Key Takeaways From Sequoia’s Investor Conference by Stock Pucker
The thing about Sequoia is 28.5% of its fund is invested in Valeant, which is a recent Bill Ackman and Pershing Square target and former Jeff Ubben and ValueAct Capital target. It’s been a great rags to riches story in pharma growing with an aggressive M&A strategy. One of the big questions surrounding Valeant is their accounting - more on that here via AZ Value.
Here’s the best Valeant questions and answers the conference [the full 23 page transcript is here]
Question: If I could ask about Valeant as well.... Being students of the family of Berkshire, can you discuss your views and perhaps comment on what Mr. Munger insinuated about Valeant recently?
Bob Goldfarb: My guess, when I saw the comments, was that Charlie might have been targeting Valeant’s accounting. If I were going to question the accounting, the principal issue I would have would be with the accounting for the restructuring charges after Valeant makes a large acquisition. The company and the analysts who follow it add back these restructuring charges to derive the company’s cash earnings. What we do is add back the restructuring charges to the purchase price; so that if Valeant buys a company for $9 billion and there are $500 million of after-tax restructuring charges, the company effectively paid $9.5 billion rather than the $9 billion that it announced initially.
If you deduct the restructuring charges associated with significant acquisitions from a given year’s earnings, I do not think that is accurate accounting even though it does conform to GAAP. When we look at a company’s reported earnings in a given year, we are always searching for a sense of what the true earning power of that company is relative to the stock price. If you deduct the large restructuring charges in a given year, you are not going to get an accurate number for the earning power.
Question: In terms of Valeant, it has no R&D, I think. Given that any drugs that it has on patent will eventually go off patent, what is Valeant’s moat?
Rory Priday: Valeant does spend on R&D. I think the company is going to spend, adding Salix and the legacy Valeant businesses, about $300 million. We met with Mike a few weeks ago and he was telling us how with $300 million, you can get an awful lot done. Mike can get a lot done with very little. Jublia is a good example. Jublia is a toenail fungus drug that Valeant just launched last year. It spent $30 ? $40 million developing that drug over the last few years, and it is probably going to do more than $300 million in sales this year. Valeant has a number of other compounds in the pipeline, especially on the dermatology side. It bought Dow Pharmaceuticals early on in Mike’s reign at the company — he paid $285 million.
Valeant has gotten Acanya out of it, which was a $70 ? $80 million drug, and it is getting Jublia now. Valeant has six or seven drugs that it expects to launch over the next eighteen months. One of them, Vesneo, for glaucoma, management thinks could generate as much as $1 billion in sales globally. I think Mike said the company is going to spend less than $100 million on that program, in total. With an R&D budget of $300 million, Valeant can do quite a bit in terms of building its pipeline. In terms of the pharmaceuticals and Valeant’s exposure to patents, one of the things the company has tried to do is go into areas where the company has durable products. Valeant has a lot of branded generic drugs overseas, which are off patent drugs. Valeant has contact lens solutions and OTC pharmaceuticals.
It has CeraVe, which is a moisturizer. And Valeant has a lot of drugs that are not going off patent. The key in the pharma game is always, once you have the distribution, once you have a sales force in the ophthalmology space or in the dermatology space, how do you source innovation? You can do that through R&D or you can do that through buying things. Mike is making a big bet that it is cheaper sometimes to buy things, to source that innovation when you have the distribution. So it seems like that model is working. The business is growing right now pretty nicely.
David Poppe: Mike Pearson believed that he could build a large and successful pharmaceutical company without taking the risk of expensive R&D that most large, successful pharma and biotech companies had taken. He would instead do it by focusing on specialties that did not require these risks through lean R&D, zero-based budgeting, minimal taxation, and high returns from the get-go on numerous acquisitions. He would target companies of all sizes in product and geographic areas in which big companies did not compete and in which there was minimal reimbursement risk. By avoiding all of those other risks, he would be able to take some risk by leveraging his balance sheet to generate very rapid growth and high returns on total capital and spectacularly high returns on shareholders’ equity
Question: Going back to Valeant, I believe it is almost 20% of the portfolio. Could you shed some light going forward?
Bob Goldfarb: It is actually more than 20%. We are always reevaluating it in terms of the risks and the rewards. To date, we have always believed that the rewards outweighed the risks. That said, the company has been operating in a fairly benign environment despite the risks that we consider. I think particularly of the risk that the low interest rate environment could change unexpectedly. But Valeant has been able to borrow money at very reasonable rates to fund acquisitions.
As Rory mentioned earlier, the company has used equity very sparingly. The second risk would be Mike Pearson’s health and longevity. So far so good — he is 55 — the mortality tables would suggest that the risk there is relatively low at this juncture. A third risk would be changes in drug pricing by the government and/or the payers, the pharmacy benefits managers and the HMOs. A fourth risk, which the company lived with in the earlier days of our ownership, was genericization. But at this point in time the portfolio is less subject to genericization within the foreseeable future.
In terms of the opportunities, management has guided to earnings of about $11 a share this year and it has given a number for EBITDA that translates into about $16 a share of earnings for next year. So the company certainly sees the very rapid growth continuing into 2016 and I think the market is beginning to accept that number and price it into the stock to some extent. One major change since we met a year ago was that the organic growth has really accelerated. It is double digit this year and we would expect a continuation of double digit organic growth next year. So Valeant has really transformed its portfolio. After the merger with Biovail in 2010, organic growth was not very good for several years. But due to some very smart acquisitions since then, Valeant has rejiggered the portfolio so it is now geared for substantial organic growth.