A new Valeant starts to take shape, and it's still not pretty

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With Joseph Papa’s second quarterly conference call as Valeant’s chief executive under his belt more evidence emerges that in him the company has found its saviour: the stock surged 25% yesterday, its biggest one-day gain this year.

Still, Valeant shares are down 72% since January, revealing the mountain that Mr Papa still has to climb to turn the group into a long-term sustainable enterprise. With a business split and $8bn of asset sales now on the cards you can forgive investors for latching onto Valeant’s revelation that it has already received offers, and overlooking the fresh threat of covenant breaches (see table below).

It was the threat of debt covenants being breached, for any of a number of reasons, that contributed to Valeant’s downward spiral earlier this year when its reliance on price hikes and opaque arrangements with speciality pharmacies came to light. That initial threat abated when, eventually, the company managed to file its annual 10-K report with the US SEC.

New threat

However, Valeant has not recovered yet – far from it. Yesterday Mr Papa cautioned that, while the company remained within maintenance covenants covering its bank debt, “our cushion is not as large as I would like it to be”. Covenant breach would be a serious problem, allowing holders of Valeant debt to demand their money back immediately.

That debt in total stands at over $31bn, including several tranches of term loans and senior notes, the really onerous part of which starts falling due in 2018. It is the reason why less than a third of Valeant’s $41bn enterprise value is reflected in its equity.

Valeant's debt maturity summary
Maturity date Type of debt Amount ($m)*
Apr/Aug/Oct 2018 Revolving credit, 6.75% senior debt & term loan 4,365.0
Feb/Dec 2019 Term loan 1,862.0
Mar/Apr/Aug/Oct 2020 Term loan & 5.38%, 7.00% & 6.38% senior debt 8,180.6
Jul/Aug/Dec 2021 7.50%, 6.75% & 5.63% senior debt 3,151.3
Apr/Jul 2022 Term loan & 7.25% senior debt 4,422.2
Mar/May 2023 5.50%, 5.88% & 4.50% senior debt 5,857.7
Apr 2025 6.13% senior debt 3,216.2
Total** 31,055.0
Note: *as at 30 June 2016; **excludes $12.3m of "other" debt; includes $294.1m classified as "current".

But Mr Papa is not known for resting on his laurels. He said he would now seek to modify covenants relating to interest cover, and would start discussing this with the lenders shortly.

Even more important, as far as investment bankers were concerned, was a plan to go into overdrive with asset divestments. While stressing that core businesses were not for sale, Mr Papa said he had identified for divestment areas that were not central to Valeant’s focus that currently generate sales of some $2bn.

“Based on ... unsolicited indications of interest we've received,” the chief exec revealed on yesterday’s conference call, “these assets represent a transaction value of up to $8bn.”

However, investors hoping for a windfall will be disappointed: any proceeds, along with the vast majority of free cash flow, will go towards paying down debt.

Debt-fuelled binge

It was a debt-fuelled asset-purchase binge that got Valeant into its current mess, and while it is still early days the signs are that Mr Papa does intend to put the machine into reverse (One way to save Valeant – stop being Valeant, March 16, 2016).

Initial divestments have included EU rights to brodalumab, the Synergetics USA business and Ruconest. It will not end there, and as if to whet bankers’ appetites even more Mr Papa yesterday launched a plan to split Valeant into three separately reporting divisions.

There is, of course, no officially announced plan for any of these to be hived off. But a business is much easier to divest when it already exists as a standalone segment than if it has to be carved out of a much larger, complex entity.

Investment bankers will undoubtedly take the hint.

Valeant's three-division makeover
Name of new division Durable growth Growth Cash-generating
Comprises Bausch+Lomb, other ophthalmology, surgical, consumer, international Branded prescription drugs, Salix, Dendreon, dermatology, dentistry, women's health US neurology, generics, Obagi skin care, Solta aesthetics
Share of 2016 revenue gudance 50% 30% 20%
Description Franchises with durable product characteristics Will attract most of Valeant's future investment Declining sales, high-margin, low-investment business

To contact the writer of this story email Jacob Plieth in London at jacobp@epvantage.com or follow @JacobPlieth on Twitter

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