Justin Sullivan
overview
The two biggest events of the last few months, the Bausch Health Companies (NYSE: BHC) is his reluctance to list his fast-growing aesthetic medical device company Solta Medical and a recent ruling by a Delaware court that he will do so effectively off-patent its flagship drug, Xifaxan. While Solta Medical’s delayed IPO due to a longer timeframe for multiple expansions may have allegedly reduced shareholder returns, it hasn’t necessarily reduced the company’s intrinsic value. However, the latter development undoubtedly and directly reduces the value of the company and may indeed require dramatic management action to ensure that BHC remains solvent. In this article, I will examine how these changes affect BHC’s value and what actions need to be taken to ensure BHC’s solvency and whether the stock is undervalued at current levels. Additionally, it should be noted that if BHC’s appeal of the recent court ruling is successful, my comment on the implications of the recent court ruling would be muted.
Free the medical IPO
The intent of Solta Medical’s IPO was simply to reduce BHC’s debt burden of >$20 billion. In my previous article on BHC, I expected Solta Medical to generate at least $2 billion in revenue to do this for BHC. However, due to the looming bear market and other macro factors as cited by management, this IPO has been put on hold. I believe this is the right decision. That’s because BHC’s desire to shed a non-essential business shouldn’t outweigh its desire to significantly reduce its debt burden going forward. Additionally, as Solta Medical continues to grow, it could well generate more revenue for BHC in the event of a future IPO.
Xifaxan Litigation
On July 28, the US District Court of Delaware ruled that BHC’s Salix segment’s patent for Xifaxan for reducing the risk of HE recurrence was valid, but its patents protecting the composition and use of Xifaxan for IBS-D were valid invalid. Since IBS-D is a much more common disease than HE, this is likely to eliminate most of Xifaxan’s revenue. Additionally, this will eliminate most of Salix segment revenue and profits as Xifaxan accounted for 79% of its revenue in 2021. This will leave the Salix segment with approximately $500 million in annual sales and a greatly reduced profit, if any, eliminating the elimination of Xifaxan’s key patents. However, BHC is determined to appeal the verdict to the US Court of Appeals. Additionally, the Salix segment accounted for 53.6% of BHC’s self-reported earnings in 2021, independent of BLCO. While the Salix segment may still be able to generate about $300 million to $400 million in profits (assuming its margins are in line with the rest of the segment’s products), that still wouldn’t make BHC FCF-generating, assuming it does No remedial action was taken by management.
The bankruptcy risk
If BHC management’s primary goal is to avoid bankruptcy, they have many options. However, if their primary goal is to distribute BHC’s stake in Bausch + Lomb (BLCO) to shareholders, the risk of bankruptcy increases dramatically. I don’t think BHC will face any immediate liquidity problems since their treasury is about $1.2 billion and they still have credit facilities to draw on. Additionally, one possibility for BHC is that its product pipeline contains enough products to boost its EBITDA, allowing BHC to retain a larger portion of its stake in BLCO. However, more exotic and arguably less shareholder-friendly options include a rushed IPO for Solta Medical to increase cash on hand and a sale of its stake in BLCO. A sale of BLCO common stock would significantly reduce their debt and interest expense to the point where they would generate several hundred million FCF. However, it’s also possible that BHC’s interest expense may increase as its EBITDA has fallen, making its debt more risky, and that its interest expense may increase as a result of the rising interest rate environment.
BHC product pipeline (BHC product pipeline presentation)
The probability of a payout on BLCO shares has dropped dramatically with recent developments. And the time horizon for such a distribution has certainly expanded. This is because it would be almost impossible to shoulder BHC’s debt burden without BLCO distributing its FCF to its shareholders, and thereby BHC. It should be noted that since BHC is the controlling shareholder of BLCO, it has discretion to make this decision. As noted, BHC could also divest some or all of its stake in BLCO to shoulder its debt, while of course dampening the potential for an 80% payout of BLCO stock to shareholders.
BLCO spinoff prospects
BHC needs to achieve its target leverage ratio of 6.5-6.7x EBITDA in order to be able to distribute 80% of BLCO shares to BHC shareholders. By my preliminary estimates, the latest court ruling will cause BHC to lose at least $1 billion in EBITDA, which means BHC will need to further reduce its debt for the spin-off to take place. As a result, assuming BHC avoids bankruptcy, returns to shareholders have inevitably been reduced. In addition, it is possible that BHC shareholders may receive a smaller stake in BLCO than they otherwise would if BHC has to sell a large part of its stake in BLCO in order to remain solvent.
As BHC needs to meet its target leverage ratio of 6.5-6.7x, it now needs to reduce its debt of $16.415 billion by using management’s most conservative estimate for 2022 EBITDA minus my estimate of Xifaxan’s patent contributions to the subtracts EBITDA. As a result, BHC needs to reduce its net debt by $5.5 billion. Therefore, I believe management could achieve such deleveraging by taking Solta Medical public, selling a portion of its stake in BLCO, possibly reducing the stake available for distribution to shareholders, or continuing to use BLCO to fund the to reduce BHC’s debt. Those options probably wouldn’t raise the $5.5 billion needed to pay out its stake in BLCO to shareholders, but they will free up more cash flow from operations to pay off the remaining debt needed to pay for the payout required are. However, given current market conditions, BHC will likely have to wait until market conditions normalize for a Solta Medical IPO to receive a reasonable valuation and should also wait until the end of the current bear market to finalize the divestment of its stake in BLCO begin unless this is necessary for short-term liquidity needs.
BHC Leverage Targets (Presentation BHC Q1 2022)
Conclusion
The recent court ruling has severely damaged BHC’s value as an independent entity and reduced the likelihood of a BLCO payout and, at least inevitably, lengthened the time horizon for such a payout. Additionally, the recent bear market has rendered BHC’s stake in BLCO less valuable and muted the likely success of a recent Solta Medical IPO, justifying its suspension. While bankruptcy is unlikely, rising interest rates and poor operating results make it possible. Given the need to meet BHC’s target leverage ratio of 6.5-6.7x EBITDA and the continuity of the current bear market, it’s likely that the BLCO payout will take maybe a couple of years. Additionally, if BHC has to sell more than its expected 20% stake in BLCO to meet near-term cash needs, the payout to shareholders will be reduced. With the recent court ruling, BHC may only have a few hundred million FCF left, and while BHC has growth prospects, it also carries uncomfortable leverage.
That BHC can reduce its leverage enough to allow a payout from BLCO is still a possibility, but the time horizon for the payout has lengthened. And while BHC is likely to remain solvent, it’s more questionable whether it can do so without destroying shareholder value. There’s simply little room for error or disaster if BLCO is to make an 80% payout to shareholders. However, if BHC uses all options available to it to remain solvent and reduce its debt burden, including selling most of its shares to BLCO, then BHC will likely remain solvent and even generate a reasonable amount of FCF due to lower interest expense. So, of course, the best outcome for shareholder value is for the payout to take place, but the worst outcome is a growing and deleveraging pharmaceutical and aesthetic device company generating a reasonable FCF, given today’s market cap of about $2.8 billion -dollar would be undervalued. Assuming management won’t let BHC go bankrupt, at least for now, the market misjudged the disasters.
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