It's hard to dispute the success of the deal-making frenzy by Valeant Pharmaceuticals International Inc. when you look at the stock's stellar gains in recent years.
Valeant's share price has surged 730 per cent over the past five years – a period that includes its merger with Biovail Corp. in 2010, Monday's deal to acquire Bausch & Lomb Inc., plus more than 50 other deals.
The acquisitions have transformed the once-tiny pharmaceuticals firm into Canada's 14th largest company, based on market capitalization, putting it ahead of Telus Corp., Sun Life Financial Inc. and Canadian Pacific Railway Ltd.
But Valeant's ballooning size should make investors think twice about joining this rally: While deal-making can work wonders for a company, the landscape is littered with companies that took too many bites.
To be sure, Valeant's growth has been relatively focused. Mike Pearson, Valeant's chief executive, has wisely steered the company away from open competition with pharmaceutical behemoths, preferring products with relatively low sales profiles in niche areas.
He has also preferred products that are bought by individuals or private plans, rather than those that rely on public health- care systems that are notoriously tight on funding.
The strategy has worked well. Valeant's annual sales have tripled over the past two years, while earnings on a per-share basis have been growing at a 45 per cent clip over the past three years, on average.
Expectations that the growth will continue explains why the shares are priced at 77-times trailing earnings. Based on estimated earnings from analysts, that P/E ratio falls to just 16.
That implies the shares are priced attractively right now, but only if Valeant meets or exceeds those expectations. Slip-ups could be costly.
But what's particularly worrisome about Valeant is the impact of future deal-making. According to a recent study by Boston Consulting Group, so-called serial acquirers tend to underperform companies with a slower approach to expansion, because companies have a limited capacity for integrating acquisitions.
And if underperforming doesn't worry you, consider the blow-ups. Waste Management Inc. was an aggressive buyer before its share price collapsed – albeit amid an accounting scandal – in the late 1990s. In Canada, Garda World Security Corp.'s share price surged above $25 in 2006 amid a takeover frenzy; six years later it went private at less than half that price.
As well, deals are relatively easy to make when your targets are too small to be on most radar screens. As Valeant grows larger, though, the size of the deals are going to have to grow with it if the company wants to maintain its current blistering pace of expansion.
That brings with it concerns about the price it pays, the debt it takes on and the new competitors it attracts.
Valeant is paying $8.7-billion (U.S.) for Bausch & Lomb, a hefty premium over the price that private equity firm Warburg Pincus paid for the company just six years ago and its biggest acquisition to date. The deal will also add to Valeant's burgeoning debt load, which has tripled over the past two years, and brings it into competition with the likes of Novartis AG and Johnson & Johnson.
Investors are betting that the deal is a natural fit for Valeant, driving its share price up more than 10 per cent on Monday – capping an amazing run-up.
If you've missed it, now is not the time to join.
David Berman