Rothschild one said "Buy when there is blood in the streets, even if the blood is your own." It is hard to go wrong as a LEAPS investor when you buy a stock with lots of earnings and plenty of assets after a major disaster. It has been a long time since I have seen a disaster this bad and there is plenty of blood in the streets shed by Valeant investors. Hedge funds are in free fall with investors demanding their money back. Fortunately we are going to buy Valeant a lot lower than they did.

VRX - Valeant Pharmaceuticals Company Profile

The Yahoo profile for Valeant says, "Valeant develops, manufacturers and markets pharmaceuticals, over-the-counter products and medical devices worldwide." They have dozens of name brand products and earn billions of dollars a year.

They were a serial acquirer and went on a buying spree that astonished the sector. CEO Michael Pearson was credited with making dozens of timely decisions that turned into a basket of golden eggs for the company.

Last year they ran into trouble when they were found to have likely acted improperly with a specialty mail-order pharmacy company named Philidor. Papers show that Valeant was the only customer for Philidor and they had purchased an option to acquire Philidor and consolidated Philidor's results into Valeant's own financial results. The entire thing appeared to be suspect to short seller Citron Research. They blasted out a short sell paper asking a lot of uneasy questions and making a lot of unsubstantiated claims as they always do when they attack a company.

Also suspect was a practice of sending out millions of dollars of product to specialty pharmacies and then claiming the profits from those drugs before they are actually sold. They also claimed the unsold inventories at those pharmacies as still on Valeant inventory lists. One specialty pharmacy was R&O, which was 100% owned by Philidor, which was secretly owned by Valeant. Citron believes this was a scam to deceive the auditors and claim sales of drugs that were not really sold. Citron dug up links to other "captive" pharmacies owned by Philidor, including West Wilshire Pharma, SaferX Pharma, Rando Pharmacy and Orbit Pharmacy. All were supposedly online drug stores and all their domain names were registered on the same day by the same person.

Since the Citron report went public Valeant ended its relationship with Philidor and the stock declined from $263 to $25. Some are trying to say that Valeant did not know about the captive pharmacies and Philidor was trying to scam Valeant. This would be hard to believe given the hundreds of millions of dollars in drugs flowing to Philidor.

Fast forward to the present. Bill Ackman and several other activist fund people have been named to the board. CEO Michael Pearson has been fired and will leave the company as soon as a replacement is named. Ackman appears to be running the board. His firm has lost more than $1 billion in Valeant stock so he is a man on a mission.

Last week Valeant received a reprieve from lenders and eliminated the pending threat of default for failure to file key SEC reports. Pearson was out on medical leave for two months, reportedly with pneumonia. It was more than likely a nervous breakdown from the Citron research publication. They used his absence as the reason for the report delay.

Creditors extended the deadline for filing the annual report from April 29th to May 31st. They allowed a delay for the Q1 earnings from June 14th to July 31st.

Much of the delay came from an investigation by the board into the Philidor disaster. The board launched an investigation into the Philidor relationship and the company had to restate earnings of $58 million from 2014 and move them into 2015. Last week the investigative committee said it had discovered no additional accounting errors and was closing the probe.

Valeant is a solvent company. They said last week they were "comfortable with its current liquidity position and cash flow generation for the rest of the year and remains well positioned to meet obligations."

Pearson was subpoenaed to appear before the Senate on drug pricing issues last week and did not appear. His lawyer said the Senate committee was unfair in that they wanted to question him on a variety of issues but would not identify which issues in advance so that he could prepare.

Ackman said he could restore value to Valeant relatively quickly. The first step will be to file updated financials later this month and that would take all the pressure off the stock. Investors do not know today what Valeant is worth because of the accounting probe and worry that some information may have been incorrect. Valeant is restating financials because of "improper conduct" of past executives including CFO Howard Schiller.

Secondly, Ackman said they were going to install a new management team within a "matter of weeks, not months" and that would reassure investors as well. Ackman said he was confident he would recover all his money in the Valeant investment. He bought VRX shares at $161 and again somewhat lower than that.

Ackman said Valeant was willing to sell off noncore assets to raise cash and pay down debt to improve the financial picture. Valeant only has a market cap of $11 billion today compared to nearly $100 billion back in August of 2015. This drop is entirely due to the confusion over Philidor and possibly impropriety. The board now claims there was no additional problems other than the $58 million restatement of earnings.

The last time Valeant issued guidance they were projecting $12.6 billion in revenues for 2016. Adjusted EPS of $13.50 a share. Double digit sales growth and $2.25 billion in debt reduction. A company that can produce $13.50 in earnings at a relatively mild PE of 10 would be worth $135 per share.

They have plenty of assets they can sell to raise cash if needed. Their Bausch & Lomb division is worht as much as $20 billion by itself or twice the current market cap of the entire company.

I believe Ackman will get the ship righted again. His reputation depends on it plus the $1 billion he has lost. The potential for Valeant shares to decline significantly has been greatly reduced with the resolution of the accounting probe and termination of Pearson and Schiller. I am sure the company made some mistakes. However, the sum of the parts is worth more than $118 a share according to a BMO analyst.

The stock has been crushed. The odds of an additional decline from here have been significantly reduced. The odds of a dramatic rebound have greatly increased.

In the LEAPS portfolio we want stocks with the potential for significant appreciation. Once positive announcements become commonplace with Valeant the shares should rebound appreciably. Just filing the updated financials later this month will be a major step forward.

I am recommending we buy the Jan $40 call and sell a $25 put to offset the cost of the call. Premiums are expensive on Valeant because of the potential for a huge rebound. The stock was $263 a year ago and I do not expect that again but we could easily see the current price double or triple given the strong earnings potential.

Buy Jan $40 LEAP Call, currently $8.25, no initial stop loss.

Optional

Sell short Jan $25 LEAP Put, currently $6.00, no initial stop loss.

Net debit $2.25.




If you like the trade setups you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.

subscribe now