Starboard Value Letter To Perrigo $PRGO
Starboard Value LP, together with its affiliates ("Starboard"), has an ownership interest of approximately 4.6% of the outstanding ordinary shares of Perrigo Company plc ("Perrigo" or the "Company"), making us one of the Company's largest shareholders. We believe that Perrigo is deeply undervalued and significant opportunities exist to create value for the benefit of all shareholders based on actions that should be within the control of management and the Board of Directors (the "Board"). We believe changes are needed to reverse the trajectory of poor operating and financial performance and reposition Perrigo for future success. We are writing to you and the Board to share our preliminary thoughts on issues facing the Company and opportunities for improvement, and to begin what will hopefully be a constructive engagement with the goal of driving value creation for the benefit of all shareholders.
In April 2015, Mylan N.V. ("Mylan") made an unsolicited proposal to acquire Perrigo for cash and stock worth approximately $205per share, more than a 25% premium at that time. Even at current market prices for Mylan shares, this combination would have resulted in a current value of approximately $167 per share, or 88% more than the current Perrigo stock price of approximately$89. Management and the Board went to great lengths to oppose this proposed combination, spending more than $100 million in advisor fees relating to its defense, and promising shareholders that their standalone strategy would produce more value than the transaction given the robustness of Perrigo's future prospects. In order to convince Perrigo shareholders to reject Mylan's offer, management and the Board made aggressive promises of drastic improvements in both financial and stock price performance.
Unfortunately, since that time, results have gone decidedly in the wrong direction, and management's promises have been woefully unfulfilled. Specifically, the Company has severely mismanaged the Omega Pharma Invest N.V. ("Omega"; now Perrigo's Branded Consumer Healthcare business) integration, committed numerous execution errors, and significantly lowered financial guidance on the past two earnings calls. This has resulted in Perrigo shares losing more than half of their value since the Mylan offer. In addition, contrary to shareholders' interests, members of Perrigo management received special bonuses for their role in thwarting Mylan's offer.
Despite these recent missteps, which have badly damaged the credibility of management and the Board, we believe that Perrigo has a strong franchise with valuable assets.
The core Consumer Healthcare ("CHC") business is the largest provider of store-brand over-the-counter ("OTC") products in the U.S. with a dominant market share of approximately 70%. Its significant manufacturing scale and breadth of distribution provide high barriers to entry. This business has produced steady improvements in adjusted gross margin and adjusted operating margin through continued penetration of store-brand OTC products supplemented with new product introductions.
Branded Consumer Healthcare
The Branded Consumer Healthcare ("BCH") business is a market leader in European OTC, and complements CHC's OTC leadership position in the U.S. Similar to the CHC business, BCH possesses significant market share in several large European markets where it maintains high levels of brand awareness. The combination of CHC and BCH provide Perrigo with a unique global OTC market position.
In addition to Perrigo's core OTC businesses, Perrigo also owns several valuable, but non-core assets.
The Prescription Pharmaceuticals ("Rx Pharmaceuticals") business develops and manufactures generic and specialty pharmaceutical products with a focus on extended topicals. It is expected to generate approximately $1.0 billion of revenue and adjusted operating profit margins in "the low 40% range" in 2016. Despite the recent increase in both manufacturer competition and customer consolidation, this business maintains strong margins with proven innovation capabilities. We believe that there are limited synergies between the Rx Pharmaceuticals business and the core OTC businesses. We also believe this would be a valuable business to several strategic acquirers.
Perrigo owns a royalty interest on global sales of Tysabri®, a leading therapy for the treatment of multiple sclerosis marketed by Biogen Inc. Perrigo is entitled to 18% royalty payments on annual sales up to $2.0 billion and 25% royalty payments on annual sales above $2.0 billion. We estimate that the royalty is forecast to generate approximately $360 million in revenue with approximately 96% adjusted operating margins for Perrigo in 2016. While non-core in nature, the royalty produces substantial and, we believe, durable cash flows for the Company. This is purely a financial asset as Perrigo has no involvement in the marketing and sales of Tysabri®.
Based on our analysis, we believe that both of these non-core assets have considerable value which is not being reflected in the current stock price. As management and the Board evaluate operational and strategic opportunities for improvement, we believe the Company could benefit from outside advice from a reputable investment bank or advisor on non-core asset divestitures or other broader strategic alternatives.
Core Business Opportunity
In addition to the opportunities highlighted above, we also believe a significant opportunity exists to improve performance in Perrigo's core businesses. For example, we estimate that BCH adjusted operating margins declined from approximately 18.8% in 2014 to 14.8% in 2015 and are expected to further decline to "low double digits" in 2016 based on management's most recent guidance. We fail to see why this should be the case – especially given the significant synergies between CHC and BCH – and believe that this illustrates a clear lack of focus and execution in the core business. Based on our analysis, we believe that there is a substantial opportunity to improve BCH adjusted operating margins above prior peak levels.
We believe the misguided confidence of management and the Board followed by deteriorating operating performance, which has been well below promised levels, has hurt the credibility of management and the Board, and, we believe, has resulted in a drastic rerating of Perrigo's once premium multiple. Historically, Perrigo traded in-line with well-performing consumer staples companies given the consistency of the Company's market-leading OTC businesses. However, the lack of focus and execution in the core business has severely depressed Perrigo's valuation. As illustrated in the chart below, from 2011 to 2015, Perrigo's valuation multiple was highly correlated with the valuation multiples of consumer staples companies. Unfortunately, since the operational and financial missteps began in 2015, Perrigo's valuation multiple has plummeted, trading nearly in line with specialty pharmaceutical companies that possess far different financial and risk profiles. The change in multiple implies that shareholders have lost confidence in the Board's oversight of management as well as management's ability to execute and think strategically on behalf of shareholders. We believe that with the proper portfolio changes, significantly better execution, and thereby renewed confidence in management and the Board, the multiple should rightfully be in line with peers that also operate high-quality assets.
1Mid-point of PRGO 2016E Management Guidance, updated Q2 2016
2Consumer Staples peers include: PG, CHD, CL, MJN & CLX
3Specialty Pharmaceutical peers include: MYL, TEVA
4Bloomberg Best P/E Ratio
Extremely Expensive Defense
Given Perrigo's possession of such high-quality assets and market leadership positions, it is not surprising that the Company caught the attention of Mylan in April 2015 when Mylan submitted an unsolicited offer to acquire Perrigo for $75 in cash plus 2.3 Mylan shares for each Perrigo share, or approximately $205 per share. Perrigo management was adamant that this proposal undervalued the Company and represented "a bad deal for Perrigo shareholders" that subjected them to "untenable risk." Following substantial public bickering between Mylan and Perrigo and multiple overly optimistic presentations by Perrigo management illustrating the potential future value of Perrigo shares, Mylan management was still able to convince a significant minority of Perrigo shareholders to tender their shares. However, Mylan subsequently cancelled its tender offer after failing to achieve a majority of Perrigo ordinary shares and having no success reaching a negotiated agreement with Perrigo.
As illustrated below, during the Mylan process, Perrigo outlined a path to continued earnings growth.
In addition, Perrigo claimed its standalone value was $202 – $210 based on the 1-year average price / NTM EPS multiple. Furthermore, former CEO, Joe Papa, supported this belief, stating "…I'd be surprised, as I said in the call, in a year, if Perrigo is not bigger, better and more valuable." It was these management and Board sanctioned claims that allowed Perrigo to persuade enough shareholders to reject Mylan's offer and support Perrigo's standalone plan.
Unfortunately for shareholders, management and the Board were far from prescient. Rather than retesting Perrigo management's target price of more than $200 per share, Perrigo lost more than half of its value since Mylan abandoned their tender offer. Additionally, after several consecutive downward revisions, current 2016 adjusted EPS guidance is $6.85 – $7.15($7.00 midpoint) versus the $9.83 that was promised.
Over the past year, Perrigo substantially underperformed all of its proxy peers and sector indices. Ironically, despite all the aggressive rhetoric in opposition to Mylan, Perrigo has also significantly underperformed Mylan over almost any time period. The performance of Perrigo in the table below over the 1-year, 3-year, and 5-year time periods unequivocally illustrates that substantial change is necessary.
As a result of Perrigo's continued execution issues and operational missteps, shareholders have greatly suffered. Clearly, the status quo is unacceptable to shareholders and should be unacceptable to you and the Board. Although we recognize you are new to the CEO role and hope you will have fresh ideas, we also know that you have been at Perrigo for approximately 27 years, and, to date, no new plans have been announced for a meaningful change in strategic direction or operational excellence. Additionally, the same Board that endorsed the "just say no" defense against Mylan and conferred wildly optimistic promises has overseen the recent tremendous value destruction.
We intend to immediately engage with you to understand how you plan to materially improve Perrigo's strategy and execution for the benefit of the Company and all its shareholders. Perrigo needs real improvements and not incremental promises. The last two earnings calls since being appointed CEO have provided successive, substantial guidance reductions without illustrating a path forward. Surely, given your long tenure at Perrigo, you have an assessment of the issues Perrigo faces and should be able to provide shareholders with substantial insights into how you intend to materially and immediately address these pressing issues.
We believe that Perrigo trades at a significant discount to fair value and that there is substantial value to be created at Perrigo for the benefit of all its shareholders. However, these are challenging times for Perrigo, and we strongly believe that material change is necessary. For the Company to approach its historical growth trajectory and regain its appropriate multiple, immediate and aggressive actions are required from management and the Board. We look forward to constructive discussions to determine the most effective path to substantial value creation for all shareholders.