2023-07-06 16:01:08 ET
Summary
- Bausch + Lomb Corporation was spun out of Bausch Health Companies Inc. this year - after years of speculation - and the new entity is an eye disease specialist.
- The parent company owns nearly 90% of the spun-out company's stock.
- Bausch + Lomb announced at the end of last month it would acquire Novartis dry eye disease asset XIIDRA and other assets in a deal worth up to $2.5bn.
- The deal will see Bausch + Lomb take on substantial debt - exactly the issues that caused Bausch Health to spin the company out.
- There are some question marks around both companies' approaches to financial stewardship, but sometimes risk leads to reward. I break down the deal and implications in this post.
Investment Overview
News broke at the end of June that Bausch + Lomb, the eye care specialist spun out of parent company Bausch Health, had opted to pay up to $2.5bn to acquire dry eye disease therapy XIIDRA from Novartis, plus other ophthalmology assets.
Given its parent company's well known financial problems, is raising more debt a good idea for a new company trying to shake off the bad old days of its parent - and still its majority shareholders' - misadventures?
Bausch Health Struggles - Brief History & Spin Out Of Bausch + Lomb Corporation
In 2 previous notes covering Bausch Health Companies Inc ( BHC ) - one bearish , back In August last year, and one undecided , in December - I have variously described the company a "dumpster fire," a "seemingly disastrous state of affairs," and a "basket case of a business" only a mother could love.
Luckily for Bausch, its management team was not listening and the company's share price has been on the rise - although it's important to provide some context.
Bausch Health Companies - current market cap $2.8bn - once enjoyed a market cap valuation of >$80bn under its former name Valeant Pharmaceuticals, but its business model was primarily based on acquiring smaller drug companies and hiking the prices of the drugs they sold to astronomical levels, and the company was soon in trouble, with its management team prosecuted by the SEC.
In 2018, under new CEO Joseph Papa, the company changed its name on the pretext that:
The Bausch name has long been a highly respected name in the health care space, synonymous for 165 years with innovation and an unwavering dedication to improving people’s lives.
The damage had mostly already been done, however, and under its new name, Bausch stock now traded ~$25 per share, when it had previously traded >$250 per share (current share price is $7.6). Today, according to Bausch's 2022 10K submission (annual report), the company is:
a multinational, specialty pharmaceutical and medical device company that develops, manufactures and markets, primarily in the therapeutic areas of gastroenterology (“GI”) and dermatology, a broad range of branded, generic and branded generic pharmaceuticals, over-the-counter (“OTC”) products and medical aesthetic devices and, through its majority ownership of Bausch + Lomb Corporation (“Bausch + Lomb”), branded, and branded generic pharmaceuticals, OTC products and medical devices (contact lenses, intraocular lenses, ophthalmic surgical equipment) in the therapeutic area of eye health.
The company now has 5 reportable segments, as follows:
- The Salix segment consists of sales in the U.S. of GI products. Sales of the Xifaxan® product line represented approximately 80% of the Salix segment’s revenues.
- The International segment consists of sales, with the exception of sales of Bausch + Lomb products and Solta aesthetic medical devices, outside the U.S and Puerto Rico of branded pharmaceutical products, branded generic pharmaceutical and OTC products.
- The Solta Medical segment consists of global sales of Solta Medical (“Solta”) aesthetic medical devices.
- The Diversified Products segment consists of sales in the U.S. of: (i) pharmaceutical products in the areas of neurology and certain other therapeutic classes, (ii) generic products, (iii) Ortho Dermatologics (dermatological products) and (iv) dentistry products.
- The Bausch + Lomb segment consists of global sales of Bausch + Lomb Vision Care, Surgical and Ophthalmic Pharmaceuticals products.
Here is a breakdown of revenues by segment - again taken from the 2022 10K submission :
Bausch Health sales by segment historic (2022 10K submission)
Revenue generation has been steady across the past 3 years, and operating profits of $1.48bn, $1.7bn and $1.3bn in 2022, 2021, and 2020, respectively. Very solid, but thanks to interest expense which has been hovering around $1.5bn per annum, and other exceptional charges, net losses have been heavy, albeit shrinking - from $(4.1bn) in 2018, to $(1.78bn), $(559m), $(937m), and "just" $(212m) in 2022.
Meanwhile, as of Q1 2023 , Bausch Health - minus newly spun out Bausch + Lomb - reported a cash position of $518m, and total current assets of $4.2bn, versus current liabilities of $3.9bn, including a $446m current portion of long-term debt, and total liabilities of $25.3bn, including $20.2bn of long term debt.
In summary, you could still make a case for Bausch being a very troubled company with an uncertain future based on the fact that it is loss-making, and its debt stands at nearly 14x 2022 operating income. In Q1 2023, Bausch earned $1.9bn of revenues, operating income of $227m, but also paid interest expense of $307m, and with "unusual items" totaling $136m, recorded a net loss of $(201m).
Bausch + Lomb Buys Novartis Ophthalmology Assets For $2.5bn
The above overview of Bausch Health's business suggests the company could do with battening down the hatches for a few years and paying down as much debt as possible while it fights a patent dispute over best-selling asset Xifaxan (more detail below).
The spinout of the eye-care division into Bausch + Lomb, completed last year, may have helped, but the financial mantra of "speculate to accumulate" may have rubbed off on the new company's management team.
At the end of June, Bausch + Lomb Corporation ( BLCO ), which Bausch Health retains ~89% ownership of, according to the 2022 10K, announced it would acquire Swiss Pharma Novartis' ( NVS ) dry eye disease drug XIIDRA (lifitegrast ophthalmic solution) 5%, plus other ophthalmology assets in a deal worth up to $2.5bn. According to a press release:
Under the terms of the agreement, Bausch + Lomb, through an affiliate, has agreed to acquire XIIDRA, libvatrep and AcuStream from Novartis for up to $2.5 billion, including an upfront payment of $1.75 billion in cash with potential milestone obligations up to $750 million based on sales thresholds and pipeline commercialization. Bausch + Lomb will also bring on the sales force supporting XIIDRA. Bausch + Lomb has obtained fully committed financing from J.P. Morgan for the transaction and intends to finance the $1.75 billion upfront cash purchase price with new debt prior to closing. The transaction is expected to close by the end of 2023 and be immediately accretive to Bausch + Lomb.
Surely the last thing either Bausch company wants to be doing at this time is issuing more debt, when the current debt schedule - highlighted below ex B+L in full from a 4Q22 earnings presentation slide - looks so onerous?
In fairness, you could argue that Bausch does not have too much debt falling due until 2025, and that Bausch + Lomb is a new entity not subject to the same constraints as Bausch Health - even if Bausch Health owns almost 90% of the company.
The Logic Of Bausch + Lomb's Deal For Xiidra - Cloudy, With A Chance Of Insolvency
The logic is somewhat perplexing, it is probably fair to say. Xiidra was originally developed by Shire, before Japanese Pharma giant Takeda acquired Shire for ~$62bn in 2019. Novartis then acquired XIIDRA - and its 400 strong sales team - for $3.4bn. The drug drove revenues of $487m in FY22.
Now, Bausch + Lomb takes over from Novartis, and the sales team is on the move once again. Xiidra is said to have patent protection through to 2033, and is complementary to Bausch + Lomb's existing commercial assets. The new company's Chairman and CEO, Brent Saunders, commented in a press release :
The strategic acquisition of XIIDRA will complement Bausch + Lomb’s existing dry eye portfolio that includes eye and contact lens drops from the company’s consumer brand franchises and its pharmaceutical business that features MIEBO™ (perfluorohexyloctane ophthalmic solution), which was recently approved by the U.S Food and Drug Administration (“FDA”) as the first and only approved eye drop for DED that directly targets tear evaporation. XIIDRA and MIEBO work differently to target distinct elements of the DED cycle.
The CEO also added:
This acquisition is a prime example of our strategy in action, as it provides needed scale for the company and transforms our pharmaceuticals business by making us a leader in ocular surface diseases.
The deal is also expected to accelerate margin expansion through a larger mix of pharmaceutical products in our portfolio, provide strong and immediate earnings accretion and presents a clear path to deleverage, making it financially compelling.
Financially compelling is one term for the acquisition, although "financially disastrous" could be another, depending on how you look at it.
There is no doubt that DED is a large market - 38m in the US, and 739m globally, according to Bausch + Lomb - but XIIDRA's sales have hardly been explosive - $376m in 2020, $468m in 2021, and $487m last year. Additionally, one of the reasons Novartis had been looking to sell XIIDRA was due to its failure to secure approval for the drug in Europe, after the European Medicines Agency raised "major objections" to green-lighting the product.
Another potential concern? Although Bausch says XIIDRA's patents do not expire until 2033, it is interesting to note in Novartis 2022 20F submission (annual report) some further detail as follows:
Xiidra . US: Four patents on compound (2024, 2024, 2025, 2026); two patents on formulation (2024, 2033); five patents on method of treatment (2024, 2024, 2026, 2029, 2029); one patent on polymorph compound form (2029). PTE pending. There is no generic competition in the US. Xiidra is not marketed in the EU. In the US, the compound, compound and use, formulation, method of treatment, and polymorph compound form patents are being challenged in ANDA proceedings against generic manufacturers.
That seems to indicate that generic drug manufacturers are already attempting to challenge XIIDRA's patents - some of which expire as early as next year! The last thing the Bausch companies need is more generic drug disputes.
Bausch Health's best-selling asset Xifaxan - which accounts for ~80% of the Salix division revenues, or somewhere around the $1.5bn mark, is subject to a patent challenge from Norwich Pharmaceuticals, and although Bausch says the courts prevent Norwich from entering the market until 2029, the situation is fluid and Norwich has filed a motion to allow it to enter much sooner.
If we now take a look at Bausch + Lomb's balance sheet as of Q123 , we can see that the company reported cash of $346m, and total current assets of $2.18bn. Current liabilities were reported as $1.25bn, whilst long term was reported as $2.5bn. Given this was reported prior to the deal, we can add at least $1.75bn to that figure - raised with the help of JPMorgan Chase ( JPM ), apparently, so close to $4bn of debt.
In Q123 , Bausch + Lomb reported revenues of $931m, but made a net loss of $90m. Full year guidance is for $3.9bn - $3.95bn, with EBITDA of $700 - $750m. Management does not give an income figure, but given the debt it is set to take on, the company will surely start 2024 in a much more precarious financial situation than it began 2023.
Concluding Thoughts - Is Bausch + Lomb Headed For The Same Slippery Slope As Its Parent
Bausch Health and Bausch + Lomb are 2 separate entities, and investors can buy shares in either, but the fact remains that Bausch Health owns ~90% of Bausch + Lomb and makes nearly all of the important decisions that affect the company thanks to its majority ownership.
There are many ways that Bausch + Lomb retail shareholders can therefore lose out. As discussed in this post, Bausch Health is in a financially precarious position and it is entirely possible that, if the Xifaxan patent challenge is lost, the company could be unable to meet its debt obligations falling due in 2025.
If that were to happen, the company may be forced to sell off its assets at a knockdown price, and presumably, that would include its shares in Bausch + Lomb. The latter's company's share price would likely tumble as a result, wiping out the 25% year-to-date gains (shares are currently priced at $19.5, and market cap is $6.8bn) and probably lowering them substantially.
Turning to Bausch+Lomb itself, the company has issued substantial amounts of debt to acquire an asset that may be a good fit for the company, but also carries some risk. It is not approved in Europe, its sales growth has been negligible in recent years, and it comes with a 400-member sales team that drastically increases operating expenses.
The company's decision to burden itself with fresh debt when the entire reason for its being spun out was to unburden its parent's debt can only really be considered a high-risk strategy.
As such, although both Bausch Health and Bausch + Lomb have been realizing share price gains in recent months, there must be significant question marks over the former's ability to continue as a going concern in light of debt and patent disputes, and the latter's ability to manage the new debt it is taking on, and make a success of an asset that Novartis seemed only too keen to sell.
With that said, the final point I would make is that Bausch Health is valued at ~0.6x FY23 revenues guidance and only just higher than forecast 2023 EBITDA of $2.35bn. Bausch + Lomb is valued at ~2x forward revenues, which, when looked at from that perspective, makes the stock price look cheap.
If these 2 companies can make it through the next couple of years without any major hiccups, as difficult as it may be to accept, both Bausch + Lomb Corporation and Bausch Health Companies Inc. share prices could gain substantially in value. Given the risks involved, I am staying firmly on the sidelines, but if you are betting money you can afford to lose, a business turnaround carries very high levels of risk, but can also be a major valuation driver.
For further details see:
Bausch + Lomb: $2.5bn M&A Deal Shows It Hasn't Learned From Parent's Mistakes