Investing in Rollups – Valeant Pharmaceuticals (VRX)

There are only two ways to grow earnings in a business, one is to sell more and the other is to  spend less.  Valeant Pharmaceuticals is an example of taking those two axioms to the extreme and what the consequences can be when the investors have decided that the strategy is no longer executable.

Valeant Pharmaceuticals has been one of the best performing growth stocks of the last five years taking revenues from $2.4 billion in 2011 to $9.2 billion in 2014, and generating an 854% return for shareholders.  So what’s the problem right?

The problem is that investing in “Rollups,” or stocks that grow through serial acquisitions, usually reaches a tipping point where the investors and sponsors of the strategy lose faith in management’s ability to continue to execute and decide to exit.  When the stock begins to fall, management loses its currency to make further acquisitions and the story usually ends badly for investors.

So let’s look at what we can learn from the get rich quick through acquisitions strategy:

  • Growth is the key to the strategy – Valeant did 50 acquisitions – Making acquisitions to grow the top line revenues and cutting redundant expenses is great for results in the short-term, but integrating 50 acquisitions into one company can be a daunting task.  Given that the CEO of Valeant has been described as a hard-charging deal maker whose McKinsey & Co. background has trained him how to make a P&L look good in the short-term, there has been little spent on R&D and a big emphasis on hitting the quarterly EPS numbers.
  • Rollups are not growth stories – The growth comes from adding revenues through acquisitions, not producing innovative new products or finding some new untapped market.  Basically it boils down to financially engineered growth.
  • The party eventually ends – Like a game of musical chairs, the stock will continue to perform as long as investors have confidence that management can execute, but as the acquisitions required to grow the top line become bigger and bigger, the management needs a strong stock price to continue to execute and when the stock begins to sell off it becomes a broken strategy and ultimately a broken stock.

Rollup strategies are just get rich quick schemes for the insiders.  Invest in companies where the management is intent on creating shareholder value through building better products or providing a better service. One with a competitive advantage in the marketplace and a large moat that protects that advantage.

Source: Valeant CEO’s Outsider Roots Spun Market Gold, Until They Didn’t


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