If Valeant Pharmaceuticals International Inc. is addicted to deals, blame investors. They're willing enablers of the company's acquisitive habits.
On Monday, Valeant shares jumped 15 per cent following news that the Montreal-based company would purchase Salix Pharmaceuticals Inc. of Raleigh, N.C., for $158 (U.S.) a share, or $10-billion, plus the assumption of $4.5-billion in debt.
The people flooding into Valeant shares appeared delighted that the company was back doing takeovers after its failed run last year at Allergan, the maker of Botox.
But the structure of the deal – Valeant's biggest acquisition to date – underlines the persistent concerns about the company. It borrows to acquire other drug makers, then cuts deep into their research budgets and other overheads to cover the cost of the new debt and generate a profit.
The strategy is a smart one, but one that may not be sustainable in the long run. Rather than developing new pharmaceuticals, Valeant is essentially an assembly line for deals – especially ones where it can use its exceptionally low tax rate to good advantage.
So long as the deals keep flowing, Valeant can prosper. The worry, though, is about whether it can keep on finding attractive acquisitions in a pharmaceutical industry where frantic merger activity is bidding up the cost of attractive targets.
The company answered some of its doubters on Monday by publishing fourth quarter results that exceeded forecasts. Revenue rose to $2.28-billion, up from $2.06-billion a year earlier, while net income soared to $534-million from $125-million.
Valeant believes the Salix acquisition will boost profits by more than 20 per cent in 2016. The North Carolina company specializes in gastrointestinal drugs, an area new to Valeant.
Its flagship product is Xifaxan, a medicine used to treat travellers' diarrhea and a rare brain condition. Salix is trying to win approval from the Federal Drug Administration for the use of Xifaxan as a treatment for irritable bowel syndrome.
Despite Salix's success in developing such medications, Valeant plans to chop roughly $500-million of annual costs following the takeover, which is equivalent to most of Salix's budget for research, marketing and overhead. In addition, the deal will benefit from Valeant's tax rate of 5 per cent, which is far below the roughly 30 per cent that Salix was paying.
While analysts generally smiled on the acquisition, it leaves the balance sheet looking increasingly precarious. Following completion of a new round of borrowing, Valeant's net debt will nearly double to close to $30-billion.
That will be about 5.6 times its earnings before interest, tax, depreciation and amortization – a big jump from the current ratio of about 3.5.
The new deal also emphasizes how eager Valeant is for acquisitions. Salix was not the most appealing target at first glance after an accounting scandal last year that prompted the chief financial officer to resign.
Valeant was quick to assure investors on Monday that it had done its due diligence on Salix. It added that it would be able to wrestle its debt load back down to a more reasonable four times EBITDA by the second half of next year.
All of that sounds encouraging. Investors, though, should ask themselves if they really want to bet on a company that must find ever larger acquisitions in a pricey sector to keep its growth story alive. One misstep and Valeant will be looking distinctly unhealthy.