When companies discuss their earnings, it is normal for management teams to exclude one-time items. Sometimes these adjustments are reasonable, for example excluding a one-time legal charge (or windfall). Such items do not reflect the underlying operations of the company and should not have any bearing on future earnings.
Having said this, sometimes companies push the envelope and direct investors to ignore charges that are normal business charges. One of these caught my eye recently – I felt it was so egregious as to be worth mentioning. In this case, Valeant (ticker: VRX) has issued debt to fuel its recent acquisition of Bausch & Lomb. The debt has two components, a regular interest cash component and a zero-coupon component. [As a reminder, zero-coupon debt works when a borrower collects a low amount today and must pay back a higher amount in the future. The interest is not made in the form of cash payments but instead builds up until the borrower pays back the higher lump sum. Every quarter, the borrower should report a portion of the interest that is due with the final payment].
In its communications to Wall Street, Valeant has indicated that it believes its ‘adjusted’ earnings should include only the cash interest it pays. The company excludes the zero-coupon interest that accrues each period. This amounted to $33 million last quarter, or about 5% of Valeant’s EPS. This exclusion is stunning to me. Even more stunning is that Wall Street analysts seem to have accepted the company’s definition of adjusted earnings.
I think this evidences either complacency, laziness, short-sightedness or some combination of these. Correspondingly, valuation of ‘the market’ may be more expensive than it appears given that true corporate earnings are lower than companies are describing.
source: Valeant Q2 2013 earnings