Enzo Biochem: Activist Pressure Could Finally Lead To A Company Sale

Jun. 27, 2022 12:01 PM ETEnzo Biochem, Inc. (ENZ)CRL, DGX, LH, NEO6 Comments

Summary

  • On June 9, Enzo Biochem announced a new strategic review that may finally lead to the sale of the long-mismanaged company.
  • Since late 2021, positive changes have taken place - long-time CEO Rabbani was replaced with an independent CEO, an experienced activist was appointed to the Board and Rabbani-affiliated President resigned.
  • For these reasons, a company or asset sale may eventually materialise.
  • The set-up appears to exist because of low liquidity and analyst coverage.
  • Downside is limited by undervaluation and net cash position of ENZ.
Virus antidote being prepared in a biochem lab

ViktorCap/iStock via Getty Images

On June 9, Enzo Biochem (NYSE:ENZ) announced that it started working with investment bank Jefferies on a strategic review. This is not the first evaluation of strategic alternatives announced - Cain Brothers were hired for a strategic review in March 2021. In fact, activists have been pushing for changes in executive compensation and potential asset/company sale since 2019 but without much success yet. The critical piece here is long-time ex-CEO and Chairman Elazar Rabbani who used to completely control the company and resist activist pressure. Currently, he still has a ~4% stake and remains on the Board. However, recent developments indicate that his influence may finally be shrinking:

  • An activist, Bradley Radoff, has been appointed to the Board. He has significant activism experience (see below) and was possibly the main force behind the announced new strategic review.

  • The company has elected a new independent CEO Hamid Erfanian who is experienced and appears to have aligned incentives. Erfanian undertook managerial roles in peers (Quest Diagnostics, Abbott Laboratories and Euroimmun). Upon arrival he received 700,000 significantly OTM ENZ (strike of $3.39 per share) stock options.

  • Other long-time activists, such as Harbert Discovery Fund (HBR) and Roumell Asset Management (RAM), have continued to express their discontent with the lack of shareholder value realisation.

  • Rabbani’s brother-in-law Barry Weiner has resigned as the President and the Board has been declassified. The latter means that each Director has to be re-elected every year.

Even though there is a risk that Rabbani will continue to control the company, recent changes are encouraging. Given this, a division or an outright company sale is more likely than before. ENZ, meanwhile, continues to trade below larger peers at 0.7 EV/TTM revenue.

Activism Background

Historically, ENZ has underperformed both against peers and on absolute terms. Since 2004, the company has only seen 4 profitable fiscal years and ex-CEO Rabbani was at the heart of this. Activists RAM and HDR have started to push for better shareholder value realization ever since 2019. In November 2020, Radoff joined the other activists. A few months later, shareholders voted for Rabbani to resign from the Board. Rabbani stepped down as the CEO but remained on the Board. In October 2021, Radoff again criticised Rabbani’s influence and a lack of strategic review outcomes. Next, at the 2021 AGM, Radoff was appointed to the Board. Moreover, the Board was declassified and Radoff received the right to replace vacant Board seats. Since then, several Executive Team changes and President resignation followed suit.

Full timeline of important events of the last 3 years is provided at the end of the article.

Bradley Radoff

The activist, Bradley Radoff, appears to already have experience of pursuing activism in undervalued companies. Some examples:

  • In 2019, Radoff, together with Etude Capital (combined 10% stake), pushed Oha Investment Corporation (OHAI) to a definitive merger with Portman Ridge (PTMN) for $0.57 in cash and 0.3688 shares of PTMN common stock. As of 30 July 2019, this valued OHAI at a 35% premium to the market price.

  • In November 2021, Radoff engaged with Newpark Resources, pushing them to split the two business segments. Both sides reached an agreement in February 2022 which allowed Radoff to nominate one Board member.

  • In August 2019, Radoff combined with AB Value to push for Board changes in Rocky Mountain Chocolate Factory. The group has already received two Board seats and may be pushing for more with increasing stake.

  • In November 2015, Radoff in conjunction with other entities started activism in Vaalco Energy due to poor corporate governance and high overheads, among other reasons. Radoff served on Vaalco’s Board from June 2020 until resigning in January 2022.

Radoff has also been involved with CST Brands, Globalscape and Trecora, among others. In his open letter to ENZ (October 2021), Radoff mostly emphasised Rabbani’s prolonged tenure, describing the company as his “private fiefdom”. Radoff also criticised “months-long” strategic review and very opaque communication. Currently, Radoff is the second-largest shareholder with 9.07% stake. Based on 13D filings, Radoff’s cost basis stands between $3-$4 per share, except for the most recent transactions since April. This suggests that Radoff is unlikely to liquidate his stake until substantial shareholder value is realised.

Company's ownership summary

Bloomberg Terminal

Previous Activist Campaigns

RAM and HDR both are investment funds, focusing primarily on undervalued companies. HDR has highlighted excessive executive compensation as one of the main concerns. According to the company, ENZ also leased a facility in Farmingdale, NY, from a Rabbani-owned company. One of HDR suggestions was that ENZ should sell the Therapeutics division and intellectual property, i.e. patents. The activist saw 2x revenue as the potential sale value in November 2020:

“We believe at a minimum the Company could realise 2x revenues in a sale. Based on recently announced run-rate Q1 fiscal 2021 revenue, that would result in $5.51 per share.”

In 2020, HDR managed to appoint two ENZ Board members (out of 5) but they resigned just after 7 months.

Meanwhile, RAM filed its first 13D in March 2019 but exited its position in July of the same year, citing the following:

“I concluded that Dr. Rabbani lacked the emotional temperament and clear-sighted judgement that was necessary to lead the company, despite what I believed to be significant underlying intrinsic value. I found Dr. Rabbani to be unnecessarily combative, petulant and wholly uninterested in genuine shareholder engagement. <...> Dr. Rabbani has overseen decades of shareholder destruction for Enzo shareholders. All the while, he has been paid handsomely in compensation and perks despite his complete failure to create shareholder wealth.”

The fund returned to an activist position in December 2020 on the positive news of two HDR directors being appointed to the Board. RAM generally addressed the same points (such as executive bonuses) and pushed for Rabbani’s removal.

Compensation

HDR Investor Presentation, 7 January 2020

Ultimately, both activists were not able to achieve material management changes in the company until Radoff joined more recently. A quote from RAM December 24, 2020, shareholder letter:

“My frustration with the Company is no anomaly. Harbert Discovery Fund, L.P. and Harbert Discovery Co-Investment Fund I, LP (together, “Harbert”), ENZ’s largest shareholders, wrestled with its own frustrations with the Company, which ultimately resulted in Harbert successfully placing two independent directors on the Board earlier this year. This was a short-term high-water mark in my optimism about where the direction of the Company’s management and the Board was heading. A direction I believed would result in Harbert likely running an additional proxy campaign to dislodge Dr. Rabbani at the Company’s upcoming annual meeting of shareholders (which turned out to be incorrect). This coupled with the company’s success in receiving Emergency Use Authorization (EUA) for its Proprietary Test System for Detection of Coronavirus SARS-CoV-2 (“Covid-19”), persuaded me to reinvest in ENZ shares. Unfortunately, even battle tested owners can run out of patience—Harbert decided not to run an additional proxy fight. My optimism in the Company’s “new direction” was misplaced.”

Business

ENZ was founded in 1976 and operates in three segments - Therapeutics, Clinical Labs and Life Sciences. Clinical services (i.e. medical diagnosis and testing in laboratories) make up 71% of revenues. The rest is generated in the Product segment where research reagents are produced. Naturally, COVID has been a huge tailwind for clinical services. In FY2021, segment revenues reached $87m, a growth of over 70% versus each of the last two years. This has been emphasised by activists, for example, RAM:

“They should be reminded that revenue performance was due almost entirely to the Covid-19 crises and a once-in-a-century pandemic is not a business plan.”

Despite the pandemic, total net income in 2021 (ending in July) was $7.9m - not very substantial compared to recent net loss years (-$28.5m in 2020 and -$11.4m in 2018). Most recent Q3’22 (ending April) net income was at -$4.9m. This suggests that as COVID’s impact fades, Rabbani might be more willing to consider the sale of a company which is likely to return to unprofitability again.

Revenues

FY2017

FY2018

FY2019

FY2020

FY2021

Product Segment ($m)

29.2

29.2

30.1

26.6

30.7

Clinical Services Segment ($m)

74.7

71.1

51.1

48.0

87.0

Source: ENZ FY2021 10-K Filing.

It should be mentioned that in the last quarters net losses were partly a result of large legal expenses, particularly in Q2'21 ($2.85m). These should subside in the upcoming quarters as settlement with one of the main activists HDR was recently reached.

Peer Comparison

ENZ

LH

DGX

CRL

NEO

PSCH ETF

Market Cap ($m)

107

21,084

15,337

10,370

987

Net Cash ($m)

27

(4,245)

(3,275)

(2,437)

27

EV ($m)

80

25,329

18,612

12,807

1,014

TTM Revenue ($m)

112

15,859

10,679

3,630

486

EV/TTM Revenue

0.7

1.6

1.7

3.5

2.1

5Y Return

-81.0%

49.2%

19.1%

103.5%

-9.8%

46.2%

Source: Company Financial Statements

ENZ has historically underperformed as last 5 year stock returns were at negative 81.02%. On an EV/revenue basis, there is a 50%+ discount to the much larger competitors. The downside looks partly protected by a net cash position of ~$27m. This translates to $0.55 per share or ~25% of the market cap.

Conclusion

This set-up seems to exist because of a long-standing mismanagement as well low liquidity and analyst coverage. Still, there are certainly risks involved:

  • Ex-CEO Rabbani continues to indirectly control the company. He was already voted out of the Board by shareholders in January 2021 but remained there eventually.

  • Clinical services revenues decline while new litigations on patents and/or with activists weigh on SG&A via legal expenses.

  • Extended timeline for the potential company sale.

Nevertheless, a new CEO, resigned Rabbani’s brother-in-law President, declassified Board, committed activist and the announcement of a strategic review with Jefferies all seem to indicate that ENZ business transformation may finally take place. Meanwhile, the downside appears to be limited by a conservative valuation and adequate net cash position ($0.55 per share). Given this, investors should at least keep ENZ on their watchlist.

Timeline

  • March 2019 - Activists Roumell Asset Management (RAM, 4%) and Harbert Discovery Fund (HDR, 3.40%) file 13D reports.

  • February 2020 - Two new Directors nominated by HDR are appointed to the Board.

  • November 2020 - Above-mentioned Directors resign due to “Chairman and CEO Rabbani creating such an extremely hostile environment that Pete and Fabian found their position untenable as minority members in opposition to Mr. Rabbani’s continued mismanagement”. Activist Bradley Radoff opens a position in ENZ.

  • January 2021 - Shareholders vote in favour of Rabbani’s resignation from the Board at the AGM.

  • March 2021 - ENZ announces that Rabbani will step down as CEO but will remain in the company. Cain Brothers are hired to explore strategic initiatives.

  • September-October 2021 - RAM nominates two directors and proposes to declassify the Board. Bradley Radoff (6.4%) also makes two nominations for the Board of Directors.

  • 18 October 2021 - New CEO Hamid Erfanian is appointed. Rabbani remains in the Board and assumes the role of Chief Scientific Officer.

  • 19 October 2021 - Radoff issues an open letter, criticising Rabbani’s continuing tenure and no strategic review updates.

  • 3 January 2022 - CEO Erfanian and activist Radoff are appointed to the Board. Rabbani remains a Director. ENZ signs a cooperation agreement with Radoff, including two Board nominees for Radoff, Board declassification and Radoff replacing all vacant Board spots going forward.

  • 21 January 2022 - The company delivered Rabbani a notice of employment termination, effective in 90 days.

  • 7 March 2022 - Barry Weiner, Rabbani’s brother-in-law, resigns as the President of the company.

  • 28 March 2022 - New appointments of Kara Cannon (COO) and David Bench (SVP) as the Executive Team is expanded.

  • 8 April 2022 - ENZ shareholders vote in favour of Board declassification and voting change from two-thirds to majority vote.

  • 7 June 2022 - ENZ enters into a legal settlement with activist HDR in an action from November 2020 on “false and misleading representation” prior to Board election in 2019 AGM. Both sides settled to dismiss each other’s claims.

  • 9 June 2022 - ENZ announces partnership with Jefferies on the evaluation of strategic alternatives.

This article was written by

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Short position through short-selling of the stock, or purchase of put options or similar derivatives in ENZ over 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.

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