We're sticking with troubled Bausch Health despite another major setback

Published Fri, May 6 20224:25 PM EDTUpdated Fri, May 6 20224:27 PM EDT

We're planning to ride it out with Bausch Health Cos. (BHC). Admittedly, shares have underperformed since we started our position in December . However, Friday marked on an important day for our BHC investment thesis, so we wanted to provide an update to Club members on why we're sticking with the struggling pharma stock. Bausch Health dropped another 4% on Friday, hitting a new 52-week low under $16 per share, down more than 40% year to date. Investment thesis When we invested in BHC in December, we did so under the belief that a three-way breakup plan would create value for shareholders of the debt-laden company. It's taken longer than expected for that process to get into motion. But now it's happening — with some turbulence, to be sure, given the overall market turmoil of late. Here's a basic step-by-step process on how we thought BHC shareholders would benefit: BHC's large net debt load, almost $21 billion, has weighed on its multiple, preventing its stock from trading at a higher equity valuation. Plans to take its eyecare business, Bausch + Lomb , and its aesthetics business, Solta Medical, public in two separate offerings would generate sizable IPO proceeds at high valuations relative to the BHC enterprise. BHC could then take that cash and pay down debt, while retaining majority stakes in both companies. As it reduced debt, investors would be more willing to pay a higher multiple for shares of BHC as a standalone pharmaceutical company. In theory, the sum of each individual parts would be worth more than BHC as a whole company, a.k.a. create value for shareholders. Bausch + Lomb, which makes contacts, eye drops and other optometry-related products, began trading on the New York Stock Exchange Friday under the ticker BLCO. The initial public offering raised $630 million — and as laid out above, Bausch Health will use those proceeds to pay down some debt. It retains a roughly 90% stake in BLCO. IPO issues The problem here is Bausch Health raised considerably less money than we thought it would in BLCO's public offering. The market valued BLCO at approximately $6.3 billion, based on its $18 per share offering price, according to RBC Capital Markets estimates. The company's own target range was between $21 and 24 per share. The company's own target range was between $21 and 24 per share. BLCO did close up 11% to $20 per share. Add in the roughly $2.2 billion debt that BLCO is taking on, and the company has an enterprise value of $8.5 billion, RBC estimates. The reason for the disconnect between our December projections and BLCO's actual valuation isn't hard to locate: Sentiment on Wall Street has gotten a lot more negative in the intervening five months, as the Federal Reserve turned more hawkish and Russia invaded Ukraine. The appetite for IPOs has largely vanished, which made it harder for Bausch Health to get the deal done at favorable terms. Make no mistake: We're disappointed by the valuation Bausch + Lomb went public at Friday because we believe its value is far too discounted versus peers. However, we're taking a longer-term view because we understand the difficult market dynamics right now and the need for Bausch Health to pay down its debt to clean up its balance sheet. We think Bausch + Lomb will eventually trade at a higher multiple. It currently trades at a heavy discount to peers, and we think the gap will narrow as investor attitudes and business conditions improve. When that happens, Bausch Health should be able to monetize more of its BLCO stake at a higher valuation, make progress on reducing their debt burden to target levels, and deliver that "unlocked value" for BHC shareholders we've been talking about. This is why we're not selling BHC. What's next Bausch Health also plans to take Solta Medical public . The timeline for that deal is unclear at this point because the IPO market is still rather chilly. The uncertainty is likely to weigh on BHC shares because, as explained above, investors want to see BHC lower its debt load. Bausch Health has been doing that since its net debt burden peaked above $30 billion in 2021, but the market is looking for more. Proceeds from any Solta IPO would be used to unlock more value for shareholders as well, and so we're willing to be patient and wait for that to happen. (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