Behind Valeant's Lender Deal, Another Dose of Accounting Tactics

Valeant Pharmaceuticals Headquarters As Investors Rise To Its Defense

The Valeant Pharmaceuticals headquarters in Bridgewater Township, New Jersey.

Photographer: Michael Nagle/Bloomberg
  • Creditors give company more leeway to adjust earnings
  • Bookkeeping move could boost earnings by $665 million

Valeant Pharmaceuticals International Inc. was built on a streak of acquisitions and accounting maneuvers that allowed it to rack up $32 billion of junk debt. Now the drugmaker is using similar bookkeeping moves to try to keep its debt pile from tipping it into technical default.

As part of an agreement with lenders this month to loosen Valeant’s credit pact, lenders gave it more leeway to boost earnings through an accounting adjustment known as add-backs -- a move that helps the company appear more creditworthy and avoid violating loan agreements.

The changes give the company the option to increase adjusted earnings by more than $665 million -- almost double the previous allowance. Because Valeant has agreed to halt its acquisition spree, the flexibility to use more of these so-called add-backs may be critical in helping it live up to its target of about $5.7 billion in earnings before interest, taxes, depreciation and amortization for 2016.

“Valeant may have trouble” meeting its guidance without the acquisition adjustments that it used historically, according to Bloomberg Intelligence analyst Elizabeth Krutoholow.

New Agreement

Valeant added $1.1 billion back to its Ebitda in 2014 for M&A reconciliations, according to Bloomberg Intelligence. That represented a quarter of the $4.2 billion of adjusted Ebitda it posted that year, according to data compiled by Bloomberg. Under its new credit agreement, the company is restricted from making certain acquisitions, capping deals at $250 million until it files its delayed financials and cuts its leverage.

The Laval, Quebec-based company last week won support from its lenders to waive a default -- triggered by a missed financial filing deadline -- and to ease some restrictions on its loan pact. The changes give the company more time to rein in its debt load as it grapples with souring sentiment in credit markets, slumping earnings forecasts, a drug pricing scandal and lingering concerns over its financial statements. The company’s debt has ballooned to about three times its market value as its shares plunged almost 90 percent since August.

Potential, Actual

Lenders agreed to let Valeant increase the money it can budget for restructuring and for potential or actual moves such as asset sales and securities issuance, without having to deduct the expenses from a measure of earnings.

Before the change, Valeant had the ability to add more than $340 million back to its consolidated adjusted Ebitda, for expenses related to restructurings, securities issuance and deals. As well as boosting the amount the company can add back for those activities, the revised agreement allows for further items. It gives Valeant the option to add up to $175 million to its Ebitda for costs related to former distribution partner Philidor Rx Services, product pricing-related matters, inaccurate information in its financial statements and any review by the company’s board of directors.

The changes to its Ebitda calculations are important also because the measure is used to evaluate the company’s creditworthiness. Under its pacts with loan investors, Valeant will have to generate Ebitda equal to at least 2.75 times its interest expenses starting at the end of June. If it fails to do that, the investors can set in motion a series of steps that could force the company to repay debt early.

Flexibility

Assuming Valeant applied all of the allowed add-backs, its interest coverage ratio for 2016 would exceed the requirement at 3.6 times. That’s based on the $1.6 billion in cash interest expense and $5.6 billion to $5.8 billion of Ebitda the company said it will post in 2016. If those add-backs were stripped out, the ratio would fall closer to 3.1 times.

Laurie Little, a spokeswoman for Valeant, declined to comment on the earnings adjustments.

Just because lending agreements allow add-backs doesn’t mean the company will necessarily use them. Add-backs give companies the option to include certain one-time expenses in their earnings to bolster the appearance of their profits, under the assumption that the expenses will be rare occurrences.

“By accepting such modifications, investors allow the company some flexibility to deal with one-time events," said Scott McAdam, a portfolio specialist at DDJ Capital Management who has written on the accounting practice.

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