Investment Overview – Unpicking A Tangled Web Of Deals, Dealmakers, and Spin-outs
In July last year, I provided some deep dive coverage of Bausch + Lomb Corporation (NYSE:BLCO), and its parent company Bausch Health (BHC). The story of the spin out – and its logic – takes some explaining, and I will refer readers to my previous note for a fuller background explanation.
To summarize, however, Bausch Health was formerly known as Valeant, and briefly enjoyed a sky high valuation of over $80bn, before the Canadian company and its management team became embroiled in a drug-price fixing scandal that saw its valuation collapse.
Revenues between 2015 and 2020 fell from $10.3bn, to $7.92bn, and, aside from 2017, losses were heavy – $(4.1bn), $(1.8bn), and $(559m) in 2018, 2019, and 2020, for example, while in 2020, the company reported $605m of cash on its balance sheet, and $24bn of long term debt.
Management’s solution to such a challenging financial situation was to plan the spinouts of different areas of the business into standalone business entities. Under new CEO Joe Papa, Bausch Health considered spinning out its skin care business Solta Medical, and its eye care business, Bausch + Lomb, into new entities, splitting the company into three.
It took another two years before the IPO of Bausch + Lomb was completed (the Solta spinout ultimately never happened) on May 6, 2022. Bausch Health stock fell from a value of $23 in April 2022, to a low of $5 by late July, and presently trades at ~$6.50 per share, with a market cap valuation of $2.4bn, and, as of Q1 2024, still $21.9bn of long term debt remaining.
Meanwhile, according to Bausch + Lomb’s Q1 2024 quarterly report/ 10Q submission, Bausch Health continues to own 88.3% of Bausch + Lomb’s outstanding common shares. The 10Q also states as follows:
The completion of the full separation of Bausch + Lomb from the remainder of BHC (the “Separation”), which includes the transfer of all or a portion of BHC’s remaining direct or indirect equity interest in Bausch + Lomb to its shareholders (the “Distribution”), is subject to the achievement of targeted debt leverage ratios and the receipt of applicable shareholder and other necessary approvals and other factors and is subject to various risk factors relating to the Separation.
Bausch + Lomb understands that BHC continues to believe that completing the Separation makes strategic sense and that BHC continues to evaluate all relevant factors and considerations related to completing the Separation, including those factors described in BHC’s public filings.
With $20bn debt and the spin-out apparently still in the balance, as I discussed in my previous note, you could be forgiven for thinking Bausch + Lomb would pursue a conservative M&A strategy, but that was not the case.
In September last year, Bausch + Lomb announced the completion of its acquisition of Dry Eye Disease (“DED”) therapy Xiidra and “certain other ophthalmology assets” from Swiss Pharma giant Novartis (NVS). According to a press release:
Under the terms of the agreement, Bausch + Lomb, through an affiliate, acquired XIIDRA and the other ophthalmology assets from Novartis for up to $2.5 billion, including an upfront payment of $1.75 billion in cash with potential milestone obligations of up to $750 million based on sales thresholds and pipeline commercialization.
Bausch + Lomb also brought on the sales force supporting XIIDRA. The company funded the acquisition with the previously announced offering of $1.4 billion aggregate principal amount of 8.375% senior secured notes due 2028 (“Notes”) and $500 million of new term B loans under an incremental term loan facility (“Term Loan Facility”).
It was an unquestionably bold move, orchestrated by Bausch + Lomb’s CEO Brent Saunders, a renowned Pharma dealmaker who had in fact arranged the sale of Bausch + Lomb to Valeant Pharmaceuticals back in 2013.
Saunders – a former Chairman, President and CEO of Allergan Healthcare, the maker and marketer of Botox, prior to its $63bn acquisition by AbbVie (ABBV) was re-appointed Chief Executive Officer (“CEO”) of Bausch + Lomb in February last year.
With his reputation for dealmaking, shareholders may conclude that Bausch + Lomb’s future will be turbulent, volatile, and uncertain, as opposed to slow, steady, and financially frugal – although to date, XIIDRA aside, that has not proven to be the case.
Bausch + Lomb As of Q1 2024 – Solid Performance With Few Alarms
Bausch + Lomb stock currently trades at $15 per share, and since it began trading in May 2022 at a value of ~$20 per share, surprisingly, it has not been especially volatile, generally trading in a range of $15-$20. The company’s current market cap is $5.12bn, which begs the question, if Bausch Health owns over 80% of a $5bn market cap valuation company, how can it be worth only $2.4bn? The answer, presumably, is that its carries over $20bn debt on its balance sheet.
For its part, Bausch + Lomb, post Xiidra acquisition, carries $4.5bn of debt on its balance sheet. In 2023, the company reported revenues of $4.1bn, and net income of $(260m), while its parent company reported revenues of $8.7bn, and net income of $(592m).
According to Bausch + Lomb’s latest quarterly report:
As a fully integrated eye health business, Bausch + Lomb has a comprehensive portfolio of approximately 400 products, which includes an established line of contact lenses, intraocular lenses (“IOLs”) and other medical devices, surgical systems and devices, vitamin and mineral supplements, lens care products, prescription eye-medications and other consumer products that positions us to compete in all areas of the eye health market.
The company reports three different segment revenues – Vision Care, which earned $635m of revenues in Q1 2024, up 8% year-on-year, Surgical, which earned $197m, also +8% year-on-year, and Pharmaceuticals, which earned $267m – up 66% year-on-year. Total revenues of $1.1bn represented 20% annual uplift.
Besides Xiidra, which contributed $79m of revenues in the quarter, Bausch + Lomb has successfully won approval for a second DED drug, Miebo, which received regulatory approval last May, and earned $28m of revenues last quarter. The company reported a small – by Bausch standards – net loss of $(54m) for the quarter, or $(0.15) per share.
As for 2024 guidance, Chief Financial Officer (“CFO”) Sam Eldessouky update analysts on the Q1 2024 earnings call as follows:
We are raising our full year constant currency revenue growth guidance from a range of approximately 12% to 14%, to a range of 30% to 50%. The raise reflects the broad-based strength of our business and the momentum we have seen in the first quarter.
Our 2024 revenue guidance remains in the range of $4.6 billion to $4.7 billion. This range now absorbs incremental currency headwinds of approximately $50 million relative to our previous guidance. For the full year, we estimate currency headwinds to be approximately $90 million. We are maintaining our guidance for Xiidra to generate approximately $400 million in revenue. Our guidance for Miebo continues to be approximately $95 million of revenue in 2024.
Shifting to adjusted EBITDA. We are maintaining our adjusted EBITDA guidance for 2024 in the range of $840 million to $890 million, while absorbing approximately $10 million of currency headwinds.
In keeping with Bausch + Lomb and its parent company’s penchant for creative accounting, revenue growth is upgraded, while end of year revenue projections remain the same! Joking aside, however, the EBITDA figures do look encouraging, although they are subject to change – as the CFO told analysts:
As I mentioned during our last earnings call, as we continue to drive pipeline innovation, we may enter into collaborations with external partners. It should be noted that our adjusted EBITDA guidance does not reflect any onetime upfront payments that may be made as part of such arrangements.
With that said, it seems CEO Saunders was content to praise performance of the existing business, as follows:
And so let me just give you some numbers if you look at the performance this quarter. Consumer, these are all constant currency. Consumer plus 15 (percent), contact lenses plus 6, Surgical plus 8, Pharma plus 66, excluding Xiidra plus 18, geographies, Asia plus 7%; Europe, plus 9%; Latin America plus 17; and the U.S. plus 33.
While rowing back from committing to any large scale M&A activity, as follows:
So all of our businesses, including consumer, contact lenses, pharma, surgical all have a really robust new product cycle coming over the next few years, and we want to have launch excellence and really have these products be the future of B&L.
That being said, what are we investing in? We’re investing in innovation. We’re doing relatively smaller partnerships, R&D collaborations, technology, investments to continue the stream of new product launches beyond the cycle we have today.
Looking Ahead – Can Shareholders Begin To Look Forward To Stable Growth?
Clearly, over the past decade, it would be hard to find a more volatile – or worse – stock to hold than Valeant/Bausch Health, however, since the Bausch + Lomb spin-off and Bausch Health’s substantial downward correction, the share price of the spin-off has been surprisingly stable, as noted above.
For its part, Bausch Health’s share price remains volatile, as the company continues to fight legal battles, over the launch of a generic version of its lead product Xifaxan – $2.2bn of revenues in 2023 – by the likes of Norwich Pharmaceuticals and Amneal Pharmaceuticals.
After I gave Bausch Health a “sell” rating back on November 30, citing the massive debt pile, which is seemingly being brushed under the carpet, the company’s shares initially performed very well, climbing from ~$7, to ~$10, as 2024 guidance for $9.3-$9.55bn of revenues (including B + L revenues) and adjusted EBITDA of $3.2-$3.35bn of revenues impressed Wall Street. The stock has been in freefall ever since, however, as attention returns to a worsening generic Xifaxan scenario amid a fresh attempt by Amneal to market and sell a generic Xifaxan. The current price of $6.50 now justifies my “sell” rating.
When we consider that Bausch + Lomb’s market cap valuation of ~$5bn is only a 10% premium to full year 2024 revenue guidance, however, we can easily make the bull case for the spin-out company. Under a veteran leader who has seen – and done – it all in Pharma, all areas of the business are growing, debt is manageable, no majorly disruptive M&A is planned, EBITDA is increasing, and profitability is in sight.
Considering other Pharma companies with revenue generation in 2023 similar to Bausch + Lomb, Charles River Laboratories (CRL) – $4.1bn revenues in 2023, has a market cap of $11.5bn. Resmed (RMD) – $4.2bn revenues – has a market cap of $32bn. On the flipside, Perrigo Company, once led by Bausch Health’s erstwhile CEO Joe Papa, earned $4.7bn of revenues last year and has a valuation of just $4bn, reflecting a pivot in strategy, and negative publicity around its business practices.
Nevertheless, it is tough to find a lower valued business in Pharma relative to revenues than Bausch + Lomb, a company that is free of such issues, and therefore it is tempting to draw the conclusion that, while it would seem difficult for Bausch + Lomb’s valuation to fall any lower, it would seem natural for such a company to potentially enjoy a long-term upward correction in its valuation, reflecting its emergence as a stable, growing business.
Concluding Thoughts – Metrics Make Buy Case But Parent’s Struggles Adds Risk To Thesis
In January, analysts at JPMorgan handed Bausch + Lomb a double downgrade, citing difficulties around its ability to be fully spun out from its parent company.
Each time generic drug disputes around Xifaxan appear to be going against Bausch Health, its stock suffers, and its ability to complete the spinout amid solvency concerns is called into question.
If Bausch Health goes bankrupt, at present, it seems possible/probable that the spinout may sink alongside the parent company, or its valuation be compromised as Bausch Health is forced to sell at a major discount to actual value. If Bausch can find a buyer for its stake in Bausch + Lomb, however, it should surely complete the sale of the majority of its holding, in order to reduce its own debt, and even if forced to sell its position in the spinout as part of a firesale, the spinouts valuation would surely recover in time.
Meanwhile, earlier this month, analysts at Morgan Stanley upgraded Bausch + Lomb stock, saying the company is performing “considerably ahead of expectations”, and that it’s upgrade was due to “material discount to peers vs. growth and better visibility on execution” – which echoes my own sentiment above.
As mentioned above, the company’s strong recent performance is undeniable, and therefore I find it hard to believe the parent company would be unable to complete a full spinout, especially given the spin-out company is led by a legendary Pharma deal-maker.
An abiding concern would be how long CEO Saunders may remain at the helm before getting itchy feet and moving on to bigger things – when you have arranged a $63bn merger/acquisition, and countless other M&A deals, how long will a $4bn per annum business with no major M&A deals planned remain interesting?
Perhaps the CEO has something up his sleeve after all, and perhaps it might involve a full separation from the troubled parent company. While CEO Saunders may be more used to M&A than divestitures, perhaps he will come full circle and successfully back B+L out of the company he originally sold to over a decade ago.
I think this is a likely outcome that supports the improving metrics, and as such I do make Bausch + Lomb stock a “Buy” at what I believe may prove – in two to three years’ time – a very cheap price for a business with this much potential to grow revenues and profits.
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