Bausch + Lomb (BLCO) reported largely in-line fiscal first-quarter financial results before the opening bell Wednesday. The numbers were not a surprise because B+L reported its first quarter results inside of Bausch Health Companies ‘ (BHC) release in early May. However, Wednesday was still an important event because it marked the first time since its initial public offering that B+L management spoke to the entire analyst community. Before getting into the Bausch + Lomb numbers and commentary, here’s why they matter to us as shareholders of Bausch Health. On Wednesday, both BLCO and BHC shares traded lower as Wall Street seemed unimpressed with what they read and heard. While the Investing Club doesn’t directly own stock in the recent Bausch + Lomb IPO for the Trust, Bausch Health owns about 90% of its former eyecare unit. Smaller-than-expected proceeds of May’s ill-timed B+L offering went to pay down debt at BHC, which plans to further monetize that stake in the future. We’ll go further into BHC’s separation strategy and how it figured into our original investment thesis a little later, but now let’s get to Bausch + Lomb’s quarterly numbers. Sales rose 5% year over year organically to $889 million, largely matching results reported last month in BHC’s own release. Driving the topline was a 4% year over year organic increase to $560 million in Vision Care sales, a 13% rise to $174 million in Surgical sales, and a 3% decline to $155 million in Ophthalmic Pharmaceuticals sales. Adjusted earnings of $0.24 per share came in slightly ahead of estimates. Operating income came in at $54 million, down $31 million versus the year-ago period due to increased what the company described as “investments in Selling, general and administrative (SG & A) expenses and R & D spending, as well as an increase in Cost of goods sold, partially offset by a decrease in amortization of intangible assets and an increase in revenues.” Turning to guidance, management forecasts full-year sales for Bausch + Lomb to come in at $3.75 billion to $3.8 billion, bracketing the $3.79 billion analysts were expecting coming into the print. Additionally, full-year adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) is expected to be in the range of $740 million to $780 million, largely matching expectations of $763 million at the midpoint. Why we care On the quarterly release, management reiterated Bausch Health’s intention to complete the spinoff of additional shares of Bausch + Lomb following the expiration of customary lock-ups related to the IPO (125 days from the S1 filing date of April 28, 2022), the achievement of net leverage ratio targets, and provided market conditions are favorable and shareholder and other necessary approvals are granted. Prior to the Bausch + Lomb IPO, management noted that Bausch Health intends to utilize 20% of the BLCO funds to pay off debt at parent BHC. The IPO represented the first 10% and looking forward, it appears that another 8.7% (the difference likely the result of transaction fees) is intended to be monetized for the purposes of paying down debt. Of course, the more BLCO is worth at that time, the greater the impact will be on BHC’s debt levels. The remaining 80% is expected to be distributed to BHC shareholders through a spinoff, which we believe will be the key event to bring out value. So, the value of BLCO is important for two reasons: First it will impact BHC’s ability to reduce debt levels — and second, it will eventually be distributed to BHC shareholders. As it stands now, there are currently 350 million shares of BLCO outstanding. At a share price of $15.66, this amounts to a market cap of $5.48 billion, which again, BHC still owns roughly 90% of. Assuming management monetizes the additional 8.7% at $15.66, they should be able to reduce debt by nearly $477 million. However, we would be surprised to see BHC monetize this last piece at such a low equity value because BLCO currently trades at a significant discount to its peers. On the IPO, which was priced well below the company’s range at $18 per share, BHC got $630 million to pay down debt. If BHC can then distribute the other 80% to shareholders at those levels, it would should mount something akin to a stock dividend to shareholders of just under $4.4 billion. Of course, if BLCO performs well and shares appreciate before then, the debt paydown at BHC would be greater, as would the distribution to shareholders in the form of BLCO shares. Recall, that one key issue plaguing BHC is a roughly $20 billion net debt load on the balance sheet. The monetization of BLCO along with the expected IPO of Solta Medical should provide a material dent to that debt level and allow shares of BHC to trade more so on the merits of its product offerings and less so on the state of its balance sheet. We purchased Bausch Health on the premise that the IPOs of Bausch + Lomb and Solta would free those faster-growing units to thrive as separate companies, untethered to the slower-growing but much larger pharma business, which stays with the parent. Unfortunately, the Bausch + Lomb IPO, which came as the stock market was in the throes of its recent meltdown, and terrible first-quarter Bausch Health earnings have hurt BHC shares and delayed the de-leveraging timeline. Given these poor results and our loss of faith in management’s ability to unlock further value via spinoffs following the completely botched Bausch + Lomb separation, we downgraded shares on May 10 to a 4 rating, designation we have not had a use for until now. As we noted at the time, we usually rate stocks 1 to 3 . The 4 rating served notice that no action will be taken on BHC stock until more information becomes available. Patent cliff Debt isn’t the only concern on shareholders’ minds. The other is the patent cliff for Xifaxan, used to treat irritable bowel syndrome with diarrhea. While this is more of a Bausch Health issue, as Xifaxan is a Salix Pharmaceuticals product and Salix is wholly owned by Bausch Health, it was the topic of the first question on Bausch + Lomb’s earnings call on Wednesday. Remember, investors know what the debt is and can model it, what we don’t have as much clarity on is the outcome of a Xifaxan patent trial that will determine how long it is before generic competition is allowed to come to market. If there is one thing investors hate more than bad news it is uncertainty because again, bad news (or debt) can be modeled effectively, uncertainty on the other hand leaves much more room for error — and as a result causes many to avoid ownership or price in severely adverse outcomes as a way to incorporate some margin of safety. While management reiterated their confidence that the trial will go in their favor, saying their legal team “felt more confident at the end of the trial versus at the start of the trial,” they did not go into much detail as to what happens if it goes the other way. Bottom line, management did note the evaluation of multiple scenarios for planning purposes. While they remain confident of victory, should they lose, it would deal a significant blow to future sales potential. According to Bloomberg Intelligence, a negative outcome for Bausch Health in its case against Norwich Pharmaceutical could move up the entry of a generic version by as much as three to four years — as early as the end of 2024 — and hit future sales by anywhere from $6 billion to $8 billion, assuming about $2 billion of sales per year, with little in the pipeline to offset the blow. This is perhaps the single greatest overhang and risk on the stock and one we are monitoring closely. As a reminder, the trial took place in March 2022 and management expects a decision in early August. Answering a common question Lastly, we want to address Club member questions we received a few times, which is how Bausch Health accounts for its BLCO position when providing financials. Without getting too into the weeds, there are essentially three ways a business can account for its investment in another business: (1) the cost method, (2) the equity method, and (3) the consolidation method. As a rule of thumb, the method used may be determined by ownership percentage. The cost method is largely used for ownership stakes of 20% or less; the equity method is reserved for stakes of 21% to 50%; and the consolidation method is used for those investments that account for over 50%. That said, while the percentage ownership is a good place to start what it really comes down to is the level of control/influence a company has over its investment. For example, if a company owns 40% of another business, but exerts immense control, the consolidation method would likely be more appropriate than the equity method. BHC’s 90% ownership of Bausch + Lomb falls into the consolidation camp. That method works exactly as one might assume — by consolidating the financial statements of the subsidiary into those of the parent. Eliminations are then factored in to adjust for the non-controlling interests and to prevent double counting between the parent and the subsidiary. These eliminations are generally found in the shareholder equity portion on the balance sheet and towards the bottom of the income statement when addressing the allocation of profits. (Jim Cramer’s Charitable Trust is long BHC. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
Joseph Papa, CEO, Bausch Health
Scott Mlyn | CNBC
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