Valeant Creditors Spooked by Possibility of Revenue Squeeze

  • Loss of mail-in pharmacy casts doubt on ability to cover debt
  • Some analysts are more optimistic about cash flow than others

In the course of a three-year, $23 billion borrowing binge that allowed Michael Pearson to turn Valeant Pharmaceuticals International Inc. into a drug-industry juggernaut, he reassured yield-hungry debt investors with this: lend us the money and watch the cash stream in.

Pearson, the chief executive officer, said in a Tuesday conference call that Valeant’s drug-pricing scandal and the severing of ties with mail-order pharmacy Philidor Rx Services will “significantly” disrupt its dermatology and neurology businesses. Together they account for about 24 percent of company revenue, according to KDP Investment Advisors Inc.

Valeant shares have plummeted 67 percent since Aug. 11, and while the debt market isn’t exactly panicking, many debt investors have bailed. Concern is growing that disruption to Valeant’s cash flow could heighten the risk of the company violating lender limits on its debt burden. Even believers are passing on the chance to buy the drugmaker’s bonds and loans on the cheap after taking on too much exposure to a company that’s now one of the world’s biggest junk-bond issuers.

“The big question is: What is the true cash-flow generation nature of the company? Will it be materially different?” said Sabur Moini, a money manager in Los Angeles at Payden & Rygel, which oversees about $85 billion in fixed-income assets, including Valeant debt. “We’re cautious.”

Some of Valeant’s secured lenders are selling. The company’s $4.15 billion loan, due 2022, traded at 93 cents on the dollar on Tuesday, according to quotes compiled by Bloomberg. it was trading at par until September. Only 6 percent -- 205 out of 3,285 -- of the dollar-denominated corporate loans tracked by Bloomberg that have secondary-market prices trade below that level.

“That’s the smoking gun to me,” said Vicki Bryan, senior credit analyst at Gimme Credit LLC.

Valeant risks violating its credit agreements and triggering a technical default on its senior debt next year if its Ebitda -- earnings before interest, taxes, depreciation and amortization -- over a 12-month period aren’t enough to cover its interest expense at least three times.

The company’s interest-coverage ratio was 3.6 times for the 12 months that ended Sept. 30, Valeant said on the call Tuesday. It posted Ebitda of $5.7 billion for that period, according to Michael Levesque, an analyst at Moody’s Investors Service.

“We were already seeing uncomfortable closeness to covenant limits before anything blew up,” Bryan said. “I have to assume that covenant pressure is only going to increase.”

A Valeant spokesman declined to comment beyond what was said in the conference call.

Ebitda Forecast

The drugmaker said in October that Ebitda would grow to $7.5 billion in 2016 and reiterated its commitment to bringing net leverage below 4 times Ebitda by the end of next year. Company executives warned on Tuesday that the disruptions to its dermatology business would be significant in the short term. Pearson said the neurological business would suffer after the company was forced to offer “significant” discounts on some of its drugs.

“When you put it all together, the question is, will there be a significant shortfall relative to the earlier expectation of $7.5 billion for Ebitda?” Levesque said in an interview.

Valeant’s Ebitda could fall to between $5.6 billion and $5.9 billion next year, according to David A. Kaplan, an analyst at Standard & Poor’s, which would further stress the company’s interest-coverage ratio. Kaplan cautioned that the forecast may be conservative relative to the way that senior lenders evaluate the number when assessing financial-covenant ratios, meaning Valeant could generate less and still comply with covenants.

Interest coverage probably won’t fall below the minimum threshold next year if the company can sustain Ebitda of $5.7 billion, at least during its transition away from Philidor and given the reduced revenue it’ll get from discounted products, Levesque said.

Even without Philidor or steep drug-price increases, the company still has growth and sizable scale, Levesque said. Its dental and contact lens businesses are still growing and will probably become an increasing part of Ebitda, he said.

More Optimistic

CreditSights Inc. analysts led by Eric Axon took an even more optimistic tone. Valeant will have $2.1 billion of discretionary free cash flow left over in 2016 after it pays off mandatory obligations, they said in a note Tuesday. That would help it push the interest-coverage ratio on its $1.6 billion in yearly interest expenses to 3.8 times.

Of course, there are two ways to keep interest-coverage ratios above prescribed minimums -- earn more or owe less.

Valeant will spend the “lion’s share” of its incoming cash next year on debt repayment as it tries to reduce leverage, Pearson said on the call.

Much of that incoming cash is already dedicated to debt service. Valeant will have to spend $2.4 billion next year just to keep up debt obligations that include term-loan maturities, amortization and $1.6 billion in interest expenses, according to the company’s numbers. It’ll have to pay down more than that to reach the leverage metric of 4 times debt-to-Ebitda it’s targeting for next year, Levesque said.

Only one other company has issued more high-yield debt than Valeant this year, according to data compiled by Bloomberg. Valeant borrowed $10.1 billion in March to buy Salix Pharmaceuticals Ltd. -- at the time the largest deal in the junk-bond market in almost a year.

The size of Valeant’s debt works against it, said Margie Patel, a money manager for Wells Capital Management in Boston, which manages $351 billion.

“They were a huge issuer, making up a good chunk of the market, and as such everyone who wanted to be involved was involved,” Patel said. “Now, facing negative news, there are fewer people to sell to. That’s exacerbating the price action.”

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