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Can Valeant Pharmaceuticals Cure Itself?

Tuesday, March 15h, 2016

I first heard about Valeant Pharmaceuticals International (VRX) in the fall of 2015.

At that time, the stock was trading well above $200 a share. Bill Ackman, who runs a hedge fund called Pershing Square Capital Management, was talking very highly of the company even though it fell from over $250/share to about $200/share.

Things have become progressively worse for this company, and I imagine as well for Mr. Ackerman since he holds nearly 17 million shares of the stock.

His investment could have been worth over $3 billion dollars at one point, and is now worth somewhere around $600 million. 

It should also be noted that VRX is a Canadian company, not a United States one. Even with the pullback in the stock from above $200/share, the price/earnings ratio (also known as the PE) is still high at 39.1. Over the last five years, this has been the lowest PE ratio for the company.

Price-to-sales looks okay at 2.4. However, I cannot say the same for the price-to-tangible book value, which is not material. This means if you back out all the intangible assets, there is no value to the company and this is not a good thing. 

One thing that may have excited Mr. Eckman was the sales that were up 24.1%, and earnings increased by 19.5%. I should point out that the financial statements are nearly six months overdue and these are numbers from September 2015.
A strong balance sheet is very important to me, and unfortunately this company’s is very weak. The current ratio is 1.5, which in reality is not that bad, but the debt-to-equity is terrible at 487.

The net profit margin and the return on equity look okay at 6.1% and 10.6%.  I would give the company a grade level of "C".

With only five analysts following the company, the pre-exempt earnings estimates for the year ending December 2017 are $15.46. However on a more stringent measure known as GAAP estimates for December 2017, the earnings estimate per share is cut in half to $7.26. 

The stock has now fallen to under $34/share, and using the share estimate of $7.26, it appears to be very attractive with a forward PE of 4.7.

But before you run out and buy this company, there are three reasons the stock has fallen so much. The first is an accounting issue, where the company recognized $58 million in revenue before they were entitled to. In addition, they removed the financial guidance for 2016 and postponed the quarterly conference call. Lastly, and maybe the biggest of the three, the company has now been hit with a probe from the Securities and Exchange Commission. This is something that no investor wants to see.

A year or two ago, I'm sure no one cared about the amount of debt this company had on the balance sheet. But now that they have stumbled, the debt that VRX owes to its creditors may cause the doors to close.

Hedge funds are very risky, take on big bets, and can leverage their portfolio as much as they want. Their fees are very high as well; the norm is a 2% management fee and 20% of the profits.

Over the years, many hedge funds have closed their doors because of how poorly they have done. I think it is best to simply invest in good quality companies through stock ownership, while not worrying about the short-term ups and downs. 

As investors you must be careful, because your broker may be trying to get you into alternative investments, including hedge funds.

So the next time you hear a broker tell you to diversify into alternative investments, be sure it does not include hedge funds!

Do you have a question or a company you would like us to take a look at?
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