Obagi Files 8k Officially Removing Poison Pill, Clears Way For Acquisition

| About: Obagi Medical (OMPI)

30 minutes after the regular trading session closed yesterday, Obagi Medical Devices (NASDAQ:OMPI) filed an 8k that officially removes the shareholders' rights provision, otherwise known as "the poison pill."

From the 8k filed, we read the following:

10-Jul-2012

Amendments to Articles of Inc. or Bylaws; Change in Fiscal Year

Item 5.03 Amendments to Articles of Incorporation or Bylaws; Change in Fiscal Year.

On July 10, 2012, the Company filed an amendment to its Amended and Restated Certificate of Incorporation, as amended, to eliminate the Certificate of Designation authorizing the issuance of 50,000 shares of Series A Preferred Stock and designating the rights, preferences and privileges thereof.

As previously disclosed, on June 6, 2012, the preferred share purchase rights to purchase one-thousandth (1/1,000) of a share of the Company's Series A Junior Participating Preferred Stock, par value $0.001 per share (the "Series A Preferred Stock"), under the Rights Agreement, dated as of December 23, 2011, by and between Obagi Medical Products, Inc. (the "Company") and American Stock Transfer & Trust Company, LLC, as amended (the "Rights Agreement") expired in accordance with their terms.

To explain the above in a simple manner, a poison pill provision allows a company several strategies to counter-act a potential hostile bid.

The typical shareholder rights plan is where shareholders will have the right to buy more shares at a discount if one shareholder buys a certain percentage of the company's shares. The plan could be triggered, for instance, when any one shareholder buys 20% of the company's shares, at which point every shareholder (except the one who possesses 20%) will have the right to buy a new issue of shares at a discount. The plan can be issued by the board as an "option" or a "warrant" attached to existing shares, and only be revoked at the discretion of the board of directors. A shareholder who can reach a 20% threshold will potentially be a takeover bidder. If every other shareholder will be able to buy more shares at a discount, such purchases will dilute the bidder's interest, and the cost of the bid will rise substantially. Knowing that such a plan could be called on, the bidder could be disinclined to the takeover of the corporation without the board's approval, and will first negotiate with the board so that the plan is revoked.

Obagi engaged the above dilution strategy in its poison pill. Although the poison pill was officially voted out by the shareholders on June 6th, Obagi did not officially remove the provision until yesterday. This signals to me that an agreement with management was negotiated and agreed to with the acquiring company, likely mediated by Voce Capital Management, who until Obagi management engaged the poison pill amendment back in February, had a close working relationship with the company.

On February 10, 2012, Voce sent a letter to the Obagi Board of Directors criticizing the Board's adoption of a poison pill and demanding immediate action to address the company's corporate governance failures. Voce's letter in part stated that it believed Obagi has spurned recent overtures to acquire the company, and further cites pervasive corporate governance deficiencies that explain the Board's unwillingness to consider those proposals. Voce also expresses concern over the Board's recent decision to adopt a poison pill, citing it as further evidence of the Board's entrenchment.

It appears to me that Voce has sought to repair any damage caused by a letter it publicly released, and have found an acceptable bidder for the company that will satisfy both management's self preservation concerns, and the majority voting block of the company's shareholders.

Who is likely to be the yet to be revealed winning bidder for Obagi? Let's take a look and see who the mentioned suitors are.

Cantor Fitzgerald's Irina Rivkind said on Monday in a note that the company could be attractive to "multiple suitors." The analyst named Valeant (VRX), Medicis (MRX) and Allergan (AGN) as potential interested companies, and also said a pure-play cosmetics company could also get involved.

L'Oreal (LRLCY.PK) offers various consumer products, such as skin care, make-up, hair color, hair care, and styling products under the L’Oréal Paris, Le Club des Créateurs, Garnier, Maybelline New York, Softsheen Carson, and Essie brand names. L'Oreal has been mentioned as one possible suitor for Obagi as well.

However, take a careful look of what Irina Rivkind said in her note; "a pure play cosmetic company could also get involved." I wonder why she did not mention this company by name? I believe I know why - she might know the unnamed company is the winning bidder.

Avon Products Inc. (AVP) filed a form 8k on Thursday of last week in regards to taking out a line of credit for up to $750 million dollars, with access to $500 million immediately. I believe this line of credit will be used to acquire Obagi for a price between $21 and $23 a share or roughly $370M to $410M. The reason I believe Avon is the buyer is because it is best suited to take on Obagi as a subsidiary, rather than to flat out buy the company for its assets, and dissolve it into its company. In other words, I believe Obagi will retain its management team for the most part, and still function as "Obagi Medical Devices, a subsidiary of Avon products. Here is my reasoning:

  • 1. A satisfactory outcome for Obagi management: Most believed that Obagi instituted its poison pill in order to save their own jobs. Obagi insiders own 0.67% of the company stock so they have no investment stake in the company - only their high paying jobs. Obagi's 8k seems to me to be a result of an acceptable outcome for its management team and board of directors.

An acquisition from a company like Allergan for example, would end up as an asset only acquisition - Allergan would simply retain the Obagi name and integrate it with its own management team, basically eliminating Obagi management - who would then be out of their jobs.

Avon, on the other hand, would not be interested in committing resources to a segment where Obagi's products are sold primarily through dermatologists. Avon only commits the capital to buy Obagi shareholders out, and possibly some additional capital to more effectively help with marketing Obagi's already successful line of products to a broader world-wide populace. Avon has had stale earnings lately, notwithstanding what many see as a failure - The Coty buyout offer being rejected by Avon management.

  • 2. It's a win for the majority shareholder voting block wanting a buyout to occur: Many shareholders of the company have held their stock for many years now, from a much lower price range than where the stock is currently selling for. While I feel any price under $25 is basically stealing the company, I am only a recent shareholder playing the stock for the obvious acquisition interest. Placing myself in the shoes of long-suffering Obagi shareholders, I would want to get this whole issue over with, cash out, and move on to greener pastures so to speak.
  • 3. It's a win for Voce Capital Management: Voce was very critical of Obagi for engaging a poison pill in February of this year. In its letter to the company, Voce stated that it always had a close working relationship with Obagi. The letter was publicly revealed by Voce, which assuredly put a strain between both parties. Voce clearly wanted the company sold, management clearly did not. By negotiating a deal where Obagi's management would be able to keep their jobs, Voce repairs and appeases management's self preservation concerns, while reaching its own goal - rewarding itself and Obagi shareholders.

Based in no small part from the points I have mentioned above, it's my strongest opinion that a tender offer will be made in short order here, announcing Avon as the acquiring company of Obagi. Therefore, I expect the stock price to gap up to at least $19, if not higher, regardless of whether the tender offer is announced today. If announced, then the price might gap higher than the actual tender offer price, as the stock's trading float has a good deal of short interest.

Disclosure: I am long OMPI.