May 17, 2018

VRX Valens Credit Analysis – CDS 485bps, Base Case iCDS 340bps, Negative Case iCDS 413bps, 2023 5.875% Bond YTW of 7.111%, iYTW of 6.241%, B3 Rating from Moody’s, IG4 (equivalent to Baa2) Rating from Valens, Low Refinancing Need

  • Credit markets are overstating VRX’s credit risk with a CDS of 485bps and YTW of 7.111% relative to an Intrinsic CDS of 340bps and an Intrinsic YTW of 6.241%. Furthermore, Moody’s is materially overstating VRX’s fundamental credit risk, with their high-yield B3 credit rating seven notches lower than Valens’ IG4 (Baa2) credit rating
  • Incentives Dictate Behavior™ analysis highlights mostly positive signals for creditors. Management’s compensation metrics should drive them to focus on all three value drivers: revenue growth, margin, and asset turnover, which should result in Uniform ROA improvement and higher cash flows available for servicing obligations. In addition, the ROTC metric should disincentivize them from overleveraging the balance sheet. Moreover, management members have low change-in-control compensation, limiting event risk for creditors
  • Earnings Call Forensics™ of the firm’s Q1 2018 earnings call (5/8) highlights that management generated an excitement marker when discussing the progress they have made in terms of SILIQ coverage
  • VRX currently trades near the low end of historical valuations relative to UAFRS-based (Uniform) Earnings, with a 9.1x Uniform P/E. At these levels, the market is pricing in expectations for Uniform ROA to decline from 51% in 2017 to 27% through 2022, accompanied by 1% Uniform Asset shrinkage going forward. Multiples for VRX materially declined following allegations of fraud, as well as their late 10-K filing and subsequent restatement in 2016. If the allegations of fraud are found to be unwarranted, even with potential drug price legislation, or should the market recognize the firm’s lower-than-expected credit risk, there could be material equity upside going forward
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