What do you get when a deep-pocketed (over $1 billion under management) activist collides with self-serving biotech? Answer: value creation. Depomed (NASDAQ:DEPO) received a wake-up call on Friday, April 8th, from Starboard Value, Depomed's largest shareholder with an ownership interest of 9.8% of the company's outstanding shares. In a letter to the company's President and CEO with a copy to the Board, the fund accused Depomed's management and Board of putting their own self-interest ahead of shareholders. Starboard came out swinging by declaring its intent to place its own slate of candidates for the Board. In a fight for shareholder rights and an opportunity to create shareholder value, including a potential outright sale of the company, my money's on Starboard based on its proven track record and pit bull-like tenacity.
Starboard's Modus Operandi
Investors don't have to look further to get a road map of Starboard's activist approach than the recently exited successful campaign against Darden Restaurants (NYSE:DRI). For anyone who followed the Darden saga, this is all old news. However, the tactics used and the success of the campaign are highly relevant when considering Starboard's potential approach with Depomed.
In January 2014, Starboard sent a similarly worded letter to Darden's Chairman and CEO with a copy to the entire Board. In the case of Darden, the issue was the company's plans to spin off or sell Red Lobster prior to monetizing the value of the real estate through the creation of a Real Estate Investment Trust [REIT].
A major distinction between Starboard's initial approach with Darden compared to Depomed is the degree of displeasure with management and the Board suggested in the correspondence to Depomed and the severity of its planned course of action. Darden's letter, on the other hand, left the door open for further dialogue and cooperation as reflected below:
We thank you in advance for considering our views and look forward to meeting with you at Darden's corporate headquarters later this month. We take our investment in the Company, and the Board's stewardship of shareholders' capital, very seriously. We look forward to maintaining an open dialogue and working with you to ensure that value is created for all shareholders.
The Depomed letter by contrast sets the battle lines from the very beginning:
To be clear, we are not currently advocating for any one particular transaction, or any transaction at all, but we firmly believe that board change is necessary to best represent the interests of all shareholders as it relates to the ongoing business and any potential transaction opportunities in the future. Given your actions, and history of actions, we cannot take the risk that you further impair our shareholder rights. We intend to share more details with shareholders in the coming weeks regarding our views on the Company, opportunities for value creation, and Depomed's significant corporate governance deficiencies.
Starboard followed the initial Darden letter a month later with a second letter that highlighted Starboard's disappointment with the company's response, just a few hours after the release of the January letter, reaffirming the company's intention to move forward with its existing plan, including the separation of Red Lobster.
Starboard followed up the second letter with action. It filed a Preliminary Solicitation Statement seeking shareholder support to call a special meeting of Darden shareholders along with an open letter to shareholders. The purpose of the meeting was to give shareholders a say, in a non-binding fashion, in the Red Lobster spin-off.
In March 2014, Darden filed a Revocation Solicitation Statement in response to the solicitation by Starboard Value asking shareholders to vote against the shareholder meeting and the proxy fight ensued from there. On May 6, 2014, the votes were counted with Starboard receiving 57% of the votes in favor of the meeting, thereby exceeding the majority needed for approval.
Having won the vote for a special meeting, Starboard's frustration with the Board's inaction in calling the meeting was evident in the May 7th letter to the board which stated:
Your continued failure to schedule the Special Meeting in a timely manner will leave us and your shareholders no choice but to conclude that it is your willful intent to delay the Special Meeting and disenfranchise the shareholders you were elected to represent. We take our investment in the Company, and the Board's stewardship of all shareholders' capital, very seriously. The Board's continued attempt to delay the Special Meeting is a clear sign that this Board does not take its obligations to its shareholders seriously, and that substantial change to the Board may be necessary.
The delay tactics were a clear tactical error by Darden's Board from a survival perspective, putting them in play to be replaced at the annual board meeting. However, it was successful in buying time for Red Lobster to be sold. As a result, in June 2014, Starboard withdrew its special meeting request. The letters to the Board continued after the withdrawal as Starboard pleaded with the company to improve performance and embrace the change that was coming.
Fast forward to October 10th, 2014. Shareholders elected all twelve of Starboard-nominated Directors to the Board and Jeffrey C. Smith, Chief Executive Officer of Starboard, was elected Chairman. Darden's CEO was a casualty months before the vote and had agreed to step down.
Activism goes beyond controlling the Board. It's about creating shareholder value. The chart below shows Darden's stock price compared to the S&P 500 during the three-year campaign. Darden Restaurants had substantially underperformed the market prior to Starboard's involvement. The results speak for themselves.
The ill-advised sale of Red Lobster that Starboard strenuously counseled against created the largest disparity with the market. However, when the new Board took control, the company's performance not only improved, it trounced overall market returns.
Depomed is a pharmaceutical company focused on pain and other central nervous system [CNS] conditions. It has six products marketed in the US for pain.
- NUCYNTA® ER, a product for the management of pain severe enough to require daily, around-the-clock, long-term opioid treatment, including neuropathic pain associated with diabetic peripheral neuropathy [DPN] in adults, and for which alternate treatment options are inadequate
- NUCYNTA®, an immediate release version of tapentadol for the management of moderate to severe acute pain in adults.
- Gralise®, a once-daily product for the management of postherpetic neuralgia [PHN].
- CAMBIA®, a non-steroidal anti-inflammatory drug for the acute treatment of migraine attacks.
- Lazanda® nasal spray, a product for the management of breakthrough cancer pain in cancer patients 18 years of age and older who are already receiving and who are tolerant to opioid therapy for their underlying persistent cancer pain.
- Zipsor® (diclofenac potassium) liquid filled capsules, a non-steroidal anti-inflammatory drug for the treatment of mild to moderate acute pain.
The company also has one product candidate in development, cebranopadol, a novel, first-in-class analgesic in development for the treatment of moderate to severe chronic nociceptive and neuropathic pain with Phase 3 trials planned beginning in 2017.
Horizon Pharma (NASDAQ:HZNP) tried to acquire Depomed in the middle of last year for $33 per share. However, Depomed fought the unsolicited offer and the companies have been feuding in court ever since due to Depomed's assertion that Horizon misused confidential information it obtained from Janssen in its pursuit of Depomed. Meanwhile, the stock continues to underperform as illustrated below:
Even before Starboard's shot over the bow, Depomed appeared undervalued based on Horizon's stated offer and the company's growth potential. Product sales grew from $114 million in 2014 to over $340 million in 2015 mainly from the acquisition of NUCYNTA®. The company expects revenues for the coming year to be between $485 million and $525 million.
An outright sale of Depomed would relieve the company of an onerous debt structure as well. The company has over $200 million in liquidity so the balance sheet is strong however it's saddled with $563 million in costly senior notes and $243 million in convertible notes as of year-end. The senior notes are at a rate equal to the lesser of (NYSE:I) 9.75% over the three-month London Inter-Bank Offer Rate (LIBOR), subject to a floor of 1.0% and (ii) 11.95% (through the third anniversary of the purchase date) and 12.95% (thereafter).
Starboard Value published its letter to management and the Board of Depomed and the market's response was relatively muted. The stock finished the day up 13% but has since given back some of the gain. If Starboard's history of unlocking value through aggressive advocacy on behalf of shareholders is any indication, the next twelve months should prove interesting for both Depomed and its shareholders. Based on the offer that was on the table, it's a potential double from here if Starboard is successful. I'm sure the company's Board won't give up without a fight. However, with Starboard going to school on the prolonged Darden battle, I like its odds of success. And, if Starboard wins, shareholders win big.
Disclosure: I am/we are long DEPO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.