Valeant must deliver on growth promises as deals continue to flow


Valeant Pharmaceuticals has certainly lived up to its reputation as a voracious deal maker this year, and comments made last week following the latest transaction indicate the company’s management team have no intention of slowing down.

As well as four dermatology transactions, which have cost the group $1.2bn in total, two European generic players have been bought for almost as much again, with Valeant each time employing the same strategy: close the deal swiftly and integrate the new business as quickly as possible. The company’s share price suggests investors are enjoying the story – up 87% so far this year to $52.49. But such a thrilling tale also demands delivery of promises, particularly in terms of profit growth, something that will increasingly become a focus as the deals continue to roll in.

Attractive risk

Valeant announced two dermatology acquisitions in quick succession last week - Sanofi’s dermatology unit Dermik was snapped up for $425m and the assets of Johnson & Johnson’s Ortho Dermatologics for $345m.

These followed the purchase of earlier in the year US and Canadian rights to three herpes and ezcema products, Zovirax, Elidel and Zerese from Glaxo and Meda, for $376m in total upfront fees. Further royalties and milestones will be paid out on the latter two products over the next 18 months.

Michael Pearson, Valeant's chairman and chief executive, said on a conference call following news of the Ortho Dermatologics that the dermatology space “has an attractive risk/reward profile, and we believe there is room for a smaller, focused player like Valeant.”

The acquisitions have given the company proforma revenues of just over $1bn “and we will continue to look for other assets that will continue this growth,” he said, a statement that referred to all parts of the business.

“It would be a bad assumption to assume we will do nothing for the next six months. We will continue to be active, not just in dermatology,” he said, pointing to recent transactions in Europe and other markets like Latin America and Australia, where Valeant still has unfulfilled ambition.

As well as the dermatology moves, Valeant has bought two European generic players - Sanitas for $440m and PharmaSwiss for $518m - bringing the group's deal spend so far this year to $2.2bn.

Delivering growth

The company prides itself on not overpaying for assets, and certainly did not pay through the nose for the dermatology businesses – by its own estimates it cumulatively paid the equivalent of 1.8 times sales.

There is a good reason for this – not all the products coming into the Valeant fold are fast growers, and by the company’s own admission many are “challenged” and need resuscitating.

However Valeant also pointed to a handful of reasons why this buying spree should ultimately create a profitable and growing dermatology business: it is now the owner of a large manufacturing plant in Canada which will eventually bring down the manufacturing costs; it has gained experienced sales forces, management teams and well known trademarks; and cost savings will be possible by merging administrative functions.

A sales force expansion is planned for the US and Canada – the core region for the dermatology business – which will eventually sell more products, as they are added in the coming months and years, through further acquisitions.

However, investors will want to see profits growing even as acquisitions continue to feed the top line.

Integration story

Key to this will be the swift and efficient integration of all these businesses, and so far the company has been doing well. Analysts reckon earnings per share will reach $2.65 this year, and grow 17% for the next five years, consensus data from EvaluatePharmashows. The more recent acquisitions have yet to be incorporated into models, but generally were viewed as likely to add to earnings almost immediately.

Mr Pearson believes that profitability should improve in the coming years – gross margins of 80% should be possible, he said. Last year, Valeant’s gross margin was 70% and consensus data imply a rate of 74% by 2016, suggesting the company sees greater scope for cost savings and efficiencies.

But a lot still relies on growth, and not just through adding new businesses via acquisition. Valeant must wring organic growth out of the products it already owns. Any sign that the company has overestimated its ability to re-energise flagging franchises will make investors nervous, given that strong cash generation is needed to pay back the debt raised to fund this buying spree.

At the moment, there is no sign of this, although the company did last week move to temper second-quarter revenue expectations, even though it does not normally give quarterly guidance.

Valeant makes no secret of the fact that further deals are on the way, and these transactions will continue to drive the headlines. But the company is increasingly becoming an integration story, and success here is crucial if current share price momentum is to be maintained.

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