Valeant Risks Dilution as Debt Threatens Rating: Canada Credit
Valeant Pharmaceuticals International Inc. (VRX), Canada’s most acquisitive and indebted junk-rated company, will probably turn to the equity market to fund further purchases as it seeks to avoid a credit-rating cut.
“We’re not going to issue bonds and make our leverage worse,” Chief Executive Officer Mike Pearson, said in a March 19 interview at Bloomberg’s Toronto office. “We have a commitment to our lenders.”
Moody’s Investors Service Inc. has said Pearson’s strategy of growth by acquisition -- which the rating company estimates has left Valeant carrying about 4.5 times more debt than pre-tax earnings -- could lead to a downgrade if that ratio is not brought below four.
Pearson said he can do another deal this year that’s comparable in size to his debt-fueled $8.7 billion purchase of the eye-care company Bausch & Lomb Inc. in 2013 without raising the leverage ratio, and maybe even reducing it.
“We can use equity,” he said, adding that “in all likelihood” he will do a deal without selling bonds. “Depending on how much equity we could de-lever. The deal could get us under” the four times ratio highlighted by Moody’s.
He said in the interview he’s committed to reaching that target by year-end.
Valeant shares fell $3.22, or 2.3 percent, to $137.19 at 10:14 a.m., the third straight day of losses.
Pearson has added $17.3 billion in long- and short-term debt to the Laval, Quebec-based company’s books since taking over in 2008. Valeant has been the most acquisitive company on Canada’s benchmark S&P/TSX Index in the past three years, data compiled by Bloomberg show. It has spent at least $19 billion since 2008 to buy 35 different firms. On absolute terms, it’s the most indebted junk-rated firm in Canada, data compiled by Bloomberg show.
The strategy has paid off for shareholders, sending the stock on a nearly 10-fold increase since 2008. It’s also rewarded bondholders. Valeant debt has returned 7.3 percent in the past year through yesterday, more than the 5.2 percent return on the Bank of America Merrill Lynch U.S. & Canada BB-B High Yield Index.
“We care about our equity investors, and we care about our bond investors,” Pearson said. “Our bondholders have made a lot of money.”
The Bausch & Lomb acquisition in August was Pearson’s biggest deal to date, and he reiterated he’s aiming to do a similar-sized transaction this year. He declined to name any companies. Teva Pharmaceutical Industries Ltd., the Israeli manufacturer of generic drugs, has been mentioned as a possible target by analysts including Raghuram Selvaraju of Aegis Capital in New York.
While Valeant remains much smaller than world’s biggest drugmakers -- Sanofi, the fifth-largest, has a market value of about $134 billion -- Pearson isn’t daunted by his goal of becoming one of the top five by the end of 2016. The acquisition of closely held Bausch & Lomb helped vault Valeant from a market value of about $27 billion to $46.6 billion.
While a transaction may involve some new debt, it wouldn’t come at the expense of the overall leverage ratio, Pearson said.
“We’re committed to working on our leverage,” he said. “If we had an acquisition that was large enough we could use enough equity to get our leverage down, but we could still do more bonds.”
There’s precedent for pharmaceutical companies bringing down their leverage ratios by issuing equity to fuel acquisitions, according to Michael Levesque, the analyst at Moody’s who covers the company.
The key metric the ratings company looks at is not how much total debt the company has in determining whether to downgrade from its Ba3 rating, Levesque said; it’s debt compared to earnings before interest taxes, depreciation and amortization, or Ebitda.
“If they use 100 percent equity, then their earnings would benefit from the Ebitda that they would acquire,” he said in a telephone interview from New York. “Their Ebitda would instantly go up, but their debt would stay the same.”
In the long term, rising interest rates mean Valeant’s deal-making may slow down. The yield on the benchmark U.S. Treasury 10-year note climbed 10 basis points on March 19, or 0.10 percentage point, the most in four months, after Federal Reserve Chair Janet Yellen suggested interest rates may rise by the middle of next year. The key rate has been held at zero to 0.25 percent since 2008.
Higher borrowing costs raise the threshold for what makes an appropriate deal, Pearson said. With the cost of capital where it is, an acquisition must guarantee a 20 percent return, he said. If those costs go up, a 25 percent return may become the minimum.
“If interest rates go up a percentage point, we don’t like that, but it’s not going to stop us from doing our strategy because interest rates are still pretty low,” Pearson said. “They’ve been historically low. Has it helped us over the last six years to be in a low-interest environment? Absolutely. The strategy will still work.”
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