In May of this year, I concluded that new headwinds appeared for Bausch Health Companies (NYSE:BHC) as the company has seen a tough start to 2022 as interest rates started to rise, creating higher future interest expenses on its huge debt load and a soft IPO of its Bausch + Lomb (BLCO) subsidiary.

While these are far from encouraging trends, the valuation reset has been huge, creating a potential opportunistic investment opportunity. Amidst all these moving parts and some clearly negative developments, there are opportunities, but this remains a very risky play.

The Thesis

Bausch Health is the successor of Valeant, whose name was too toxic to still use in operations, after its deal- and price-driven expansion strategy went awfully wrong. In the aftermath of this, Valeant was an $8.7 billion business in the year 2017 on which a fat EBITDA number of $3.6 billion was posted. Despite this big number amount, the adjusted EBITDA number was quite adjusted as leverage was very high with net debt equal to $25 billion.

What followed were years of stagnation as the company has been posting rather flattish sales and margin developments while gradually bringing net debt down to the $20 billion mark in 2021, a very modest pace of achievements. With the 360 million shares early in the year trading at $27, the resulting $10 billion equity valuation translated into a $30 billion enterprise valuation, equal to 4 times sales and 9 times EBITDA.

The promise was that deleveraging and the Bausch + Lomb spin-off should provide a boost to the earnings performance of Bausch Health, but that all went wrong. After posting $8.4 billion in sales in 2021, EBITDA came in at $3.5 billion, as operating momentum was flattish. There were, however, two big issues.

For starters was the fact that the company was rapidly facing higher interest expenses (going forward) on the still elevated net debt load given that interest rates have been moving higher. The other issue is that demand for Bausch + Lomb, the eye business, was not very strong which makes that Bausch Health did not deleverage as much as expected.

The company originally guided for sales around $8.5 billion for the two businesses combined in 2022 with EBITDA seen flattish at around $3.5 billion. Net debt of $20.8 billion and interest costs of $1.4 billion were still quite high. The problem is that the company has been off to a soft start to the year, as the company lowered the sales guidance to roughly $8.3 billion and EBITDA at around $3.3 billion, with the EBITDA guidance including some dis-synergies from the split up of the company.

Bausch sold 35 million shares of Bausch + Lomb in its IPO at $18 per share, raising $630 million in gross proceeds, but this was all far lower than expected as the preliminary pricing range was set between $21 and $24 per share. Bausch holds another 315 million shares which were valued at $5.7 billion at the offer price of $18 as Bausch + Lomb only saw $2.2 billion in net debt being allocated to itself from Bausch Health.

This makes that Bausch + Lomb is essentially valued at $8.5 billion which compares to a $24 billion enterprise value of Bausch Health (including its ownership of Bausch + Lomb) at $10 per share, largely made up of debt of course. This furthermore reveals that Bausch + Lomb is valued at just around a third of the enterprise valuation of the combination, despite a greater revenue portion, although the eye business is far less profitable than the Bausch Health business.

If the entire stake in Bausch + Lomb would be divested, the enterprise value would fall from $20.8 billion to $12.3 billion, yet EBITDA would fall from $3.5 billion to $2.7 billion, as leverage will come down but only in a relatively modest fashion to 4.5 times EBITDA. With so much of the enterprise value of Bausch Health represented in the form of debt, the equity is essentially a call option, and while it is a risky one, I allocated a tiny speculative position here in May.

And Now?

Between May and July, shares of Bausch have been trading sideways. After trading at $10 in May, shares initially dropped to the $7 mark, but now trade in the high $8s as the situation remains very uncertain and nervous as well. Part of this lower valuation comes as shares of Bausch + Lomb have fallen a bit as well, now trading at $15 and change after trading at a low of $13 and change in recent weeks.

No major corporate events have been seen during these weeks as wider equity markets have seen some volatility but have stabilized as well, of course. By mid-June, Bausch announced that the IPO of Solta Medical was suspended given the market conditions, as that is not going to provide a trigger as well for the shares, with the overall situation still very discomforting as the delay hardly comes as a surprise.

Nonetheless, it is a shame as the multiples for aesthetic medical device and body treatments typically come in a bit higher, as that could have provided some relief to Bausch but at least not in the near term.

The cross-holdings create a difficult situation with the equity valuation of Bausch + Lomb actually exceeding that of its majority owner Bausch Health, as the negative implied value is the result of a huge net debt load, of course, continuing to cause an overhang, although it must be said that interest rates have consolidated, providing some kind of comfort. Speculation is still the best conclusion here.