Investor Activism Erupts At Volcano

About: Volcano Corporation (VOLC)
by: EP Vantage

While shareholder activism is a fact of life in the pharma sphere, it is less common in medtech. But this could be changing. The worrying downturn in medtech M&A over the past year means that some investors are getting restless as an exit is denied them, and more and more may take it upon themselves to ensure companies make appealing takeover targets.

Volcano Corp. (NASDAQ:VOLC), a cardiovascular imaging device developer, might be the bellwether. The investment fund Engaged Capital, which has a 5.1% stake in Volcano, is trying to steer the company towards a $200m share buyback and away from dilutive acquisitions, the prospect of which, it believes, is holding the shares back. So far its tactics have been gentle - it is not trying to force an EGM or take seats on the board - but if Volcano's performance does not improve soon things might get nastier.

Estimates missed

Engaged Capital said in an SEC filing that Volcano's products, especially its fractional flow reserve (FFR) technology, used to image blood vessels during coronary interventions, are likely to generate significant revenue growth over the next five years.

It also pointed out that Volcano has missed consensus revenue estimates in six of the past seven quarters, and alleges that the $450m of convertible debt that Volcano raised this year is causing concern on the part of investors who fear the company intends to pursue dilutive acquisitions.

Engaged suggests that Volcano use the cash to buy back shares - $200m worth - as well as investing in existing product lines. It also says that executive pay should be linked more closely to performance, pointing out that at Volcano's 2013 annual meeting more than 57% of shareholders voted against the proposed executive compensation.

The springboard for Engaged's offensive was a 19% plunge in Volcano's shares on October 28, when the company warned that third-quarter revenues would miss expectations. Sales were hit by a poor performance in Japan, and Volcano once again lowered its guidance.

M&A moribund

The endgame for Engaged, as for most investors in small medtech companies, will be a takeover. Engaged believes Volcano would make an attractive acquisition target for many large medical device companies, which would be able to realize revenue and cost synergies that justify paying a significant premium. The investor also says Volcano may have been approached by potential acquirers several times since floating in 2006, so it is to be hoped that further overtures are made in future.

At this stage Engaged does not seem to want to take any concrete steps, preferring instead to let management know that it is under the microscope. In the filing, Engaged says it believes that Volcano's management is committed to taking substantive actions to improve the share price. The investor has made no threats of what might happen should management fail in this regard, and is doubtless awaiting Volcano's response, but if the company does not improve sharpish the campaign could accelerate.

The current M&A scene in medtech is pretty moribund and in this climate companies like Volcano need to present a compelling story to attract both investors and potential suitors. Unless activity picks up, something that seems unlikely to happen soon, underperforming medtech companies can only expect investor scrutiny to increase.

With shares where they are, Volcano risks either being left on the shelf or being bought too cheaply - a prospect that Engaged will be very keen to prevent.