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A Buried Scandal, Shedding Of Assets, And Forthcoming Spinoff Means Substantial Upside For Bausch Health

Apr 28, 2021

William "Bill" Ackman, founder and chief executive officer of Pershing Square Capital Management LP, ... [+] from right, Howard Schiller, former interim chief executive officer and former chief financial officer of Valeant Pharmaceuticals International Inc., and Michael "Mike" Pearson, chairman and chief executive officer of Valeant Pharmaceuticals, listen during a Senate Special Committee on Aging hearing on Valeant Pharmaceuticals in Washington, D.C., U.S., on Wednesday, April 27, 2016. After months of turmoil, which began with a controversy over the price increases of two cardiac drugs by 525 percent and 212 percent, Valeant has lost more than 85 percent of its stock market value, failed to file its annual report, and said it is being investigated by the U.S. Securities and Exchange Commission. Photographer: Andrew Harrer/Bloomberg *** Local Caption *** Bill Ackman; Howard Schiller; Mike Pearson © 2016 Bloomberg Finance LP Five years is a long time. Even a week in politics or business can see off the taint of scandal or poor leadership. Not usually in pharma, though, where cutting-edge drugs often take decades to develop. Add in a Coronavirus pandemic - oh, and a massive coordinated gut-busting effort at producing the vaccine to fight it - and things have been fast-forwarded somewhat. Pharma stocks were the old cyclicals, the defensive ones. The reliable ones. Then came a few scandals, paralleled with a public disenchantment with science and traditional medicine and well, you probably know the rest. One company synonymous with scandal was Valeant Pharmaceuticals. The company, whose name was a Latin derivative of both strength and health, could - like so many rivals - originally do no wrong. The Valeant Years Valeant was founded in California 1959 as ICN Pharmaceuticals by Milan Panić. He was at the helm of the company for 47 years. In 2003, after he was ousted from the company due to ill health, ICN was renamed Valeant Pharmaceuticals. By 2015, a series of acquisitions (including Bausch & Lomb in 2013) had created one of the most valuable companies in Canada. The driving force behind Valeant was CEO J. Michael Pearson, a McKinsey & Company alumnus who took over the role in 2009. Pearson saw through Valeant’s merger with Biovail in 2010 when the company moved to base itself in Canada, largely for tax reasons. MORE FROM FORBES VIDEO McKinsey and Co. Pearson’s management style attracted attention, mainly because he made no secret of the need to appease shareholders by pursuing an aggressive acquisition strategy. His clinical leadership style of scarfing up smaller companies meant Valeant had no need to invest in R&D, it just had to buy up innovation and watch the stock climb. This momentum met several brick walls; notably a failed merger with Allergan in 2014 which resulted in the company being sued for insider trading. By 2015, Valeant was being investigated for price fixing by the U.S. Securities and Exchange Commission. This caused its stock price to plummet more than 90 percent from its peak. Its debt surpassed $30 billion. The party was over. SAN FRANCISCO, CA - MAY 28: Boxes of Bausch and Lomb contact lens solution sit on a shelf at ... [+] Arguello Market on May 28, 2013 in San Francisco, California. Valeant Pharmaceuticals, Canada's largest drugmaker, reported Monday that they will purchase eyecare product maker Bausch and Lomb from private equity firm Warburg Pincus for $8.7 billion. (Photo by Justin Sullivan/Getty Images) Getty Images The Eye Care Crown Jewels   In 2016, Pearson was replaced by Joseph C. Papa, and for a while activist investor Bill Ackman (who had been one of Pearson’s allies in his attempt to take over Allergan) was kept on as an advisor; though in 2017, Ackman's Pershing Square sold out of Valeant for a reported loss of $2.8 billion. So far, so bad. But the story of Valeant may not be over yet. In fact, The Edge believes it may only just be beginning. Pearson’s decision to buy Bausch & Lomb for $8.7 billion in 2013 is now looking like a smart move and one that could see the company restored to an even greater glory. The B&L takeover meant Valeant was able to slough off the association with its name by rebranding itself Bausch Health Companies, Inc. (BHC) in 2018. A move that became, with hindsight, even smarter when on August 6, 2020, BHC announced it would be Spinning off its crown jewel eye health segment - Bausch & Lomb - into an independent publicly traded company. As CEO and Chairman of BHC since May 2016, Joseph Papa has more than 35 years of experience in the pharma, healthcare and specialty pharma arena. Having an impressive value return for shareholders at his previous position as CEO at Perrigo Co. Plc (PRGO) from October 2006 to April 2016 (PRGO up +625 percent vs +53 percent S&P 500 Index return), the stock price at BHC has been less than stellar over the nearly five years at the helm (BHC down -11 percent vs +89 percent S&P 500 Index return). Mr. Papa was credited for the successful build-up of PRGO and fighting off a hostile takeover bid by pharma giant Mylan in 2015, which secured a $2 million pay bump for key contributions related to the takeover attempt. Shortly after, Mr. Papa resigned and left PRGO in April 2016, to the dismay of PRGO’s management at the time of how Mr. Papa left the company, following which PRGO slashed its full-year earnings guidance. Mr. Papa was brought in to turnaround and transform BHC and a new executive team was brought in to deal with its high debt levels, accounting and business practice issues, and to resolve the coming class action lawsuits. Mr. Papa was credited for the successful build-up of PRGO and fighting off a hostile takeover bid by pharma giant Mylanin 2015, which secured a $2 million pay bump for key contributions related to the takeover attempt. Shortly after, Mr. Papa resigned and left PRGO in April 2016, to the dismay of PRGO’s management at the time of how Mr. Papa left the company, following which PRGO slashed its full-year earnings guidance. Mr. Papa was brought in to turnaround and transform BHC and a new executive team was brought in to deal with its high debt levels, accounting and business practice issues, and to resolve the coming class action lawsuits. The Spinoff was originally expected to be completed by the first quarter of 2021 but has since been pushed to Q3 2021. However, the fact BHC can consider a Spinoff in the first place indicates a remarkable turnaround. The Edge is convinced this is one of the most extraordinary re-inventions of the last few years. FILE - In this March 15, 2016 file photo, a trading post on the floor of the New York Stock Exchange ... [+] displays the Valeant Pharmaceuticals logo. The Wall Street Journal reported Thursday, April 21, 2016, that Valeant is finalizing a contract with Perrigo Chairman and CEO Joseph C. Papa and could announced the hire as early as next week. Perrigo said Friday that it would not comment on “speculation or market rumor.” (AP Photo/Richard Drew) ASSOCIATED PRESS Activism as Revisionism  Several well-known activist investors hold stakes in BHC (close to 30 percent of the outstanding shares), some of whom have seen themselves through the company’s previous incarnation. Having been involved with this company since 2014, activist investor ValueAct Capital still holds a top five position, while the firm’s partner Dr. Robert Hale has served on BHC’s board since August 2015. Likewise, John Paulson (President of Paulson & Co) has served on the board since June 2017 and is currently the largest shareholder of the company, which was a mantle previously held by Bill Ackman’s Pershing Square Capital back in 2015. Mr. Paulson increased his position by 25 percent in Q2 2020 (adding 5 million shares), taking his total stake up to 25.8 million shares. More recently, Larry Robbins of Glenview Capital took a 5.9 percent stake in late July 2020. Glenview pushed for the break-up of Tenet Healthcare Corp by 2021, now expected to be completed in Q1 2022 after pandemic-related delays. Likewise, activist Carl Icahn added a new stake in BHC during Q4 2020, reporting an 8 percent stake. With debt continuing to be a major eye-sore for investors, The Edge believes the presence of Icahn and adding two of his nominees to the board (portfolio managers of Icahn Capital LP) could bring on other strategic options outside of the currently announced Spinoff to unlock value. Potential Index Shift Leads to Selling Pressure BHC is not part of the S&P Index and while the Spinoff is likely to remain in the NYSE and the TSX (as guided under the methodology of the S&P/TSX Canadian indices where the Spun off company is added to all of the indices of which the Parent is a constitute), there is potential for B&L being removed from the S&P/TSX 60 Index. BHC is currently the 48th largest constituent out of 60 on the index by market cap size. The smallest player, SNC-Lavalin Group (SNC CN), has a market cap of over CAD $4.6 billion. While not explicitly clear, there is the possibility that if BHC (Parent, ex-Spin) is listed at the estimated CAD $3.2 billion market cap size (below SNC’s market cap), BHC may be removed from the S&P/TSX 60 Index, resulting in some initial selling pressure. Thinking along similar lines, The Edge expects BHC (Combined) to sell its Skin Care/Aesthetics business (within the Ortho Dermatology segment), Solta, ahead of the upcoming Spinoff in order to further lower its leverage. The sale of Solta is worth a potential $1.9 billion (valuing on FY22E deal multiple of 15x on FY22E EBITDA of $125m). Experience-Driven Value Creation Alongside the Spinoff plans, there have been a couple shake-ups in the top offices at BHC. Previously serving as Senior VP, Controller and Chief Accounting Officer, Sam Eldessouky was recently promoted to Chief Financial Officer (CFO) and PNR in 2012 and COV and Tyco Electronics in 2006. The Edge believes Mr. Eldessouky will leverage his previous experiences and play an important role in replicating Tyco’s success with BHC’s own upcoming separation. Couple this with Herendeen supporting Papa in his efforts, and the management is in a strong position to build on BHC’s legacy once the Spin is complete. What’s Next for BHC? The company is expected to provide further clarity around the Spinoff, as well as new executive leadership when it releases its Q1 2021 earnings in early May. Post-Spin, BHC will be a pharma business with an estimated net debt of $14.6bn (at 6x on FY22E EBITDA). Although the debt load is quite high, BHC’s high EBITDA margin of 53 percent in FY22E makes the case for a sustained debt reduction in the next few years, bringing the company down to its peer average debt profile of 2.9x. At current technical split levels, Bausch & Lomb (Spinoff) is trading at roughly a 56 percent discount to its peer average of 23.8x. The Edge expects this break-up to help reduce this discount pre-Spin with attractive potential upside for investors. While the prospectus has not yet been filed, The Edge’s combined and SOTP valuations highlight a strong amount of potential upside (+45 percent for BHC on a combined basis) with limited downside (-11.8 percent Bear Case) and further value creation for Bausch & Lomb (Spinoff) once it becomes independent. Reach out here for The Edge’s analysis on BHC and for more details on the 30+ Spinoffs on the calendar.

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