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After you receive this note, we will be initiating a position in Bausch Health (BHC), buying 1,500 shares at roughly $24.68. Following the trade, Bausch Health will represent roughly 0.9% of the Charitable Trust.
At a high level, we like the idea of increasing our health care exposure as it represents a defensive posture that we believe appropriate given the heightened uncertainty resulting from the Omicron variant. That is adding additional pressure to the global supply chain and reared its ugly headed at the same time that the Federal Reserve has shifted its view on inflation, noting that it will be around for longer than expected and that a quicker than previously anticipated tightening of monetary policy is therefore warranted.
At the company level, we believe that CEO Joe Papa, has made significant progress in righting the Bausch Health (formerly Valeant) ship since he took over in mid-2016.
First, when Papa took over, the company held over $30 billion of debt on its balance sheet; that figure has been reduced by $10 billion.
Second, when Papa took over, the company was facing legal issues related to improper revenue recognition and misleading disclosures. These legacy legal issues were resolved in July 2020 when the company agreed to pay a $45 million penalty to settle the charges.
Finally, while the two issues noted above were certainly priority issues, Papa also steered the company back on to a path of organic growth.
That is a quick rundown of what has happened thus far, however, it is what is set to happen next that we believe makes Bausch Health an attractive investment. Thanks to Papa’s intense multiyear focus on resolving legal issues, strengthening the balance sheet, and investing in growth (research & development as a percentage of revenue nearly doubled, to 6%, under his leadership), Bausch Health is in a position to unlock additional value via a three-way breakup.
On Aug. 6, 2020, management announced its intention to spin off its Eye Health business, a move that would result in two separate companies: Bausch + Lomb, “a fully integrated, pure play eye-health company,” and the remaining company, “a diversified pharmaceutical company with leading positions in gastroenterology, aesthetics/dermatology, neurology and international pharmaceuticals.” Management believes the move will unlock value by allowing for improved strategic focus on the eye care front — a factor that should aid earnings power, while enhancing financial transparency — something that allows investors to better value the business and thanks to the improved confidence that provides, perhaps reward shares with a higher valuation multiple.
However, nearly a year after the Eye Health spinoff announcement, management announced intentions to further separate the remaining company by spinning off its medical aesthetics business Solta Medical, “a leading global provider in medical aesthetics with innovative and effective skin rejuvenation and body contouring solutions, including the Thermage RF systems, Fraxel laser, Clear + Brilliant laser and VASER ultrasonic systems.”
The move is expected to aid in further debt reduction and unlock value by allowing investors to value the business on its own merit, with management believing that a higher multiple will be awarded to the business given its enhanced growth profile (sales grew at a compounded annual growth rate, or “CAGR,” of 32% from 2017 to 2020) and peer medical aesthetics valuations.
Ultimately, what is now Bausch Health is set to become three separate entities – an eye health business, a fast growing medical aesthetics business, and a diversified pharmaceutical operation. Now that we have an idea of what current shareholders will ultimately end up owning, the question becomes, what exactly are those three entities worth individually and is it more than what the current company is valued at?
Let’s start with the fast growing Solta operation. Despite being announced later, it will actually be the first part to be separated via an early 2022 IPO. In the first three quarters of 2021 (+27% year-to-date), Solta generated $219 million in sales. Moreover, EBITDA has grown at an 87% CAGR from 2017 to 2020, and had $135 million in adjusted EBITDA in 2020. Additionally, while we don’t know the adjusted EBITDA numbers for 2021, applying the 27% top-line growth rate to the 2020 adjusted EBITDA base we get a 2021 adjusted EBITDA estimate of $171.5 million – a figure we think could prove conservative.
Now for the multiple. Investors place a high valuation on aesthetics business. For example, the Beauty Health Company (SKIN) sports an incredible 108x adjusted EBITDA multiple based on estimates into the end of 2021 (or ~73x next year’s projected adjusted EBITDA), while InMode trades at ~30x next year’s projected EBITDA numbers. Slap that lower ~30x multiple on our projected EBITDA of $171.5 million for Solta and we get a market cap of ~$5.15 billion.
As for Busch + Lomb, the eye health business did $909 million in “EBITA” in 2020, down from $1.1 billion in both 2018 and 2019. Additionally, the operation reported $699 million in “EBITA” in the first three months of 2021. Tack on an estimated (based on 2020 results) fourth quarter “EBITA” of $248 million and we get a FY2021 “EBITA” estimate of ~ $947 million for the Bausch + Lomb operation.
While peers on this front are limited, Alcon, a Swiss company specializing in surgical equipment for the ophthalmologists and more mass-market things like contact lens, lens care products, etc., trades at ~22.4x multiple 2021 adjusted EBITDA expectations. Put that on Bausch + Lomb’s $947 estimate and we get a market cap of ~$21.1 billion.
Finally, there is the remaining Bausch Pharma. Given this is the most challenging part of the business, we will simply utilize the company’s current ~2.6x adjusted EBITDA multiple. Given current projections for the entire company (pre-splits) to generate $3.35 billion to $3.5 billion (call it $3.425 billion at the midpoint) this year, and subtracting out the ~$1.118 billion we attributed to Solta and Bausch + Lomb, we get a remaining EBITDA base of ~$2.3 billion. Apply the 2.6x multiple and we value this operation at ~$6 billion.
Add the three pieces which we have now valued individually on their own merit (a sum of the parts valuation or “SOTP”) and you get a combined market cap of ~33.3 billion. However, there is still of course debt to consider, worth $21.9 billion. Subtract that out and we get an estimated combined market cap of about $10.4 billion or just over $29 per share for BHC once broken up and value unlocked!
As a result, we believe this exercise to indicate a solid risk reward as the sum of the parts is greater than the whole, a factor that should support a solid floor in the share price at current levels as management executes on the spinouts and unlocks value.
Lastly, while we are initiating shares with a $29 target based on this SOTP valuation, we do believe this to be a conservative target given our use of the lower multiple on Solta and room for upside resulting from the enhanced strategic focus on the eye health business and ability to manage for increased efficiencies at Bausch Pharma.
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(Jim Cramer’s Charitable Trust is long BHC.)
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