Tuesday the Valeant VRX released preliminary unaudited Q4 financial results and it did not go well. I perused the results, saw that the 2016 revenue forecast was shy of previous estimates and assumed the stock would rise 10% as usual. By mid-morning my brokerage account had gone haywire; VRX had free fallen 45% and my long-dated puts were deep in the money.

The Situation

Management’s estimates for both revenue and “adjusted EBITDA” are lower than its previous guidance delivered in mid-December. The prior revenue guidance was $12.5 – $12.7 billion and the new guidance is $11.0 – $11.2 billion. That would make revenue flat versus an $11.2 billion run-rate through nine months ended September 30, 2015. This is key for two reasons; it probably means that recent price cuts have taken a toll and revenue contribution from the Sprout acquisition (consummated in Q4) is negligible. I previously warned that the value destruction from the $1 billion purchase of Sprout’s Addyi would come back to haunt Valeant.

The adjusted EBITDA figure is less useful; it sounds like an internal metric only meaningful to Valeant. At the mid-point of the range ($5.7 billion), management expects it to be about 19% lower than previously estimated. Either way, its $31 billion debt load is over 5x EBITDA — junk levels. The company’s cost of capital will likely increase until Valeant can prove it can generate enough cash flow to support its debt load.

Debt Covenant Defaults

In November I advised investors to ignore Citigroup’s C bullishness as Valeant’s debt covenants would be a problem. As usual, I was viewed as an alarmist by bulls. Tuesday management divulged it was in compliance with most of its debt covenants — interest maintenance, senior secured leverage, net leverage, etc. However, Valeant would be in default of its revolving credit facility and its bond debentures if its 10-K was not filed by March 30th and March 16th, respectively.

The company could cure the breach under the revolver by filing the 10-K within 30 days of the default event; it could cure its breach under the debentures by filing the 10-K within 60 days of receiving a default notice. That’s a long-winded way of saying there is a risk that [i] Valeant’s debt could accelerated and [ii] it would have to file for bankruptcy. That’s what drove VRX down on Tuesday and why it was sub-$30 on Thursday –a 52 week low.