UPDATE: The Problem With Valeant's Guidance, According To Wells Fargo

Wells Fargo’s David Maris mentioned that there were unanswered questions related to the guidance issued by Valeant Pharmaceuticals Intl Inc VRX. He explained the discrepancy between management’s updated guidance and the previous statements about the impact of Philidor.

Analyst David Maris initiated coverage of Valeant with an Underperform rating and a valuation range of $65-$68. While mentioning that valuation range implied a 42 percent potential downside from the current levels, Maris noted that there were concerns related to management’s strategic direction and the company’s business outlook.

During Valeant’s call on October 26, management had reported that Philidor represented 6.8 percent of total Valeant sales and about 7 percent of Valeant’s EBITDA.

Maris pointed out, however, that when management revised its Q4 guidance, total revenue had been reduced from $3.25-$3.45 billion to $2.7-$2.8 billion. At the low end, this revision represents a reduction of $550 million or 17 percent. On the high end, this revision represents a reduction of $650 million, or 19 percent.

The EPS reduction is even larger, the analyst pointed out. The adjusted EPS guidance had been reduced from $4.00-$4.20 to $2.55-$2.65. At the midpoint, this represents a decline on 36.6 percent.

“Valeant has not explained how the unwinding of a business that represents only approximately 7% of total revenue, and is, according to Valeant, less profitable than traditional prescriptions, results in a 36.6% reduction in EPS,” the Wells Fargo report noted.

Moreover, if Valeant has about 351 million shares outstanding, and the midpoint of the EPS decline, at $1.50, translates to a $526.5 million decline in cash earnings.

While Valeant had indicated that Philidor represents only 6.8 percent of revenue, this represented about $227.8 million at the midpoint of the previous revenue guidance. Therefore, it does not make sense if Philidor’s unwinding had an impact of $526.5 million on earnings.

“Also, we wonder how good a proxy is Valeant’s adjusted cash EPS to real cash when we see that this adjustment represents 71.5% of cash flow reported in the Q3 2015 results,” Maris commented, while adding, “Overall, we believe the new guidance is not compatible with the data presented by Valeant. In other words, the reduction in guidance does not match the impact, as described by Valeant.”