Valeant is deeply undervalued as it will generate enough cash to buy back the entire company and pay off debt in 9 years.
I examine Valeant's cash generating power in the absence of price increases and specialty pharmacies.
Valeant's cash flows masked by restructuring costs and acquisitions.
In a worst case scenario, Valeant will generate $68bn in total cash, enough to take the company private and pay a $22/share special dividend.
It is clear that the company has been pursuing aggressive growth strategies of reducing the cost of its drugs for patients (through Philidor) while increasing the price of its drugs. While investors have correctly sold the stock as these practices cannot continue, it has now come to a point where the cash flow generating potential is being ignored. This creates a unique buying opportunity for a long-term investor.
Historical perspective on VRX cash flows
As you can see from the table below, VRX reports a GAAP operating cash flow and an Adjusted Operating Cash flow.
| | 4q14 | 1q15 | 2q15 | 3q15 | Total |
| CFO - GAAP | 529 | 491 | 411 | 737 | 2,168 |
| CFO- non GAAP | 624 | 708 | 773 | 865 | 2,970 |
| Adjusted Net income | 881 | 809 | 897 | 962 | 3,549 |
| Delta | -95 | -217 | -362 | -128 | (802) |
In the last 4 quarters, they have generated $800m less in GAAP operating cash as a result of the inventory flushing of the Salix pharma products and restructuring costs. Note I've excluded the gain from their Allergan stock in q4 2014. However, as these costs have wound down due to fewer large acquisitions, and Salix inventory normalization, the gap narrowed in the last reported quarter. Thus based on the q3 results, it's clear that the company will generate at least $3.6bn in cash in 2016
Constructing a worst case future scenario
VRX is now a fundamentally different company post its acquisitions of Salix, Dendreon, and Bausch and Lomb. In Q3 2015, these contributed 35% of total VRX sales. The products sold by these businesses have demonstrated significant consumer/patient benefit and organic growth has accelerated under VRX ownership.
Analysts have recently reduced their 2016 revenue targets for VRX to $13.0 bn. With the recent approval of Xifaxan in IBS-D, expected approval and launch of oral Resistor, and the refreshed B+L portfolio I estimate that these businesses along with the other non pharma businesses will contribute approx. $7bn in 2016 revenues. I consider these as core VRX revenues. So the remaining portfolio is expected to be $6bn of NON-CORE revenues.
When viewing the business through this core vs non-core lens, it's reasonable to make the following assumptions:
1. VRX will see volume declines in its non-core portfolio and no price increases. This portfolio has been declining 1% ex price which is a safe assumption to make going forward
2. VRX will incur incremental costs from higher compliance infrastructure (to avoid another Philidor) and will have to accept lower margins for its non-core business as it sells the products through other channels
3. Core revenues (Xifaxan, B+L, other non pharma products) continue to grow at an accelerating pace
As you can see from the table below, this translates into an organic growth of 4% from 2016-2025:
| | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | CAGR |
| Non-core VRX revenues | 5.9 | 5.8 | 5.7 | 5.6 | 5.7 | 5.6 | 5.6 | 5.5 | 5.4 | 5.4 | -1% |
| Core VRX revenues | 6.9 | 7.6 | 8.3 | 8.9 | 9.6 | 10.4 | 11.2 | 12.0 | 12.7 | 13.3 | 7% |
| Total revenues,$bn | 12.8 | 13.5 | 14.0 | 14.5 | 15.2 | 16.0 | 16.8 | 17.5 | 18.1 | 18.7 | 4% |
By contrast, analysts currently forecast that VRX will generate >$25bn in sales by 2025. So in our worst case scenario the company will generate $6bn less.
Future cash flow forecasts
VRX has guided to a floor EBITA of $7.5bn in 2016. Since that was before they discontinued using Philidor and changed pricing tactics, it's fair to assume that 2016 EBITA will be reduced by the incremental costs and loss of volume. My 2016 estimate is $6.7bn or 10% below company guidance. Additionally, with the lack of pricing power, it's reasonable to assume that its EBITA will grow slower than sales.
The one other thing to consider is that VRX is likely to continue to restructure its business so GAAP cash flow will be lower than adjusted cash flow. This is a pretty onerous assumption if the company will not do any more acquisitions but still worth considering in a worst case scenario
Here are my free cash flow forecasts after assuming declining margins and ongoing Cash restructuring costs and capex equal to the depreciation:
| | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | Total |
| EBITA, $bn | 6.7 | 7.0 | 7.2 | 7.4 | 7.7 | 8.0 | 8.4 | 8.7 | 9.0 | 9.2 | 79.1 |
| EBITA Margin, % | 52.0% | 51.7% | 51.2% | 50.7% | 50.3% | 50.1% | 50.0% | 49.8% | 49.6% | 49.4% | 50.4% |
| After tax EBITA | 6.4 | 6.6 | 6.8 | 7.0 | 7.3 | 7.6 | 8.0 | 8.3 | 8.5 | 8.8 | 75.2 |
| Restructuring costs | -1.2 | -0.7 | -0.7 | -0.7 | -0.7 | -0.7 | -0.7 | -0.7 | -0.7 | -0.7 | (7.5) |
| Free cash flow before interest expense flow | 5.2 | 5.9 | 6.1 | 6.3 | 6.6 | 6.9 | 7.3 | 7.6 | 7.8 | 8.1 | 67.7 |
So even with slower sales growth, declining margins, and ongoing restructuring the company will generate $68bn in operating cash.
Conclusion
The stock closed at a market cap of $29bn on Nov 7. They have total debt outstanding of $31bn. That implies a total enterprise value of $60bn. With the company on track to generate $68bn in cash in the next 10 years in a worst case scenario, VRX will be able to take itself private in 10 years and still have cash left over to pay an $8bn or $22/share one time dividend to its shareholders. It's rare that you have good companies trading at these distressed valuations.