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The lone wolf has arrived at the doorstep of Forest Laboratories (NYSE:FRX) and has made it known that he’s knocking at the door. Carl Icahn, corporate raider (or as we call him, “the lone wolf”), has increased his position and come out of the shadows. This definitely isn’t the guy you want showing up at the board meeting or holding stock in your company if you’re the CEO. As an activist investor, his goal is to identify substantially undervalued assets, shake things up inside, and make a substantial profit in the process by any means necessary.

Now he isn’t wasting any time as he prepares to nominate four directors to the board of FRX. The board seats a total of nine members; if he gets all four of his men onboard, he’ll be just shy of actually controlling the board outright. Still, even without full control, he’ll be acting as if he does.

The way we see it, the current CEO has done a poor job of managing a product pipeline that is now dwindling, underutilized the balance sheet, and failed to take advantage of the firm’s success. After reviewing the financials of FRX, we see that the foundation of the firm is sound but management is a little rotten and/or too comfortable.

Icahn wouldn’t be preparing to “shake things up” with FRX if he felt management was doing a great job. FRX already has a strong foundation and we rate it a Buy for a few reasons, but we see Icahn as being the largest positive catalyst to take this stock higher.

The Financials Are a Buried Treasure: Take a glance at the most recent numbers on FRX’s balance sheet and it doesn’t take a rocket scientist to realize that there is a lot of cash lying around. The management team could have done a variety of things over the years with this cash in order to further maximize shareholder value and to grow the firm further, but it hasn’t.

Yes, we’re aware of the $500M buyback plan from 2010. That was nice, but according to the firm’s most recent 10-K, that still leaves a few billion just laying around. In our opinion, management failed to strike while the iron was hot. We honestly don’t see much of a point in building up a company into something great and then just letting it idle. Given Icahn’s history, we believe he’ll likely start pushing for better utilization of the assets either to make the firm look more attractive as a takeover target and or to drive up shareholder value. This looks like a win-win situation for FRX shareholders, because either way it should keep driving the stock higher.

Firm Highlights

Latest Quarter (2011)

Operating Margin (ttm)

30.27%

Net Margin (ttm)

23.68%

Return on Assets (ttm)

15.93%

Return on Equity (ttm)

20.15%

Quarterly Revenue Growth (yoy)

7.78%

10-Year Average Revenue Growth

14.17%

Quarterly EPS Growth (yoy)

59.56%

10-Year Average EPS Growth

19.79%

Current Ratio

5.61

Quick Ratio

4.68

The Pipe Is Looking Dry: The firm has made some decent acquisitions but doesn’t have any new blockbusters in the pipeline. Analysts have voiced their concerns about this more than once, but haven’t received a response that quells their fears. Further, the blockbuster drug Lexapro makes up half of the firm’s revenue; however, the patent is set to expire early next year. This means finding a replacement on something of that scale won’t be an easy task. If a portfolio of drugs or new potential blockbuster drug cannot be acquired at a reasonable price quickly, then the probability of the firm becoming a takeover target increases in our opinion.

The Icahn Way or the Highway: Icahn is entering the picture like a new coach coming in to make a good football team great; the current CEO is obviously the quarterback. A top priority for him will be to get the house in order, make sure everyone is on board with change, and make sure everyone understands that it’s the Icahn way or the threat of the highway.

A couple things he may push for are share buybacks, aggressive cost cutting, and/or deal making. No matter what he pushes for, we have little doubt that Icahn has thought of multiple ways to skin this cat. It wouldn’t be too surprising to see him try and kick off the CEO if he doesn’t want to play ball. Either way, it doesn’t matter to us. Our focus is on seeing shareholder value maximized by any means necessary, and Icahn looks to be the catalyst that will make that happen.

Conclusion: Forest Laboratories is a great company with or without Icahn, but that doesn’t mean it’s a great stock. Sometimes great companies are poor stock picks because there just isn’t a great catalyst to really get investors hyped up on the company’s future prospects. We feel that by having Icahn come into the fold, this is the exact catalyst the firm needs in order to go much higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Forest Labs: 3 Reasons to Finally Be Bullish