells Fargo analyst David Maris questioned whether things were really changing with Valeant or if the Canadian drug company was simply putting "new paint on the same old shed."

He concluded Valeant's new actions were far from enough to change his mind – declaring the company's business trends were weak, its debt was high, its key management were leaving, congressional and Securities and Exchange Commission investigations were ongoing and the firm remained a "price-driven model in a payer market that has gotten smarter."

But investors were pleased with Valeant's plan for a turnaround – pushing shares up nearly 26% before closing at $28.16, a gain of $5.74, or 25.4%.

Papa, who has been trying to turn things around for Valeant since he was installed as CEO in May – replacing Mike Pearson, who was essentially fired by the firm's board in March but stayed on until a replacement could be found – said the company's reorganization currently doesn't involve a name change, although he said it's "something we'll always continue to evaluate." (Also see "Valeant: Seeking Disaster Expert To Run A Hot Mess" - Scrip, 21 Mar, 2016.)

Nonetheless, he said the new Valeant will consist of three reorganized business segments: Bausch & Lomb Inc. ophthalmology products and international business; branded prescription medicines, including dermatology, gastrointestinal and women's health drugs; and the company's US diversified products, including the firm's neurology and generic drugs, its Solta medical aesthetic device systems and its Obagi skin care line.

The latter segment, said TD Securities analyst Lennox Gibbs, appears to be earmarked for divestment.

Indeed, Papa said Valeant was looking at alternatives for a number of its "noncore businesses and geographies that represent revenue greater than $2bn," although he said the company thinks it can get up to $8bn, which Gibbs noted would go a long way towards paying down the firm's $30bn debt.

Papa said Valeant has received "indications of interest on these assets and we have engaged respected banks and advisors to assist us in exploring our options."

About a third of the offers that have come in have been unsolicited, he said.

Valeant officials noted the company already has taken steps to streamline its portfolio in the second quarter by agreeing to return its European rights to its plaque psoriasis drug brodalumab to AstraZeneca PLC, divest its Synergetics USA OEM business and sell back its rights to its recombinant human C1 esterase inhibitor Ruconest to Pharming NV, which brought in $181m in cash and the potential for up to $329m for in approval and sales milestones.

Those actions, said Rodman & Renshaw analyst Raghuram Selvaraju, "constitute logically structured transactions that do not, in our view, impair Valeant's base business."

"In our view, Valeant is taking a measured and rational approach to targeted divestitures of non-core businesses," he said.

"We fully intend to make decisions regarding our asset base in the best long-term interest of our shareholders," Papa said.

He said Valeant expects to "simplify the business and reduce our debt through strategic measures and cash generation over the next 12 months to 18 months."

Papa noted that Valeant already had paid $1.29bn towards its permanent debt so far and has completed all 2016 scheduled amortization payments and the payment for the first quarter of 2017.

It has about $475m in remaining mandatory term loan amortization for next year, he said.

But Papa said that while Valeant continues to be in compliance with its financial maintenance covenants under its bank debt through 2016, "our cushion is not as large as I would like it to be."

So the company is seeking to modify its interest coverage financial maintenance covenant with its lenders and plans to launch an amendment process shortly.

"We plan to modify the interest coverage, financial maintenance covenants as well as a couple of other small changes," explained Linda LaGorga, senior vice president and treasurer at Valeant. "This is all opportunistic and focus on getting us the flexibility to up-size our capital structure. So while the interest coverage financial maintenance covenant is a bit tight right now with additional push, we think we'll be very comfortable going forward is just able to focus on the strategy of the business and talking about the business."

Analysts noted, however, this would be the second time Valeant has had to ask for covenant relief from its lenders. (Also see "Valeant Reset: Will It Cure What Ails It?" - Scrip, 29 Apr, 2016.)

Valeant surprised Wall Street by not lowering, but reaffirming its 2016 full year guidance of total revenue of $9.9bn to $10.1bn and adjusted non-GAAP earnings per share of $6.60 to $7 and continuing to expect adjusted EBITDA of $4.8bn to $4.95bn. Evercore ISI analyst Umer Raffat pointed out "this means business has to improve" in the second half of this year.

But Wells Fargo's Maris was doubtful – insisting "achievement of that guidance is increasingly unlikely," with the core franchises continuing to deteriorate.

Valeant reported an 11% decline in reported revenue for the second quarter versus the same period last year.

Its dermatology revenue fell by a whopping 55% from a year ago, while its ophthalmology sales dropped by 25%. Its neurology sales also fell by 11% and its gastrointestinal segment was flat.

Nonetheless, Morningstar analyst Michael Waterhouse insisted there were some encouraging signs in Valeant's results – pointing specifically to a 28% growth in prescriptions for its irritable bowel syndrome and travelers' diarrhea drug Xifaxan (rifaximin), which he said suggested a return to healthy growth in 2017 following extensive rebating this year.

In addition, he said, the launch of the recently FDA approved oral version of Relistor (methylnaltrexone) later this year, the end of a supply disruption for olfoxacin otic and improving prescription profitability under the Walgreen's partnership should all help performance in the back half of the year, despite modest headwinds from expected generic competition on Nitropress (sodium nitroprusside) and Isuprel (isoprenaline). (Also see "Valeant’s Oral Relistor Poised To Face-Off Against AstraZeneca’s Movantik" - Scrip, 20 Jul, 2016.)

Plus, "Valeant's international operations continue to mostly meet our expectations and remain a source of stability," Waterhouse said.

But he also said plenty of work remained for Valeant's management team to successfully turn around its business.

"We still want to see greater evidence of management's ability to turn around its core segments of ophthalmology, gastrointestinal and dermatology," Waterhouse said.