Valuation of the Week #9: Pricing a Pharmaceutical Company (in trouble)
Unless you have been living under a rock, you are aware that Valeant Pharmaceuticals is in trouble. The company which is incorporated in Canada but has much of its revenues in the United States had been a high flyer in this business for the last few years, as it pushed a different way of doing business, centered around less R&D and more acqusitions to generate growth, with many of the acquisitions of companies that Valeant perceived as having "under priced" drugs. Along the way, the company accumulated admirers including activist investors like Bill Ackman who liked its hard nosed strategy to the business but also doubters who felt that its accounting for acquisitions made it ripe for earnings manipulation. In the last few months, the wheels have literally come off the bus as the company has been exposed to a series of revelations that seem to suggest that its image for efficiency may be as much the result of questionable relationships with holding companies. The stock price has dropped by more than 50% in the last few weeks:
The drop in the stock price has attracted the attention of knee jerk contrarians, who believe that any stock that has dropped this much must be cheap. That, of course, is a dangerous strategy.
There are two ways to gauge whether Valeant is now a cheap stock. One is to try to do an intrinsic valuation of Valeant. I was tempted but valuing this company now, with the numbers on the verge of being restated and more revelations on the way, will be like nailing jello to a wall. The other is to do a pricing, which will tie to what we are going to do in class starting soon. I began with a very simplistic comparison of the pricing of Valeant to the pricing of other pharmaceutical/biotechnology companies in North America:
| All drug firms (660) | Drug firms with mkt cap > $ 1 billion 98) | ||||
| Multiple | Valeant | Average | Aggregate | Average | Aggregate |
| PE | 56.97 | 74.89 | 36.31 | 46.66 | 29.88 |
| PBV | 6.34 | 25.65 | 5.66 | 15.03 | 5.64 |
| EV/EBITDAR | 9.37 | 85.07 | 10.87 | 26.71 | 11.49 |
| EV/EBITDA | 9.93 | 38.76 | 15.26 | 17.11 | 16.84 |
| EV/EBIT | 17.46 | 58.49 | 19.71 | 24.85 | 22.33 |
| EV/Sales | 4.94 | NA | 5.73 | NA | 5.83 |
The first comparison is to all 660 publicly traded drug (pharmaceuticals and biotechnology) in North America that have a market price and the second is only to the 98 drug companies that have market capitalizations that exceed a billion. The first column in each is a simple average, close to useless largely because you have a few outliers with outlaandishly high values. The second is a more useful measure that is derived by adding up the market capitalizations (enterprise values) of all of the firms in the group and dividing by the aggregate value of the metric (net income, EBITDA, EBIT, Sales) of all of the firms in the group.
It is see why analysts and sales people love multiples. If I wanted to make the argument that Valeant is cheap, I would use EV/EBITDAR and EV/Sales as my multiples of choice and note how much lower Valeant is trading at, relative to the sector. If I wanted to convince you that Valeant is still expensive, I would latch on to PE ratios. It is worth noting that one reason Valeant looks attractive on an EBITDAR basis is because it does not do R&D and instead acquires other companies to grow. In this final table, I contrast Valeant's operating statistics with those for the sector.
| Valeant | All drug | Large cap drug | |
| R&D/Sales | 2.98% | 16.09% | 15.19% |
| Revenue Growth (Last 5 years) | 61.50% | 16.75% | 23.10% |
| Expected EPS Growth (Next 5 years) | 22.80% | 18.36% | 14.42% |
| Operating Margin | 28.32% | 26.09% | 29.08% |
| (EBIT Adjusted for R&D)/Sales | 30.32% | 30.48% | 33.00% |
| ROE | 11.13% | 15.55% | 18.97% |
| Dividend Payout | 0.00% | 23.36% | 19.86% |
| (Dividends + Buyback)/ Net Income | 8.26% | 49.13% | 41.73% |
| Effective tax rate | 9.84% | 38.89% | 29.75% |
The company has been able to register high revenue growth, through acquisitons, and its operating margin looks comparable to large cap drug companies, before you adjust for R&D, but lags after. Note that all of the earnings figures are also prior to special charges related to acquisitions that eat into earnings every year. In effect, the claims that the company has a found a better way to do business did not seem backed up by the numbers even before the scandal in the last few weeks, making it a curiosity that investors with as much sophistication as Bill Ackman found it to be alluring.
Bottom line
Valeant has dropped in stock price, but only to the levels of other drug companies. It may become cheap if it keeps dropping, but if you are a trader or a pricer, it does not look like a screaming bargain.
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