The Stock Making Buffett’s Pals at the Sequoia Fund Rich: Valeant Pharmaceuticals

Big pharmaceutical companies keep shareholders happy with big dividends and the occasional revolutionary drug to keep earnings rising. Valeant Pharmaceuticals International (VRX), however, pays nothing in dividends and doesn’t even try to find blow-out drugs. But boy, does this company know how to make investors happy.

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Valeant shares booked a 65% share in 2011, moving its market cap up to about $15 billion by the end of the year. The rise benefited a long list of hedge funds that had piled into the stock earlier, making it one of the most popular holdings at Sept. 30. Ruane, Cunniff & Goldfarb made its traditionally conservative, Warren Buffett-endorsed (BRK.A) (BRK.B) Sequoia Fund famously rich last year by making Valeant its biggest holding.

And the share price growth is showing no sign of faltering in 2012. On Jan. 6, the company announced 2012 earnings forecasts above everyone’s expectations, adding flare to a recently glorious ride.

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All but two of 20 analysts following Valeant have buy recommendations on the shares. YCharts Pro gives it a strong rating on fundamentals but a poor rating on share price value. That value rating isn’t surprising considering Valeant’s growth depends on acquisitions that charts can’t forecast. Is there any reason Valeant might disappoint today’s buyers?

The uncertainties involved in corporate takeovers probably pose more danger to Valeant shares than the inherent risks of selling drugs. Valeant markets generic drugs, but it gets them mainly through hostile and friendly acquisitions, rather than its own research and development department. Like roll-ups of past decades, Valeant’s success depends on management’s ability to target good companies, pay reasonably for them and integrate them well.

Obviously, Valeant management has done a bang-up job of this so far. It’s bought some 30 in the past three years, including 11 in 2011. Valeant looks for cheap companies with unsexy drugs treating mainly neurology and dermatology problems that the Mercks, (MRK) Pfizers (PFE) and Eli Lillys (LLY) of the world aren’t much pursuing. Management also has shown some restraint in what might otherwise look like a mad dash for size. When Teva Pharmaceutical Industries (TEVA) upped Valeant’s $5.7 billion bid for Cephalon by nearly $1 billion last spring, Valeant congratulated them and walked away.

Valeant needs lots of cash for acquisitions the same way Big Pharma needs it for R&D. And thanks to solid underlying sales growth, Valeant has it.

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But predictably, debt, too, has grown a lot at Valeant.

Valeant Pharmaceuticals International Debt to Equity Ratio Chart by YCharts

Valeant certainly isn’t predicting that debt or anything else will slow down growth any time soon. It forecasts earnings up about 40% in 2012, which has led analysts to dismiss outright the shares’ historic price/earnings ratio of more than 150. Acquisitions, they contend, will more than make up for it.

Those hedge funds, however, are not always the best partners in shareholding. That 25%+ share price drop three months ago probably had as much to do with the funds’ need for cash at the time as with Valeant’s mildly disappointing results. In 2010, a worrisome merger led those investors to more than halve the value of Valeant’s shares in about a week. Sometimes happiness in this business means taking profits.

Valeant Pharmaceuticals International Stock Chart by YCharts

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.