Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Jacked-up drug prices and a convoluted distribution network have been at the heart of Valeant's controversies. A far thornier issue is simmering in the background: All those IOUs.

Borrowed money is the lifeblood of Valeant Pharmaceuticals. It’s what keeps the acquisitions pumping. Salix, Medicis, Amoun, Sprout, Provenge, Bausch & Lomb -- more than 50 in all, and the debt has stacked up.

As everyone tries to get a handle on the scrutiny and allegations Valeant's now facing, damage is already being done to its credit standing. On Friday, the pharma giant was downgraded deeper into junk territory by Standard & Poor's, threatening its ability to maintain the deal-fueled growth model that rewarded its investors monumentally in the past.

Valeant distinguished itself by having one of the industry's fastest growth rates with minimal investment in research and development of new products. Some say it more closely resembles a private-equity firm because of its penchant for acquisitions and slashing costs. But with its deteriorating credit quality, it's possible that the same company to kick off the industry's takeover spree will need to pull back. The catch-22 is that it needs acquisitions to bring in more cash-generating products in order to reduce debt.

At $31 billion, Valeant's debt load is almost sixfold what it was four years ago. That's also a leverage ratio of 7 times Ebitda, compared with a median of 2.3 for members of the Standard & Poor’s 500 index.

This hadn’t concerned many investors or analysts previously because the idea was that Valeant would just keep doing more deals, which would bring in ever more cash flow. Allergan, with which it pursued a mega-merger 18 months ago, would have been the ultimate vehicle for Valeant to improve its credit worthiness. But at the time, bankers were advising clients invested in Allergan to take cash, not stock, if any were approached by the suitor because of the risk associated with a company whose fate is dependent on constant M&A. 

Allergan averted Valeant's cash-and-stock bid and instead sold to Actavis. It wasn't long after that things started to head downhill for Valeant. While its shares did reach a high on Aug. 5, and 85 percent of analysts recommended buying more, the price has dropped by more than half since. 

Valeant's bonds also lost 11 percent this year through October, a worse performance than any of the top 50 issuers in the U.S. pharmaceuticals industry, according to Bank of America Merrill Lynch indexes. Its weighted average debt coupon is almost 6 percent, higher than most of its rivals, data compiled by Bloomberg show.

S&P said that recent developments regarding Philidor -- the shadowy pharmacy Valeant just severed ties with -- further harms Valeant's "already tarnished reputation." With an already high cost of debt in a period of otherwise low rates, this added perceived risk could hinder its ability to borrow more money. And good luck persuading investors to accept Valeant shares as payment in a deal. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net