S&P Affirms Rating on Valeant Pharma (VRX) Amid Weak Q3 Report, Cut Outlook
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S&P Global Ratings said its ratings and outlook on Valeant Pharmaceuticals International Inc. (NYSE: VRX) (B/Stable/--) are unchanged following the company's weak earnings report for the third quarter and lowered guidance for 2016. The company also indicated 2017 performance will likely be weaker than in 2016, because of the loss of exclusivity on certain neurology products. This contrasts with our prior expectation that 2017 would be materially stronger than 2016, given that 2016 has been a year of significant turbulence and transition for the company.
This represents a significant deterioration from our expectations and we are lowering our 2017 EBITDA estimate to $3.9 billion (from $4.9 billion), and revising our 2017 estimate of adjusted debt leverage (excluding the impact of any potential asset sales) to about 8x from 5.3x. Whereas previously Valeant was comparatively very strong within the current rating, there is now very limited cushion for further deterioration at that rating.
While we believe Valeant's forecast, by the new CFO, is at the conservative end of likely results, and presents a chance of material upside, the company faces a multitude of challenges which reduce visibility, including retaining employees, marketing effectively to doctors given a tarnished reputation, pressures on pricing, and diminished negotiating power with partners given the company's weakened position.
Despite lowered expectations, we continue to believe the value of the company's assets likely exceeds the total debt outstanding, and we view the company's ability and willingness to monetize its pharmaceutical assets as supportive of creditworthiness. The company's new management team has emphasized that asset sales are part of its near-term strategic plan and we believe the lowered financial expectations increases the importance of asset sales to address the thin covenant cushions on the senior secured leverage covenant (maximum of 2.5x), stay ahead of approaching debt maturities, enable management the financial flexibility to focus on optimizing the business, and to reduce debt leverage (though the deleveraging benefits are liable to be more muted with debt leverage at these higher levels).
The corporate credit rating reflects the high debt leverage and substantial free cash flow generation (helped by a low tax rate). It also takes into account its business risk, which is characterized by substantial scale; extensive product, therapeutic, payer, and geographic diversification; and strong margins. This is partially offset by the low level of investment in research and development, and elevated operational risks associated with managing a large portfolio of small products. While we are encouraged by the new management team and the fact that the majority of the board of directors has turned over, given the multitude of remaining legal, regulatory, and reputational issues that Valeant faces, our assessment of management and governance as weak is unchanged, reflecting the lingering fallout of aggressive business practices under the prior management team in recent years.
Our stable rating outlook reflects our expectation for Valeant's debt leverage to remain above 5x, while continuing to generate substantial free cash flow (helped by a low tax rate). We could lower our rating if we believe reputational, legal, or regulatory developments are likely to undermine the company's ability to generate substantial free cash flow. Although unlikely absent extensive asset sales we could raise the rating if we gain confidence in the company's ability to reduce and sustain debt leverage below 5x.
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