Sun Pharmaceutical Industries LTD. (Ticker: SUNP in India) "Sun" is offering to buy the remaining shares in Taro Pharmaceutical Industries LTD. (NYSE:TARO) at $39.50 per share and this offer has been accepted by Taro's board of directors. We believe this offer to be wholly inadequate and intend to vote our shares against this transaction. As we understand Israeli law, and as set out in point three of Sun's offer, this transaction still requires the approval of more than 50% of the minority shares outstanding. Our rationale for why this offer is well below fair value for our shares is set forth below.
On October 18, 2011, Grand Slam Asset Management, LLC (Grand Slam) sent a letter to Taro's board of directors urging them to reject Sun's first offer of $24.50 per share. At the time, Grand Slam believed that Taro was worth at least 15 times latest twelve months earnings before interest, taxes, depreciation and amortization (LTM EBITDA) based on comparably publicly traded companies and similar generic drug company merger and acquisition (M&A) transactions. Sun's offer of 7.2 times LTM EBITDA was therefore demonstrably low. Today's offer values Taro at 4.8 times LTM EBITDA, which is a 33% discount to the previous offers multiple.
Had Sun merely kept their previously inadequate multiple, their offer would have increased to at least $55.00 per share. At our suggested 15 times LTM EBITDA multiple the offer should have been for $110 per share. If Sun were to offer the same multiple that its own shares command of 20.5 times LTM EBITDA then the deal would be valued at $150 per share. Since Taro accounts for approximately 33% of Sun's revenues and close to 50% of its EBITDA, using Sun's multiple would seem to be the most appropriate course of action.
Since Sun thinks so little of Taro's value, perhaps a better course of action would be for Sun to open up the sale process to outside bidders. We believe that Sun can sell its interest in Taro for significantly more than five times LTM EBITDA to another pharmaceutical manufacturer. Such a process would also allow Taro's board to fulfill its fiduciary responsibility to obtain the best price for all shareholders. Taro's two direct competitors, Perrigo Co (NYSE:PRGO) and Glenmark Pharmaceuticals LTD (Ticker: GLENMARK.NS on National Stock Exchange), trade in the public markets at 18 times LTM EBITDA, so a transaction at 15 times LTM EBITDA would be highly and immediately accretive to either of those companies, even before the impact of any synergies.
Sun's premise for the low price seems to hinge on its publicly stated belief that Taro's improved profitability is unsustainable. During Taro's last few quarters earnings releases, its Chairman (who is a Sun appointee) has made statements to the effect that "...we remain cautious of the increasing competition and consequential erosion of volume on some of our major products and the challenge in maintaining current performance." In fact, for each subsequent quarter the operating results have improved. Grand Slam believes that Taro's performance is sustainable for the following reasons:
1) It is our understanding that the formulation and testing of dermatological ointments, creams and gels is much more difficult than the process for pill based drugs, creating a high barrier to entry;
2) Prescription counts for many of Taro's products are quite low by prescription drug standards and typically can only economically support a very limited number of competitors;
3) Even if a competitor decided to enter any of Taro's key markets based on today's pricing, there is a 32 month average time to receive FDA approval in addition to the time it would take to create the application and conduct testing.
Therefore, Grand Slam believes that Sun has been disingenuous with fellow shareholders prior to its offer in an attempt to keep the price of Taro's shares artificially low. We are certainly content to continue owning Taro's shares despite Sun's perceived risk should a deal not be consummated.
For all of the reasons set out above, we intend to vote against this transaction. We would encourage all minority shareholders to consider the points we have raised and conduct proper diligence prior to voting.
Disclosure: I am long TARO.