Pharmacy is hard consumer brands are better
Pharmacy is tough companies spend millions of dollars to develop drugs that have protection for around 20 years before low cost generic competitors enter the market and eliminate profits. This risk is known as the patent cliff where revenues from protected products can drop dramatically when protection runs out. Research and development spend to produce these drugs tends to be high risk but low reward with only 4% of compounds becoming approved medications, it has been estimated that R&D investments produce around 4.8% ROI.
Source: Valeant Pharmaceuticals
Make or buy decision
Instead VRX conducts targeted research and development. The CEO believes that R&D is generally a waste of money. It is better to make small bolt on acquisitions with successful medications that can benefit from VRX's distribution and sales team. VRX chooses to buy products instead of investing in creating them. VRX assigns no value to the acquisition pipeline and tends to pay cash. VRX is not a roll up story that is reliant on issuing expensive acquisitions reliant on an expensive share price. The Allergan acquisition below is an exception due to the size.
One big injection (botox)
Bausch + Lomb was a major acquisition in 2013 this year producing organic growth of 12%, 8 of VRX's top 20 products are Bausch + Lomb products. This acquisition is serving as a model for what VRX hopes to achieve with Allergan. VRX has decided to bid for Allergan the maker of Botox. VRX is offering US$58 per share and 0.83 VRX shares for Allergan. Its a big bite for VRX but they believe they can drastically cut costs at Allergan. They also share similar consumer type products which are out of pocket expenses not reliant on government reimbursements Botox is also more of a consumer durable than a pharma product. Once again the opportunity for VRX is to reduce costs as the average pharma spends 19% on research and develop versus VRX 3% below.
Source: Valeant Pharmaceuticals
Cash is fact profit is an opinion
VRX financials are messy. It is a company that has done 100 acquisitions over the past 5 years. There are a lot of restructuring charges, acquisition accounting and amortization of intangible patents but importantly free cash flow has been strong. As anyone with a business knows cash is king. You can actually do things with cash in the bank but accounting profits are just a number on a page.
Source: Valeant Pharmaceuticals
VRX has become a battleground stock with those who love the cost cutting model and those that hate the low research and development spend. The stock trades at a 12x multiple with the opportunity to take on another great consumer brand like Botox alongside with Bausch and Lomb. Its a stock that eventually could trade on a more durable consumer product multiple than that of a pharmaceutical stock. With Bausch and Lomb eye drops it is a company to keep an eye on.
Jason
Disclosure: Decisive does not have a position in Valeant (VRX) stock
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