Sunday, January 12, 2014

Stocks DD Opines: An Opportunity To Invest Alongside A Billionaire With A 20-Year Annual ROI Track Record That Beats Warren Buffett's By 85%


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About:TARO Includes:BRK.B
Full Disclosure:
I intend to use this blog for future write up's on any stock ideas. No more Seeking alpha. I am a long term retail shareholder of Taro Pharmaceuticals (TARO). A significant part of my net worth is tied to Taro. 
Taro has one of the lowest number of Seeking Alpha followers (see table below) which is ironic considering the stock has gone up 5 times in ~2.5 years and its products are widely used in the US. My objective of writing this article is to let market participants discover Taro and my long term investment thesis on it. After being introduced to an idea, I encourage everyone to use their independent judgement, conduct their own due diligence, read SEC filings, before making an investment(buy/sell/hold) decision. 
Number of Seeking Alpha FollowersPublic Float (in $millions)Number of Seeking Alpha Followers/Public Float Ratio
1 Drug ponyAMRN9,43638424.57
1 Drug ponySRPT5,7307307.85
MNKD922790010.25
DNDN935245620.51





TARO40014460.28
I think for investors with "Buffett-type" mindset this stock idea may resonate well. Well, what exactly do I mean by "Buffett-type" mindset ? These are investors who truly believe that they are going to own a piece of business when they are buying a stock; investors who have a long-term view, who do their due diligence to own a business with favorable characteristics that can generate long-term returns and have the following traits:
  • Strong business(high barriers to entry, less capital-intensive) with favorable risk profile
  • Business selling at a discount
  • Proven management with a great track record
A good example of "Buffett-type" investors are shareholders of Berkshire Hathaway (BRK.B). Below I intend to succinctly make my 'going long' case for Taro with the above 3 pillars in mind. When the above 3 traits are met in an investment, all investor needs is PATIENCE, PATIENCE & PATIENCE!! Investors only need to monitor once a quarter the earnings and future pipeline.
Business
In the pharma sector, I have compared some of the key business factors for Branded pharma and Generic Pharma vis-a-vis a Niche Generic Pharma like Taro.
(click to enlarge)
From the above analysis, it is easy to see why Niche Generic pharma business is a pretty favorable business to be invested in vis-a-vis lower barrier-to-entry Generic pills business as well as vis-a-vis Branded pharma business which is high-risk, capital-intensive and low speed-to-market business.
Price - Is the business selling at a discount ?
Using Taro's TTM EBITDA of 405.42M, Taro at $107 per share trades at ~10 TTM EBITDA. The stock back in July 2013 was trading at bargain basement price of <~5 times ttm EBITDA when I wrote this article making my long case. Some seeking alpha contributors have opined on the topic of valuation using evidenced-based market approach (trading multiples of peers and precedent transactions in the niche generic pharma space) and one could use this as a starting point in this analysis. Obviously an existing shareholder opining on this topic is not exactly unbiased. So I encourage the reader to do their own due diligence in looking at market evidence.

The Mylan-Agila Transaction : What can we learn from it ?

The Agila Specialties (another niche generic pharma) acquisition by Mylan, that closed in Dec 2013 after the FTC settlement, does lend some pointers.
1. The market is willing to pay a high valuation multiple for a niche generic pharma: Agila transaction happened at 18.6 times TTM EBITDA
2. Highlights the secular low competition in the niche generic pharma space due to the high barrier to entry. For the Mylan-Agila transaction, FTC had several objections in Sept 2013 from an anti-competition perspective, alleging that the proposed transaction would reduce existing and future competition in several key generic drugs and could cause price increases.
Valuation
in millions
TTM EBIDTA~$405
Cash*$519
Debt$28
Share Count*42.54
Enterprise Value/ LTM EBIDTA Multiple15
Implied Enterprise Value$6075
Implied Market Cap$6566
Implied Value per Share$154.35
*Note: I have adjusted cash and share count for the recent buy back of ~2m shares. I have not adjusted for the increase in cash from the operations in the December quarter.
Here are other other points to consider that suggest upside to the above valuation:
  • Taro has demonstrated EBITDA margin >40% (actually >50% in the last year or so) for the last few years.
  • The solid growth rate in Taro's business (see chart below). Yahoo finance indicates PEG multiple of ~1 which is cheap.
  • Taro's last quarter EBITDA was $124.4m (when annualized this comes to $497.4m) a run rate significantly higher than the prior quarters. Thanks to the solid pricing power in the US-based business and the management's exploitation of it.
  • There is value in Taro's existing assets in the ROW markets that has not yet been fully exploited. In fiscal year 2012, the sales in ROW markets (ex-USA,ex-CAN,ex-UK and ex-Israel) constituted only 1% of Taro's overall sales. Some observers have opined that the ratification of EU-Israel treaty in Oct 2012 is positive for Taro and paves the way for exports to EU without additional quality costs.
  • The existing cash hoard (>$519m) could be used opportunistically to buy late stage specialty assets that could further accelerate the growth trajectory. Note Taro has foretress-like Balance sheet with just $28m debt.
  • Some recently launched and yet to be launched exciting specialty assets would have an impact on future growth. These are Topicort spray 0.25%, Calcitrene ointment, Daranide (new indication approval received in Dec 2013) and Novexatin (in-licensed this phase 2a completed asset).

Taro's recent performance




People - Taro's Chairman Mr. Shanghvi's track record for shareholders in the parent company SUN is simply outstanding
Warren Buffett has produced a stellar investment performance over the past 45 years, compounding returns at 20.46 per cent per annum. If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.8m.
Mr. Shanghvi's is the 3rd richest Indian with a net worth of $13.9 billion. Dilip Shanghvi's annual returns of 38% beats Warren Buffet's 20.6% returns by a cool 85% though for shorter period of 20 years. This is indeed a very impressive track record. Below I have reproduced verbatim a quote from page 32 from SUN pharma's Investor presentation
Rs 1,000 Invested in the 1994 IPO is currently worth more than Rs. 490,000.
This is a whopping 490 times return on investment over a period of 20 years or a compounded annual return on investment of ~38%.
(click to enlarge)
Controlling Shareholder's Incentives - Alignment of incentives with Taro's independent shareholders.
For the same controlling owners of Taro and SUN, the Billionaire/promoter family, ~64% of the value creation at SUN directly accrues to their net worth where as ~44% (Sun's ~70 ownership in Taro) of value creation at Taro accrues to them. Clearly the ownership interests of Mr. Shanghvi incentivizes him more for value creation directly at Sun relative to value creation at Taro. Note though as the controlling ownership stake increases via open market purchases (like the recent buyback) to 90%, this incentive differential(58% vs 64%) reduces significantly.
Any discussion on a company with a controlling shareholder is not complete without looking into the protections granted for minority shareholders in the jurisdiction where the company is incorporated.

Robust Minority Shareholder Protections in Israel
Israel has robust minority shareholder protections. This document (pages 95-108) is a must-read. From this document, I have tried to glean some of the highlights:
1. Majority of minority vote is required for a buy out.
2. There is threshold limit of majority ownership of 90% for buying shares in the open market.
3. Majority of minority vote is required for appointment of Audit committee chairman, an independent director.
4. A central provision of the Companies Law establishes that all shareholders are required to "act in good faith and in a customary manner" towards the company and towards other shareholders, including a duty to avoid discriminating against other shareholders. More specifically, shareholders shall refrain from abusing their power in the company when voting, inter alia, on alteration of the articles of association, increases in the registered share capital, mergers, approval of acts and transactions requiring the approval of the general meeting. A controlling shareholder or shareholder who knows that he or she has a decisive vote on a resolution has an additional duty to "act fairly" towards the company.
5. ISA (regulatory agency) financially supports minority shareholder to file derivative suits.
6. Tel Aviv District Court's Specialized Department is created to consider class action and derivative suit.
7. Tel Aviv District Court's Specialized Department in its first decision in May 2011 ruled that despite passing the approval process (audit committee, board and shareholder approval) a Related Party Transaction still needed to pass a fairness test: the minority shareholders were entitled to the best possible price.
8. Regulatory scrutiny to see whether shareholders have been correctly classified as interested or disinterested in proxy voting.
Activist Shareholders
For Joe Schmoe small retail shareholders like me, the above minority protections don't mean a squat if there are no activist shareholders willing to stand and fight for these rights. I do like to point out there are some "big boys" (namely institutional shareholders Bluemountain Capital and Iszo Capital) that have been active on this front. Although I have followed Taro from the early 2000's and all the way into 2008 when it did not have audited financials and was delisted, it was this Dec 2011 letter from Iszo that piqued my interest back into Taro. Investors can glean information from the past events, sec filings, press releases and form their opinions. I do like to see the Board, Management and shareholders constructively and positively work towards the common goal of taking our company Taro to the next level. I believe use of cash to acquire late stage/in-market assets and grow Taro significantly is one area where shareholders could help the board/management.
Hopefully, I have convinced potential investors with "Buffett-type" mindset that Taro at least warrants a Seeking Alpha following here to get email alerts (and if you find my articles informative I welcome you to follow me on Seeking Alpha here ). I welcome feedback, any corrections to my article if I have made errors and a vibrant discussion on this stock via comments.
Disclosure: I am long TARO, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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