Bausch Health: A Timely Divestiture Is The Key To An Higher Valuation (NYSE:BHC)

Bausch Health (NYSE:BHC) is a high-quality pharmaceutical company that has shown great resiliency and ability to innovate. However, it is also loaded with an expensive and heavy debt load of more than $20 billion that is weighing on the equity valuation.

The key to resolving the leverage issues remains the complete or substantial divestiture of the Bausch+Lomb Corp shares. This would bring much-needed cash to reduce debt and increase the chances for a stock valuation re-rate. We believe that after the divestiture, there is an upside potential of around 40%.

A snapshot: leverage, cash flows, and products portfolio

Bausch Health is a highly diversified business with 4+1 segments, if we include the Bausch+Lomb partnership. The four core divisions of the standalone Bausch comprise Salix, International, Solta Medical, and Diversified Products. Let’s visualize what they do:

1. Salix: The Salix segment focuses on developing, manufacturing, and marketing prescription pharmaceutical products for gastrointestinal (GI) disorders – Xifaxan alone represents 80% of the revenues of the segment. This segment is the bulk of Bausch’s revenues that are generated through its proprietary drugs.

2. International: The company also distributes drugs outside the US, and this segment provides a quick overview of the size of the foreign market for its products.

3. Solta Medical: Solta Medical is a segment focused on providing aesthetic and medical devices for skin rejuvenation, body contouring, and other cosmetic procedures. The smallest segment.

4. Diversified Products: The Diversified Products segment encompasses a range of pharmaceuticals and consumer healthcare products that do not fall into the other specific segments. This includes OTC medications, vitamins, and other wellness products.

This is a visual breakdown of revenues by segment. Notice that the clear underperformer is Solta Medical, a mildly growing division that is the most non-core asset. If we combine the International and Salix segments, we notice that proprietary drug sales represent the vast majority of income, close to 75%. This means the company is highly dependent on patent protection (we will discuss more about this later), and regulatory approvals.

And what about the balance sheet profile? Well, here is the weak link of the chain: debt. The company has around $21 billion of debt, $760 million in cash, and a TTM EBITDA of $2.8 billion.

This is the maturity profile, which shows no meaningful repayment before 2025. However, in that year some $2.8 billion of debt needs to be refinanced. That can be described as a maturity “wall”, as the company will face a significant financial hurdle. The leverage ratio using the latest EBITDA figure is around 7.2x, and with FY24 guided EBITDA it should get down to 5.8x (guided $3.5 billion across Bausch and B+L). We believe that the real hurdle will be posed by two main factors combined: (1) the Salix segment revenues, and (2) the second, more significant maturity wall in 2027.

What is going on: B+L divestiture and Xifaxan litigation

In May 2022 Bausch sold a 11% stake in Bausch + Lomb Corp to the public through an IPO. The company still retains 89% of the business but plans to divest the entire stake subject to certain conditions being met. We believe this is the key point around which we should discuss both leverage and valuation, the resolution of which can determine the upside scenario for shareholders. As of today, Bausch + Lomb (BLCO) has a market value of $6 billion, which values the stake of its parent company at some $5.4 billion. We believe that Bausch should concentrate all its efforts on negotiating a fair but timely exit from this investment and use the proceeds to pay down debt and de-leverage.

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These represent three scenarios that we think are reasonable expectations of proceeds from a divestiture. The markdown in the valuation figure is a direct outcome of a larger sale, as both the market of private parties would demand a discount to bear a larger number of shares. In all scenarios, it is clear that the company could easily collect around $3 billion, along with spinning off the debt associated with BLCO. We however report here a comment from the filings on the proposed transaction:

At the time of our announcement of the B+L Separation, we emphasized that it is important that the post-separation entities be well capitalized, with appropriate leverage and with access to additional capital

This means that the two standalone entities cannot differ substantially in terms of leverage ratios. That is, Bausch cannot use all the proceeds to pay off its own debt only. For this reason, we expect these proceeds to be used to equally retire obligations at the two companies. We will present valuation scenarios for all three cases of sale in the next section.

There is, first, another key issue. The most important drug marketed by Bausch, Xifaxan, brings home around $1.6 billion in revenues per year. This is 21% of 2022 revenues and around 80% of the Salix segment. It was reported in 2022 that there was a generic in the workings, and soon it was news when the company started several lawsuits to block the approval. In May 2023, it was confirmed that Bausch won also the appeal at the federal circuit, which upheld the decision of the lower court to stop the approval process of the generic, and allowed exclusivity for Xifaxan up to 2029. But the problems are not over for two reasons: (1) we expect a significant risk of more lawsuits for pre-expiration approval into 2027, and (2) there is a pending patent litigation against the company. The latter news is the most important. It was reported in September 2023 that Bausch is also facing the threat of having to pay damages to some patent owners. This would link to our first concern. A loss on key patents could again open up to the threat of a pre-expiration generic approval likely into 2027.

Risks: execution and lawsuits

Our recent discussion of Bausch’s legal issues is the best summary of what could go wrong. Evaluating legal proceedings’ impact on a business is always a tough job for investors, and this case is no different. The company could face major financial setbacks if a significant enough ruling hits, and most severely it could bring deadly competition in the market in the form of generics.

Another major risk is the execution of the divestiture plan. This is subject to several conditions being met, and it could significantly delay the transaction. We expect eventually that all issues will be resolved, but we consider this another risk.

Assessing the valuation spectrum from the sale of BLCO

Going back to our main point, we need to assess the EV/EBITDA profile of a post-divestiture entity. We will take the upper end of our aforementioned scenarios of a sale, and assume proceeds of around $4 billion. This represents a margin of safety of around $1.4 billion compared to the current fair market value of their stake.

The Bausch parent has $16.4 billion in debt, while the BLCO has $4.6 billion. This would translate into a pro-forma net debt of $14.4 billion and $2.6 billion.

Using the guided EBITDA for the two businesses, we derive that the ending leverage ratios would be around 6x and 3.1x. As one can grasp, very different indebtedness profiles. However, the resulting entities’ EV/EBITDA would be significantly more appealing. Bausch parent would end up with a 7.4x multiple (vs 9.2x today for TTM EBITDA, and 8x for FWD EBITDA), and on top of this, significantly better cash flows as interest expense goes down with deleveraging efforts. As a fair price, we simply apply today’s valuation multiples to the pro-forma entity to derive a value of $13 per share. This implies an upside potential of around 40% from the current price.

Conclusion

Bausch Health is facing several issues, mostly related to its capital structure, an ongoing divestiture, and lawsuits that affect its most important drug. However, there is a clear path to resolving these issues and emerging as a stronger (and cheaper) company: divesting BLCO as soon as possible. We believe that once a transaction is completed, the fair value could be as high as $13 per share, with a 40% upside potential.