Undervalued Valeant's Unique Strategy Is Underappreciated

David Krempa: Drug development is an inherently risky and uncertain business. Pharma companies have to invest capital today in drug discoveries that might pay off five to 10 years down the road if the drug is approved. Valeant (VRX) takes a unique strategy to pharmaceutical development. They focus on buying products that are already approved so that they can more accurately predict the returns on capital and they can ensure to shareholders that they are making value-creating investments.

The company also focuses their portfolio on cash pay products such as contact lenses, plastic-surgeon products, and over-the-counter medications. Because [these products] aren't covered by governments or large insurance companies, Valeant is isolated from some of the paying pressure that we are seeing a lot of the traditional pharmaceutical companies deal with right now.

Valeant's acquisition strategy creates a lot of skeptics, but we actually believe the company is a very rational buyer and we give management an Exemplary stewardship rating. They have shown they are willing to walk away when deal prices get too high, which we saw recently with Allergan (AGN), as well as a number of other times over the last six years. They have also shown a willingness to buy back their own shares when that represents the best investment. So, we don't have much concern that they are engaging in empire building and buying just to grow.

The company has also been a pioneer of the inversion strategy. They were one of the first pharma companies to do it back in 2010. Since then, we have seen the whole industry try to follow their lead and catch up to them, and we've seen almost a dozen pharmaceutical inversions over the last three years.

We think shares are currently undervalued, in part, due to some of the skepticism about their unique strategy, but we think long-term investors are going to get attractive returns on the stock.