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Valeant: Will Buyers Cut Sales Price For $2 Billion Legal Exposure? PDF Print E-mail
Many moons ago I was handed an M&A assignment to help a client analyze a $10 million acquisition of another company's subsidiary. In other words -- I drew the short straw. I advised the client to structure the transaction as an asset sale because the risk attached to the stock would be multiples of the $10 million purchase price. Of course the target company didn't want this; it wanted a stock sale. My counter was that the indemnifications would have to be number so big that we couldn't lose money. I recommended a $75 million indemnification for any trailing risks. The seller and my client had a conniption. I was clear that I wasn't going to risk my career or our parent company's capital for a $10 million deal ... pick one. That is the conundrum potential buyers of Valeant's asset sales now face. 

The Situation

Valeant needs cash. The company's $30 billion debt load is at 7.2x EBITDA and its revenue and EBITDA are expected to decline. The company former hedge fund hotel has vowed improve cash flow and sell assets to pare debt. However, asset sales have not materialized. Valeant is currently in the market to sell Salix for $10 - $12 billion. Market chatter suggests that Takeda is interested at $9.3 billion or about $6 billion less than Valeant paid for Salix last year. Chatter also suggests ( http://seekingalpha.com/article/4027554-valeant-avoid-post-salix-takeda-deal-breakdown that talks with Takeda ) have fallen apart over value. In effect, the $9.3 billion purchase price at about 7.3x EBITDA might not even stick.

Valeant is long on leaks and short on results. Additional deal chatter ( https://www.bloomberg.com/news/articles/2016-11-10/blackstone-kkr-said-to-ready-bid-financing-for-valeant-s-inova ) suggests Blackstone and KKR have made bids for Valeant's Australian drug unit -- iNova -- for $773 million. Valeant is in dire straits and buyers know it. My sum-of-the-parts valuation ( http://seekingalpha.com/article/4026171-valeant-salix-rumors-send-sum-parts-valuation-1  ) is around $1; it could go lower if bids for the underlying properties disappoint or if Valeant decides to call off it auction process(es).

Legal Woes

Valeant also faces a bevy of legal risks. The "OJ Simpson of biotechs" is constantly getting sued. Valeant faces several lawsuits, including a class action lawsuits from shareholders, T. Rowe Price for fraud and the NYPD's labor union for overcharging for drugs. A big potential risk is [i] whether former specialty pharma Philidor engaged in insurance fraud and [ii] whether Valeant executives were culpable.

I estimate that known risks for potential insider trading and Philidor fraud could be around $934 million. Some estimate Valeant's legal exposure at around $2 billion ( https://twitter.com/brianfires/status/805789225350266881 ). Valeant has not put a value on its legal exposures and nor has it reserved for them. That still doesn't mean they don't exist though.

Will Buyers Cut Sales Price For $2 Billion Legal Exposure?

I previously warned Valeant bulls that structuring around Valeant's legal exposures could hurt deal values:

The recent lawsuit could hamper its sale processes or even hurt potential purchase prices for certain assets. Buyers might lower their purchase price(s) to compensate for potential legal risks that come with target companies. Another strategy could be to [i] structure purchases as asset sales to [ii] leave behind liabilities attached to the stock -- such as legal liabilities -- with Valeant. At a minimum, the T. Rowe Price lawsuit and other shareholder suits will not aid Valeant in its quest to get buyers to pay up for assets it seeks to divest.

It would behoove potential buyers to structure the deals as asset purchases, which might leave more liabilities on Valeant's books vis-a-vis a stock sale. Otherwise it would behoove them to hold back on some of the purchase price until Valeant's legal exposures dissipate. For instance, Takeda could still pay $9.3 billion for Salix but put $2 billion in escrow to cover any tail risks. Valeant would get $7.3 billion up front and $2 billion at a later date. The iNova sale would result in [i] no up front pay out to Valeant and [ii] Valeant having to fund $1.2 billion in escrow ($2 billion less the $800 million purchase price) to protect buyers.

Conclusion

Though Valeant has not reserved for legal exposures, potential buyers have a fiduciary responsibility to reduce their potential asset purchases by $2 billion or more. This will hurt cash flow from asset sales -- assuming they actually occur. The other nuance is that seeking asset sales could actually hurt VRX. Buyers could uncover risks or confirm known risks that were not priced into the stock. The $2 billion or more in legal exposures could sink VRX. Get out.

On Shock Exchange 

With the critically acclaimed, Shock Exchange: How Inner-City Kids From Brooklyn Predicted The Great Recession And The Pain Ahead, author Ralph W. Baker, Jr. predicted the current global economic slow down, the demise of China, emerging markets and the pending stock market crash.

Where to Buy:

"Shock Exchange" is available electronically through Barnes & Noble (NOOK), Amazon (Kindle), iTunes, etc. The print version is available through the following retailers and bookstores:  

Print Version: 

Amazon http://www.amazon.com/

Barnes & Noble online http://www.barnesandnoble.com/

Hampden-Sydney College Bookstore: http://cougar.hsc.edu/cgi-bin/main_inv.exe , item number: 38561. Or call Jason Huskey at 434-223-6117.   

 

 

 

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