Margin for Error Gets Much More Narrow for Valeant Pharmaceuticals Intl Inc (NYSE:VRX)

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It doesn’t take a genius to see that Valeant Pharmaceuticals Intl Inc (NYSE:VRX) had a disappointing quarter. The real question for investors is how quickly new CEO Joseph Papa can right the ship.  Papa called Valeant’s turnaround a “multi-year process.” The burden of the company’s $31.3 billion dollar debt pile is building and the company’s just over $1B EBITDA in the quarter will not do the trick going forward.

Guidance of $4.8 billion to $4.95 billion

Valeant guided for $4.8 billion to $4.95 billion in EBITDA. The problem is this projection comes after several drops in guidance, most recently from $5.6 billion to $5.8 billion, and the latest revision puts the company right at the edge of complying with its agreements to lenders according to Bloomberg. Any further slip ups and lenders could demand repayment.

Even with new management it has become very difficult for investors to trust.

“Problems in a company are like cockroaches in the kitchen. You will never find just one.”

-Warren Buffett

The company has cash interest expenses of $1.7 billion and to remain in compliance must have an interest ratio coverage of 2.82 times that in 2016. This would leave the low-end of the company’s 2016 EBITDA estimate at just over the 2.75 times it needs.

Based on the midpoint of guidance and given projected costs for Taxes, Restructuring, Capital Expenditures, Contingent Considerations/Milestones, and a Sprout Payment, Valeant will have just over $1.7 billion available for debt repayment and other purposes. This comes with some strings attached as the company can not make any acquisitions worth more than $250 million until it reduces it’s leverage below 4.5 times. The company is currently at “approximately” 6 times leverage if you use the mid-point of the most recent guidance.

First quarter 2016 EBITDA came in at just over $1B, which means to reach their goals for 2016 and stay out of debt trouble the company will have to average around $1.27B of Adjusted EBITDA per quarter for the rest of the year.

How will they get to their Guidance?

In VRX’s Q1 presentation they lay out several items that they hope will get them there.  The company hopes Historical Seasonality to drive the significant part of improvement, with Fixing Dermatology and growth acceleration in Salix to be the second largest driver. They also hope Other Markets Growth to mostly offset losses in Generic Erosion and Pricing. Last year Valeant had over $580 million more in average revenue Q2 through Q4 2015, but it is hard to isolate this for the affects of any acquisitions.

At this point it’s hard to get a sense of whether Valeant can deliver or whether there are more surprises to be found. All we known for certain is that Valeant has a margin for error that is extremely narrow, and mountain of debt that needs repaying, that will hamper reinvestment in the company’s future.

The key question for investors will be whether Valeant can meet the new lowered guidance or whether there are more bumps in the road. The company doesn’t have much room for any more surprises.

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