Merrill Lynch recommends Valeant 4% convertible on attractive price, positive view on stock

Nashville, Oct. 19 - Merrill Lynch & Co. convertible analysts in a report Tuesday recommended Valeant Pharmaceuticals International's 4% convertible due 2013 based on its attractive valuation and the firm's positive outlook on the underlying stock.

On Monday, the convertible analysts pointed out, Merrill Lynch pharmaceuticals analyst Gregory Gilbert initiated coverage on Valeant with a buy rating on the stock with a $32 price objective.

The stock price target is based on a hybrid valuation approach. Gilbert applied an enterprise value to revenue multiple of 2.3 times - a 20% discount to Valeant's peer group average - to the base business estimated for 2005 and ascribed a net present value of $16 per share to its drug viramidine. Risks include dependence on viramidine, limited growth of the base business and risk to royalty revenue.

At 103.625 versus $22.80 for the common stock, the convertible is trading with a 43.7% premium and a yield to maturity of 3.5%. Using an equity volatility of 36.5% and a credit spread of 349 basis points over the five-year Treasury, the Merrill analysts estimate the convertible is trading at a 2.1% discount to theoretical fair value.

The convertible has an attractive risk/reward profile, too, the analysts added. They estimate the convertible would produce a total return of 14.2% on the upside and lose 8.3% on the downside for a 25% move in the common equity over a one-year period. Also, the analysts said that should Valeant stock reach the one-year price target of $32, the convertible would produce a total return of 22.1%.

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