Valeant gears up for another assault on dermatology

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The ability of Valeant Pharmaceuticals to live within its means is to be tested with yet another debt-financed acquisition – that of the dermatology specialist Medicis Pharmaceutical – which is set to add another $2.4bn to the US speciality company’s already bloated debt pile.

The takeover is Valeant’s biggest since it paid $4.5bn for Biovail in 2010, and underlines the group’s desire to become an even bigger player in dermatology. But, at a time when Valeant’s net debt already stands at half its market cap and a massive 11x 2011 operating cash flow, many might ask whether shelling out $2.6bn on an unexciting and underperforming business is a smart move or simply gears up disaster (see table).

Valeant’s acquisition spree last year included four dermatology companies for a combined $1.2bn (Valeant must deliver on growth promises as deals continue to flow, July 18, 2011). It also tried and failed to buy Cephalon, while a rumoured bid to take over Meda AB, a Swedish speciality company with a significant dermatology portfolio, turned out to be a straight licensing deal.

But such frenetic activity comes at a price. In Valeant’s case the price has been debt, which at the end of 2011 stood at $7.6bn against the company’s $395m of gross cash. Notwithstanding dermatology’s stability and mid-single-digit annual growth rate, these acquisitions have stretched Valeant very thin, and the Medicis takeover will do little to remedy the situation.

Valeant stretches itself thin
Valeant 2011 operating cash flow $676m
Valeant net debt $7,155m
Valeant debt/cash flow 10.6x
Medicis 2011 operating cash flow $180m
Medicis net cash $239m
New debt to fund Medicis acquisition  $2,600m
Annual cost savings $225m
Combined pro forma 2011 operating cash flow (incl savings) $1,081m
Combined pro forma net debt $9,516m
Combined pro forma debt/cash flow (excl savings) 11.1x
Combined pro forma debt/cash flow (incl savings) 8.8x

Driven by inefficiencies

The saving grace for Valeant is the inefficient manner in with which it believes Medicis is operating; it aims to slash a massive $225m off the target’s annual cost base within six months of completing the deal next year.

However, as the simple calculation in the table above shows, if the planned savings do not come through or if Medicis’s products underperform, Valeant’s net gearing might be pushed higher still. Earlier this year Moody’s downgraded Valeant’s senior debt rating to junk, with a negative outlook based on the likelihood of future M&A resulting in even higher leverage.

The attraction of Medicis is its North American portfolio of marketed products, which Valeant says will consolidate its position as the biggest US dermatology player and add strength in Canada. But by far its biggest product, the acne drug Solodyn, saw sales dip 6% to $368m in 2011, and a further slump has been seen this year after fulfilment snags.

While a rebound from this is far from certain, doubts also surround a future growth driver, the recently launched actinic keratosis drug Zyclara. A generic challenge against this product was recently made by Actavis, and it seems likely – as was the case with Solodyn – that a financial settlement will have to be struck to protect the franchise.

The unknown pipeline

On the other hand very little is known about Medicis’s R&D pipeline, which could deliver an unexpected boost. UBS analysts broadly welcomed the acquisition, saying it fitted with Valeant’s dermatology strategy, while Bernstein said Valeant was getting a good deal and could see a 10% share price uplift.

Still, banks have earned significant corporate finance fees from Valeant over the past two years, and there is probably little sense in killing the goose that keeps laying golden eggs. Investors were nonplussed by balance sheet distractions, sending Valeant’s stock up 15% in early trade today.

Bernstein also expressed surprise that the relatively cash-rich Medicis, which had previously been earmarked as predator and not prey, had agreed to be bought. Valeant said this was the third time it had discussed a takeover with Medicis management, as well as claiming that even with the new debt it should be able to pursue additional small takeovers.

The $44 per share Valeant is offering is a 39% premium to the previous day’s close and represents a level not seen since 2004, although the stock came close to $40 in April. Perhaps the premium offered by Valeant is not particularly exciting, but then neither is the asset being acquired.

It remains to be seen whether any other suitors for Medicis will emerge. For Valeant, the pressure to deliver is now even greater.

To contact the writer of this story email Jacob Plieth in London at jacobp@epvantage.com

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