Why Ruane Cunniff & Weitz Funds Like Valeant Pharmaceuticals (VRX) ~ market folly

Friday, September 14, 2012

Why Ruane Cunniff & Weitz Funds Like Valeant Pharmaceuticals (VRX)

We've seen past commentary from multiple managers on shares of Valeant Pharmaceuticals (VRX) and thought it was worth highlighting given that numerous respected managers own it.

Hedge Fund Activity

As of the end of the second quarter, prominent institutional owners of VRX include (in descending order): Ruane Cunniff, Jeff Ubben's ValueAct, Andreas Halvorsen's Viking Global, Glenn Greenberg's Brave Warrior, Lee Ainslie's Maverick Capital, and many more.  In the past, VRX has also made Goldman Sachs' VIP list of most important stocks to hedge funds.

Weitz Funds Commentary

While this perspective on Valeant is from June 30th, it still gives a good background of the story/thesis.

Weitz Funds' Portfolio Manager David Perkins, CFA penned the following note on VRX embedded below:

Ruane, Cunniff & Goldfarb Commentary

The well known manager of the Sequoia Fund holds quite a large position in VRX that has appreciated in value over time.  It initially started as a 6% position and has grown to a 10% position in the main fund.  They were the largest institutional owner of VRX as of the end of Q2.

They addressed their stake during their investor day back in May of this year.  Again, while dated, the comments still outline their rationale for owning shares:

"The reason that we still like Valeant is the reason we liked it in the first place. It is a pharmaceutical company that does not really function like a traditional pharmaceutical company. By that I mean most pharma companies, if you look at how much they spend on research and development might spend 10%, 15% or in the high teens as a percentage of sales on research and development. Last year Valeant did about $2.3 billion in sales and it spent $66 million on R&D, which is about 3% of sales. So instead of spending money on R&D, it spends money acquiring whole companies and/or products and other assets. And what it does is restructure those assets. So we think of it as a value investor in other companies or in the assets of other companies which are available for purchase.

The reason that Valeant can do that is that it has a good team at the top led by Mike Pearson, who has been an extraordinary and very aggressive manager. The types of returns that Valeant can generate by acquiring another company and cutting costs can be in the 15% to 20% range. Just to give you an idea of that, when Valeant merged with Biovail, Biovail was doing a billion dollars in sales, and management cut out — the year-end synergy target this year is $300 million to $350 million. Valeant is eliminating costs that represent 35% of sales. Because of the company’s tax structure, it pays taxes at very low rates. So a lot of that $350 million is going to flow through to the bottom line. You can generate huge returns if you do those kinds of deals. Last year Valeant acquired Ortho Dermatologics, Dermik, Sanitas, PharmaSwiss and a few other companies. In aggregate, these companies added another billion dollars in sales and the synergy target is $250 million. Again, a lot of that is going to fall through to the bottom line. So Valeant is generating really high returns by acquiring other businesses in the pharmaceutical industry.

One of the most attractive things about the company is that it is going to generate $1.3 billion in cash earnings this year and there are not many companies that can retain that amount of money and reinvest it at a rate of return of 15% to 20%, and we could potentially see Valeant doing that for a number of years. You can get a huge amount of growth if you can reinvest that amount of earnings at those rates of return. That is the main reason that we are excited about it."

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