Over the past few weeks, shares of Valeant Pharmaceuticals Intl Inc. (TSX:VRX)(NYSE:VRX) have been in the news … again. The most recent reason Valeant was in the news was because well-known hedge fund manager Bill Ackman announced that he and another representative would be walking away from the investment, effectively leaving the board of directors once their terms were up.
Since investors have had a few weeks to digest the news and observe the share price decline in value (yet again), we can now step back and ask ourselves what this means for Valeant.
Mr. Ackman has an incredible track record for getting things done while making a splash in the media. Although he is 36 years younger than Warren Buffett, he has probably spent as much time (if not more time) in front of the camera than Mr. Buffett.
As an investor in Valeant, Mr. Ackman brought a lot of attention with him. He also brought confidence and the ability to rally people to reach an end goal. With Valeant, the end goal was to reach a point where it would be sustainable to pay the company’s interest expenses given the revenues that came through the front door.
With the company spending between 15% and 20% of revenues on interest expenses and bondholders losing faith, there is little reason to relax the covenants. Going forward, it would be completely understandable to see the bondholders force the company’s hand if push comes to shove.
Shares of Valeant made up a significant amount of Mr. Ackman’s portfolio several years ago; the reality is, a market decline not only wipes out the value of an investment but also the entire portfolio. Investors need to realize what it means to lose money and to make it back.
Take Hot Stock A as an example. We invest 50% of our portfolio into the stock. Hot Stock A represents $50,000 and 19 other securities represent $50,000 of the entire portfolio. Assuming 19 stocks do not move and Hot Stock A declines by 90%, then the entire portfolio is now worth $55,000, and the holding accounts for 9.1% of the portfolio.
A 90% decline in value changed the value of the stock by 90%, but the weighting moved from 50% to 9.1%. As investors, we obviously want securities that make up a bigger part of a larger portfolio instead of the above situation.
This is why Mr. Ackman hung in for so long.
Barring a major cash injection into the company, there is simply too much debt and not enough revenues to cover the company’s long-term financial solvency issues. Investors need to ask themselves: “Just how much longer will I hold on to this sick puppy?”
