As many who follow me know, I wrote several articles covering Obagi Medical Products (OMPI) as a key acquisition target for several larger players in its field. Obagi engages in marketing and selling skin care products which include: Obagi Nu-Derm Systems, Obagi Condition & Enhance Systems, and Obagi-C Rx Systems, just to name a few.
Numerous sources at the time claimed that Avon (AVP) had interest in the company and was willing to pay upwards of $22 a share to acquire the company. When it comes to buy-out rumors, they are hard to confirm because of the very "tight-lipped" nature of such potential transactions.
Needless to say, my sources turned out to be wrong. But, I have to wonder if these sources were really wrong, or if Obagi turned away yet another potential suitor and/or suitors for the company. I also call into question whether the Obagi Board of Directors (BOD) is properly carrying out its fiduciary duty to fully explore strategic initiatives -- which includes the possible sale of the company.
On December 23, 2011, Obagi initiated a shareholders' rights provision into its corporate governance -- commonly referred to as "a poison pill." Often times, company boards of publicly traded companies engage a poison pill to ward off potential hostile take-overs.
This action by the Obagi BOD prompted Voce Capital Management, an advisor to institutional shareholders, to send a letter to the Obagi BOD on February 10, 2012, 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 had spurned recent overtures to acquire the company, and further cited pervasive corporate governance deficiencies that explain the Board's unwillingness to consider those proposals. Voce also expressed concern over the Board's recent decision to adopt a poison pill, citing it as further evidence of the Board's entrenchment.
On June 6th, 2012, Obagi shareholders voted out the poison pill by more than a 2 to 1 margin -- subsequently, the stock went on an extended run, rallying from $13.15 a share to a 52 week high of $18.00 on July 11, 2012.
Shareholder expectation was high going into the company's earnings call on August 2nd, 2012. Many believed, myself included, that Obagi would address potential strategic alternatives to facilitate an acquisition of the company. In my opinion, Obagi did not properly address the issue in its earnings and did not give a direct answer to a specific question about events surrounding the poison pill. This included information relevant to the initiation of the poison pill, Voce Capital's apparent activist stance to remove the pill, and exploration of strategic alternatives -- in other words, the company still showed zero interest in being acquired.
Enter Activist Shareholder David Callan:
David Callan is an activist shareholder who owns a large block of Obagi shares. I had the pleasure of interviewing David both via a phone call and by email for this article. Callan has been involved with helping to initiate the acquisitions of other companies in the past.
Callan has had success as a shareholder activist in the past with other public medical companies generating sales similar to Obagi in excess of $100 million dollars. In 2007 he was actively involved in the sale of E-Z-EM for $240M to Bracco Diagnostics, Inc., the US based subsidiary of Bracco Diagnostics.
In June 2010, Callan sent a letter to the SRI/Surgical Express, Inc. BOD expressing his frustration with the company's ongoing poor results and pushing them to explore a sale of the company. Though it took about a year, on July 16th, 2012, Synergy Health plc acquired the company for approximately $25 million through a cash tender offer followed by a short-form merger of Synergy Health plc's wholly-owned subsidiary in the United States, SHM Acquisition, Inc., with and into SRI. As a result of the acquisition, SRI became a wholly-owned subsidiary of Synergy Health plc.
Now he has his eyes set on persuading the board members of Obagi Medical products to sell the company at what he considers to be the ideal time for shareholders.
In an email exchange I had with Callan, he offered the following remarks:
Far too often, companies with limited product lines peek out between the $110-130 million range. They reach a level of scale where typically the only way to break the ceiling is to either acquire or be acquired. While Obagi has a strong balance sheet, I personally do not see a "tuck in" acquisition that fits their sales model. As a potential acquisition target however, Obagi Medical sits in an ideal position for larger companies (with much more leverage of scale and financial synergies that make this accretive) to successfully integrate the Obagi high margin product line into its existing sales forces. It is an opportunity for the titans of industry to expand their platforms further into the highly desired space of Dermatology and skin care management systems.
I agree with Callan's above assessment as Obagi's sector has seen a good deal of acquisitions lately. An industry titan, Valeant Pharma (VRX), recently made a tender offer to acquire Medicis Pharma (MRX) for $2.6 billion, or $44 a share -- the latest in a series of mergers and takeovers for the company after its hostile takeover attempt for Cephalon failed last year. Valeant had bid $5.7 billion, but Teva Pharmaceutical Industries (TEVA) won the bid at $6.2 billion.
Also in the same sector, Physicians Formula Holdings Inc. (FACE), announced on September 27th that Markwins International Corp will acquire all of its outstanding shares for $4.90 per share, which represents a 33 percent premium to the company's closing price of $3.68 on Aug. 14, the last trading day before the company entered into a merger agreement with Swander Pace.
Allergan (AGN) is another industry titan in Obagi's sector that could have interest in acquiring Obagi, as Allergan is a multi-specialty healthcare company primarily in the United States, Europe, Latin America, and the Asia Pacific. Allergan might feel a little pressure to increase its market position since its close competitor Valeant could gain the upper hand with its recent acquisition of Medicis, as mentioned above.
Callan went on to remark:
Hiring a reputable investment bank to formally explore the sale will uncover interest here in the United States and abroad that will be well outside the range of the obvious candidates. There is a lot of money sitting on the sidelines, and a vast majority of interested parties looking to enter this space with a well established foot print and reputation like Obagi. This is the time for the banking professionals to do their job. It should not be the responsibility of active shareholders like myself to "shop" the company. In the case with the last two companies I was involved with, the buyer came from outside the United States, and was not personally viewed as a well known contender for acquirer.
I also agree with this assessment by Callan here -- it's not the job of Voce Capital and Obagi shareholders to get the company sold. However, shareholders in early June did have a chance to vote the entire BOD out, and failed to do so. Shareholders should consider holding a special meeting to vote out these BOD members if they feel the BOD might be failing in their fiduciary duty to explore strategic alternatives. Furthermore, institutions own nearly 90% of Obagi's stock, so it is possible they might become more activist as well.
In the company's last earnings call, I did not hear any reference to "shareholder value," and that rubbed me the wrong way. Callan confirmed to me that he did not like this omission as well.
Both Callan and I find the Obagi's BOD's current position unacceptable since it owns less than 1% of the company. So while I agree with Callan in terms the BOD'S responsibility to hire an investment banker, it's on the shareholders to vote these BOD members out if they are not willing to do what the majority of shareholders want.
Also Callan remarked to me on the phone:
The company stands behind the fact that the new e-commerce program will yield positive growth and results. While I do not challenge the theory, I continue to argue that selling the company at this stage is in the shareholders best interest long term. If indeed this were the new game changing platform to yield shareholders high returns, I would expect the professional analysts that follow this company to be upgrading their ratings and price targets, rather than the recent downgrades. I would also expect insiders to jump on board with purchases at these low levels, and much more optimistic future earnings projections. While close to $1.00 share projected for 2013 is respectable, it is simply the same earnings from 2012 combined with lack of capital costs in 2012 to build out the e-commerce platform. I view this stance, and its newly built e-commerce distribution Salt Lake City facility, as means of further entrenchment. I argue, let those with greater leverage of scale take this wonderful small company and its' products to that next level: World recognition- a status that will not be achieved as a standalone company.
While an online pharmacy is interesting and could bring additional value to the company, it can also open up potential regulatory issues related to Hydroquinone. With online pharmacies, it is typical to hire a physician to write out mass prescriptions for buyers of products that require it by federal law. In this case, dermatologists would be needed by Obagi to prescribe any product containing Hydroquinone.
Obagi needs a stronger international presence in my strong opinion where the regulatory environment is much less restrictive than it is in the United States. Both Callan and I feel that the company is just too small to unlock the potentially massive revenue stream an international market would provide. We strongly feel that Obagi would fare much better in the hands of a larger operator, which would give its shareholders the maximum value.
Callan plans to take aggressive steps here to ensure the shareholders get this maximum value. As Callan engages in these steps, I will do my best to report on them. For the most part, I agree with Callan's assessment of the Obagi situation and I support his efforts 100%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: Disclaimer: This article is intended for informational and entertainment use only, and should not be construed as professional investment advice. They are my opinions only. Trading stocks is risky -- always be sure to know and understand your risk tolerance. You can incur substantial financial losses in any trade or investment. Always do your own due diligence before buying and selling any stock, and/or consult with a licensed financial adviser.