Biovail’s (BVF) share price has risen substantially over the past couple weeks as good things are happening to the company. Yesterday, the company announced that it is shifting its strategy – cutting its U.S. sales staff (opting instead to contract with existing distributors), boosting R&D spending, buying in all of its long-term debt, tripling its current annual dividend, and paying a special dividend. The company also issued guidance for 2007 that was above expectations. The company’s own projections now assume that generic competition for Wellbutrin XL (41% of sales) will come online January 1st. Management is finally facing reality by factoring this early date into its projections.
These actions raise some questions. One problem that stuck out to me is that they’re forecasting roughly $2.00 in operating cash flow for 2007, which happens to be the exact amount they’re going to be paying out in dividends over the next 12 months - or rather, "contemplating" paying that amount, according to the press release.
They’ve got more than enough cash ($630M) to buy in their existing long-term debt ($400M). Doing this will reduce interest expense (and add to cash flow) about $.30 per share. But they’ll also need more cash for ramped-up R&D spending and severance related to the layoffs of its U.S. salesforce (12% of the total workforce). They’re going to be spending about $125M (roughly $0.75/share) each year over the next four years for R&D. And they’ll book restructuring charges related to the layoffs in the fourth quarter, but the cash outflows related to this will not be confined to one period.
All things considered, unless they get a significant new product on the market, I think they’re going to need more cash than they’re currently generating to maintain their announced goals for a length of time. The $1.50 annual dividend plus $0.50 special dividend totals $2.00 per share. With projected operating cash flows of $2.00-$2.12 per share and an additional $0.30 in interest savings, I get to only around $2.40 in annual operating cash flow on the high end (my hunch is that guidance already factors in the interest savings). They’ll save on compensation costs in future periods, but near-term severance costs will use cash. Paying out more than the cash flow they generate should work this year with no problem, because they’ll have quite a bit of cash left over after buying in debt. But if capital expenditures are higher than expected, current products do not perform as projected or those in the pipeline don’t take off, they may have to increase short-term borrowing or cut back their dividend plans in another year or so.
This recent action makes me think that management is preparing for something on the horizon – like a private equity deal or acquisition. Why else would you elect to become debt free and start paying nearly all operating cash flow as a dividend? Does the founder/chairman/largest individual shareholder want to exploit the low price and take the company private for himself? If he wanted that, he’d be more likely to use the extra cash allocated for dividends to reduce the outstanding share count. It seems to me the founder wants to get the cash off the balance sheet in the event a buyer emerges to buy the whole company at a price he considers undervalued.
1 comment:
Perhaps, but I think you can eliminate a management-led LBO. If that were a possibility, I think they would not be using cash to pay down debt because it would be useful to take the company private. I think the more likely scenario is by reducing debt, they are prepared to weather a downturn in revenues/earnings by reducing leverage. Why else would they pay off debt rather than buy back shares? It must be because they expect a higher return on capital from reducing debt than they think the company will generate on its own common stock. This might indicate they are preparing for the worst.
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