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Ackman and Icahn have been fighting over Herbalife whose outcome is very hard to predict considering the complexity of determining the legality of a Multi-level marketing business as well as the international nature of Herbalife's business. Here I ask them to look at TARO Pharma(TARO) which is very easy to understand, low risk, high reward and where an activist investor can easily make a big difference.
1. TARO at its present price of $59 per shares offers compelling value-> link. TARO trades only at 5 times Q4 2012 annualized EBITDA.
- TARO is the market leader in the USA generic dermatology pharma business with nearly 120+ products.
- TARO is in limited competition generic pharma business of making dermatology products. Hence it enjoys pricing power as seen in price increases on lot of its products in the last 3 years.
- TARO has grown its earnings and sales every single year in the past 5 years.
- TARO's revenues does not have one-off 6 month exclusivity revenues, the bread and butter for most generic pharma
- TARO has little to no competition from Indian generic pharma that are a dime a dozen in the generic pill business.
- TARO is in niche generic pharma business just like Agila Specialties. Agila specialties was recently sold to Mylan for 19 times EBITDA. If TARO is purchased at the multiple Agila was sold at, the share price would be $187 per share.
- TARO's sales in countries like Brazil, South Africa, China, India, Australia, Japan are negligible today. I think TARO's value can be further realized if an acquirer like Valeant which already has world-wide presence unlocks this value.
Then, why does TARO trade at such deep discounts ?
2. Major reason why TARO is severely undervalued is because TARO does NOT have any minority shareholder representation on the board. TARO's board has representation from majority shareholder SUN pharma. TARO's board has not worked in the best interest of minority shareholder. The board unsuccessfully tried to buy out minority interest at <6 times EBITDA without exploring all strategic options to maximize shareholder value.
The market also does not understand well the minority protections.
3. One of the other reasons why TARO is severely undervalued is because TARO is not known to most market participants. Since TARO re-listed in NYSE a year ago, TARO has never attended an investor conference or conducted an earnings or investor call.
Minority Shareholder Protections (why, in the end, minority shareholder should come out ok?)
4. While TARO is majority(66%) owned by SUN pharma, any buy out of TARO's minority interest will have to happen at fair market multiples. TARO's peer Perrigo trades >16 times EBITDA. Here is why :
- a. For any buy out transaction , TARO will need a majority of minority vote per the Israeli law.
- b. Many minority shareholders of TARO are active and sufficiently educated about TARO's fair value. Many shareholders(Bluemountain, Iszo, GrandSlam and many other small retail shareholders) have written public letters to the board educating the board about the fair value of TARO.
- c. Courts will ensure minority shareholders are paid fair value for their shares. Courts have repeatedly said the following:
- i. All strategic alternatives alternatives have to be considered and not just a merger with majority shareholder. There is a thing called "go-shop" where once a proposed deal is announced the board is expected to shop like paris hilton as Delaware judge once put it, for better deals. Link
- In the business that TARO is, there are a lot of strategic acquirers including the most voracious acquirers: Valeant pharma, Teva and Perrigo. In my opinion a marriage of TARO and Valeant pharma would be the best outcome for TARO shareholders.Here's why: Valeant and TARO are both in dermatology. Valeant is in specialty pharma and TARO is in generic/OTC pharma. This acquisition will also fly by without FTC issues. Valeant's acquisition of TARO will also bring in synergies in sales, marketing, distribution, R&D and general corporate expenses. It may also open up TARO's products to new markets where Valeant already is. For reasons not known to me, TARO's sales in countries like Australia, Japan, Brazil & Latin america, India, China are neglible. With anticipated synergies, potential opening of new markets, Valeant will likely be able to pay a premium to 15 times EBITDA and yet make it accretive to its shareholders. Valeant recently was in talks with Actavis(a generic pharma that competes with TARO) for a merger at around 15 times EV/EBITDA. Also, it is abundantly clear from the prior absurd majority shareholder offers that they don't see value in TARO at 15 times EBITDA.
- ii. Merely appointing an "independent" special committee to evaluate a buy out transaction is not enough. The burden of persuasion to show the fairness of the transaction rests with the defendants. Here is a recent $2 billion in damages judgement that went against the controlling shareholder.Link
- "Court clarified in such cases going forward that the burden of persuasion would remain with the defendants throughout the trial to show the entire fairness of the interested transaction." In this regard, the Supreme Court's ruling is likely in keeping with the advice of counsel to controlling stockholders in such cases already, i.e., establish a special committee process that is unassailable but prepare for trial as if the burden of proof remains on the defendants."
4. TARO's appointment of chairman of audit committee requires majority of minority vote ->Link . This appointment will likely have to be made in the next proxy and could be a nominee from minority shareholder.
5. TARO has a cash hoard of $550m(includes estimates from Q1 performance) earning little to nothing in interest. In my opinion, TARO's board has not used this cash hoard strategically to the benefit of all shareholders over the last 2 years. An activist shareholder could help the board in acquiring synergistic companies/products and maximizing shareholder's value. Competition(Mylan, Perrigo, Actavis) has been acquiring products and companies. TARO's majority shareholder also purchased a dermatology asset DUSA. TARO has not made a single acquisition in the last 3 years.
What can an activist investor do ?
An activist shareholder like Icahn has an opportunity to bring in the following changes that will ultimately allow TARO to trade at fair valuation levels of EV/EBITDA of >15:
- 1. Bring in minority nominees to the board including for the position of the chairman of the Audit committee.
- 2. Improve corporate governance and introduce proper controls and procedures before entertaining any future buy out offers. No offer should be entertained by the board without looking at all strategic options.
- 3. Ensure TARO presents in all major Investor conferences and adopts investor friendly practices. For an activist investor to step, TARO's liquidity/volume has to improve significantly. For this to happen, TARO has to present in investor conferences which is hinged on getting minority representation on the board (kinda Chicken or egg situation).
- 4. Assist in acquisitions and ways to opportunistically use cash to maximize shareholder value. A lot of value can be unlocked by making strategic & synergistic acquisitions for $550m(est cash by end of Q1) and taking on some debt.
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