Shares of Bausch Health Companies Inc. (NYSE: BHC) continued to slump in a difficult market environment. This slump, the publication of quarterly results and the IPO of its subsidiary create sufficient reasons here to update the investment thesis.
In January of this year, I thought Bausch Health was improving, very gradually. I concluded that the company has reduced its net debt by about $5 billion since the worst of the 2017 turmoil, while the underlying business has stabilized. I was hoping that further divestments and an upcoming IPO would create potential triggers for further debt reduction, and while I still viewed Bausch as a very risky investment, the risk-reward ratio was improving, as this conclusion has was pulled a bit quickly.
Bausch Health is the successor to Valeant, a name that was too toxic to use after a deal-and-price-driven expansion strategy went horribly wrong a few years ago.
At the start of 2018, Valeant reported 2017 revenue of $8.7 billion, EBITDA of $3.6 billion and net debt of $25 billion. With the company having since divested some assets, the company experienced stagnation in 2018 and 2019 as the pandemic initially hit the business hard. In 2020, sales fell to $8.0 billion and EBITDA fell to $3.3 billion as results saw a modest impact from the pandemic, while net debt was further reduced to $22.3 billion. The company further pointed towards a recovery in sales and EBITDA, comforting signs as net debt is expected to fall to $20 billion in 2021.
With 360 million shares trading at $27, the company commanded a stock valuation of $10 billion at the start of the year, for an enterprise valuation of $30 billion. This equated to less than 4 times sales and 9 times EBITDA. There was potential as net interest charges fell and Bausch’s eye assets (Bausch + Lomb) were due to launch this year, of course. Given all these observations, I saw that the risk-reward ratio had improved a lot since 2017, but I was not going more than a small allocation in the middle of the above average risky investment proposition .
Bausch shares fell to $25 in February when the company reported 2021 results. The company saw a modest recovery in sales to $8.4 billion as the company posted a slight increase in adjusted net profit. at $1.6 billion, while adjusted EBITDA came in at $3.5 billion, all slightly below initial guidance for the year. Some of the momentum faded as fourth-quarter revenue of $2.2 billion was flat from a year earlier. Adjusted earnings came in at $4.50 per share, because of course that’s pretty adjusted earnings.
The company splits its revenue into two segments. Bausch & Lomb, being the eye business, reported a 10% decline in full-year sales to $3.7 billion. Revenue from the Bausch Health business, however, rose 1% to nearly $4.7 billion. This momentum should only be replicated in the absence of real growth in 2022, as full-year revenue was guided between $8.4 billion and $8.6 billion, with adjusted EBITDA also expected to stagnate between 3.45 and 3.60 billion dollars. Net debt was reported at $20.8 billion, and although the annual interest bill fell slightly to $1.4 billion, it is still huge and having a real negative impact on net cash flow.
The company’s shares fell to levels just below the $10 mark at the time of writing after posting lackluster first quarter results, which were very weak. First-quarter sales fell 5% to $1.92 billion, entirely due to lower pharmaceutical revenues, with the Bausch + Lomb business posting flat sales. This led to lower adjusted earnings as net debt is flat sequentially at $20.8 billion as the company cut its full-year sales guidance to $8.25-8.40 billion. dollars. EBITDA is now estimated at a midpoint of 3.3 billion dollars, including around 100 million in dis-synergies.
The only “comforting” factor is that the shortfall appears isolated (largely) in the first quarter, driven by supply chain constraints, among others. The flat results were not inspiring for Bausch + Lomb Corporation shares themselves, as its shares fell from $18 to $17 following the new lows. Of course, there were more factors behind a 60% drop in share price since February, including a rapid increase in interest and a very smooth IPO process for Bausch + Lomb.
The big news for Bausch Health shares in recent weeks has been the IPO of Company Bausch + Lomb (NYSE: BLCO), the matter of the eyes. With the IPO, Bausch Heath will get a listing for its most promising assets, as the company sold 35 million shares at $18 per share, in an offering in which Bausch Health raised $630 million. dollars of gross product. Note that this price has been held a bit below the $21-$24 preliminary supply range of the past few weeks.
This represents 10% of the outstanding share base, implying that Bausch Health owns an additional 315 million shares which are valued at $5.7 billion at the offering price. Bausch Health further allocated $2.2 billion in net debt to Bausch + Lomb.
This roughly means that if Bausch Health were to sell all of its shares in Bausch + Lomb here, the company only recouped $8.5 billion (defined as IPO proceeds, the value of the remaining shares and the debt attributed to Bausch + Lomb), or approximately $8.2. billion if we take into account shares of Bausch + Lomb falling to $17.
Note that this compares to an enterprise value of around $24 billion of Bausch & Health here at $10 per share, indicating that Bausch + Lomb is valued at around a third of the combined value, even though its shares of total revenues are at percentages in the mid-forties, while its growth is better than that of Bausch Pharma.
On the other hand, Bausch + Lomb has an adjusted EBITDA of just over $800 million (based on 2021 results), indicating that it is significantly less profitable than the remaining Bausch Health businesses. This is where the advantage could exist. After all, if Bausch Health eliminates its entire stake in Bausch + Lomb, the net debt of $20.8 billion will drop to $12.3 billion. EBITDA will drop from $3.5 billion to $2.7 billion, marking further deleveraging on a net basis. Also, paying off expensive debt means adjusted earnings might not suffer (as much).
Note that this analysis assumes that the shares will be monetized by Bausch Health and that the shares held by Bausch in Bausch + Lomb will not be sold to investors. Otherwise, even an implied negative stock valuation could exist, but the reality is that Bausch Health cannot afford to give away the stock for free, due to its debt position.
Having initiated a small speculative position at the start of the year, I certainly think conditions have deteriorated, as rising interest rates have of course hurt the business a lot. On the other hand, the valuation has been reduced a bit, as it seems that some kind of forced selling is involved here in Bausch Health shares in relation to Bausch’s softer IPO price action + Lomb.
While still very far from a safe bet, the valuation bump has likely improved the risk-reward proposition here. Therefore, I am happy to buy a little more on the downside, but I fully recognize that this is a very opportunistic investment here, attributing it to a very speculative part of the portfolio.