REDEMPTION CYCLE
Institutional Consultants are the capital "gatekeepers" of the asset management industry, and are in the process of evaluating their client's exposure to Valeant (VRX). As of 2Q15, 24 funds held a position in VRX that was > 4% of the portfolio, representing 26% shares outstanding. At this stage, VRX is not investable, with any long exposure bringing into question the research process and risk controls of the manager. Consultants will likely be forced to recommend clients to redeem completely from those funds where VRX resulted in a significant capital impairment. Start to finish, this process can take 3-5 months depending on lock-up periods, finding a replacement manager and getting board approval. We do not believe the precipitous decline in Valeant's stock reflects forced selling due to redemption requests that will likely come in full force later in 4Q15 and into 1Q16.
bear case $20
We don't think Valeant is worth anything more than the value of the assets management paid for them, less the accumulated debt during the 5-year, acquisition spree. Due to the lack of organic growth and internal investment, the assets on Valeant's balance sheet reflect a reasonable fair value based on market prices paid. Of course, value is in the eye of the beholder, and it can be argued that Valeant overpaid for certain assets as their now defunct model allowed them to extract "value" that others couldn't. It has always seemed unreasonable to us how Valeant could purchase an asset for x and the market immediately value the equity in that asset at 3-5x or more.
The simple question we ask is if Valeant were to liquidate today, what would be left after meeting all liabilities?
The simple math is that Valeant has $48.5 bill in assets ($40 bill intangible) and total liabilities of $41.9 bill ($31 bill in debt), leaving $6.6 bill in equity. Even if you assume the assets are worth 50% more today from when they were acquired, you get to a stock price of only $90. At the stock's peak of $265/share investors were paying 14x the equity value of the company, which we find unreasonable in the most optimistic of scenarios given the risks inherent in the business model and debt load.
Please call or e-mail with any questions.
Thomas Tobin
Managing Director
@HedgeyeHC
Andrew Freedman
Analyst
@HedgeyeHIT
