Valeant Pharmaceuticals Part III: Assessing The One-off Charges From The Medicis Merger

In Part II of this series I explained how to look at Valeant Pharmaceutics GAAP and non-GAAP accounts. In particular I showed how the GAAP accounts show large and increasing losses which the company asks you to look through. Instead they prefer you look at earnings disregarding large and increasing "merger and restructuring charges", "asset writedowns" and "legal settlements".

This is a reasonable thing to do if you think these charges are (a) reasonable and (b) non-repeating.

If the "one-off charges" are not really "one-off" then the "non-GAAP" earnings (presented net of these charges) are a fraud on the gullible.

This is the central point of the series. It would be dead-easy to fake "earnings after one-offs" by putting ordinary expenses in the restructuring budget. I could make margins almost as large as I liked by telling you to ignore costs. Take an extreme example: if I called marketing expenses one-off (and put them in a bucket which I ignored) my margin would look much higher. Telling you to ignore those expenses of course is a sort of con - a Wizard of Oz trick where you tell people to "ignore those expenses by behind the curtain".

The "non-GAAP" earnings presented by Valeant however are not audited. GAAP accounting does not ignore the one-off expenses. The question is whether you - as an inventor - should ignore them like management encourages you to do.

The purpose of this post is to assess whether one-off charges as booked by Valeant are reasonable.

To assess reasonableness I looked at a few mergers where the acquired company had public accounts prior to the merger. It is against those accounts and that business said merger charges arise.

I start with the Medicis Pharmaceuticals merger.

Here, from Medicis's last filed annual report on Form 10-K here is the business description:

Medicis Pharmaceutical Corporation ... together with our wholly owned subsidiaries, is a leading independent speciality pharmaceutical company focusing primarily on helping patients attain a healthy and youthful appearance and self-image through the development and marketing in the United States (“U.S.”) and Canada of products for the treatment of dermatological and aesthetic conditions.  

Also according to that form 10-K Medicis had 646 full-time employees. No employees were subject to a collective bargaining agreement, and as seems obligatory in a 10-K they believed they had good relationships with their employees. 253 employees were in sales.

Medicis was acquired by Valeant during the year following these disclosures - and the deal closed in December 2012.

The Valeant form 10-K for the year ended December 2012 gives details on the merger including the restructuring charge. Our job in this post is to assess whether those charges are reasonable.

If they are reasonable then we can accept the "non-GAAP" earnings. If they are not reasonable then the "non-GAAP EPS" is a Wizard-of-Oz style con.

Here is what the 10K says about the charges.

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