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Summary
- In the area of acquisitions, we’ve had a solid history of very accurate behavior-based predictions.
- Although many companies do an excellent job of hiding the progress of a potential acquisition, some clues can still give observant investors an indication that an acquisition is close.
- However, it can be difficult to make accurate conclusions in that company officers are obligated to keep quiet about these details to obviously avoid insider trading and other SEC violations.
- We believe we have identified one such company we believe is close to be acquired.
The company we believe is close to being acquired for a nice premium is Volcano Corp. (VOLC). Volcano Corp. designs, develops, manufactures and commercializes a broad suite of precision guided therapy tools, including intravascular ultrasound and fractional flow reserve products. The company’s intravascular ultrasound (IVUS) offerings are used by clinicians to measure the stage and severity of disease present in cardiac and peripheral vessels. IVUS is also used in post-stent placement procedures to confirm adequate expansion of the stent and full apposition to the vessel wall. Volcano also provides functional measurement (FM) consoles and single-use pressure and flow guide wires, which are used to gauge the impact of arterial plaque on blood flow and pressure.
Currently, more than 3,900 Volcano s5/s5i IVUS and FM systems are installed worldwide, with approximately half of its revenues coming from outside the United States. The company is located in San Diego, CA, and had sales in 2013 approaching $400 million.
Volcano has been the focus of an activist investor who has had success in encouraging takeovers in the past. We will look at some of the clues that indicate a takeover may be close, as well as comparing with other takeovers, mainly ones we have closely followed and written on.
Toward the end of last year, a fund named Engaged Capital, LLC became vocal, as well as announcing a 5.1% stake in Volcano. Glenn Welling, founder of Engaged Capital, said at the time:
Volcano is a very attractive acquisition candidate for the large medical device players within the cardiac space. We don’t believe they should sell themselves today. Once the stock is more fairly valued, and once they’ve achieved some of the targets.
Engaged pursues “constructive” activism, working with management to make changes that boost shareholder value, according to its website.
Engaged Capital requested at the time that Volcano use some of its $500 million in cash to buy back its own undervalued stock (then priced around $20/share). In December of last year, Volcano announced that it is authorizing a $200-million share buyback program.
Along with this measure, Volcano also restructured its business towards the end of 2013, spending about $20 million in one-time costs. The market seems to have simply looked at the bottom line quarterly miss, versus the details of why the company missed on earnings. To us, this “cleanup” or restructuring seems to be to preparation to be acquired.
Another reason the stock has dipped, perhaps, is management’s less-than-attractive guidance in the recent earnings call. This prompted us to think back on the acquisition of both Solta and Obagi Medical, with their stock prices dropping to lower levels prior to their respective takeovers — both on lowered guidance.
We covered both Obagi and Solta, accurately predicting the acquisition of both companies. We believe the case for an acquisition to occur soon with Volcano is as strong, if not stronger than the prior acquisitions of Obagi and Solta.
In Obagi’s case, the management said they had no plans to hire an investment banker, which went against the activist’s position of wanting a takeover. However, when looking back, it clearly seems Obagi was working on a deal quietly when we consider that there was a sale approximately six months after. Solta also appeared to become entrenched by stating it would be fine on its own, and subsequently announced drastic cost reduction and restructuring plans in a quarterly earnings call, soon before being acquired. The difference shown so far in the case of Volcano is that the company appears to have taken most of the steps that the activist requested.
Both Solta and Obagi were purchased by Valeant Pharmaceuticals (VRX) in 2013. Valeant is a huge player, which is evident from its most recent bid to buy Allergan (AGN) for $52.7 billion in cash and stock. This deal was rejected, accompanied by some jabs from Allergan CEO claiming the bid doesn’t offer sufficient value. Since the acquisitions of Solta and Obagi, Valeant stock has gone up considerably, as it appears to be making good use of the companies, along with typical great performance in other areas.
What is also interesting to note is that Volcano recently acquired AtheroMed for $115M, with an upfront cash price of $100M, and $15M reserved for future milestone payments. However, with no comments from Engaged Capital yet, it’s possible this was by design and not against its wishes. So, this deal is likely to add value to Volcano without taking on debt, along with making the company more attractive and a more complete asset to potential suitors.
Volcano seems to have acquired AtheroMed mainly for its Phoenix device which received 510(k) clearance last January. In addition, the device also has CE Mark designation in Europe.
The Phoenix device is a peripheral atherectomy system which is designed to provide physicians with a safe, versatile, and user-friendly primary therapy medium for treating PAD to restore blood flow to the ankle and foot.
Volcano believes that this acquisition could place its company in position to grab a decent share of the global atherectomy market, which is valued in the range of $350-$400 million, with an annualized growth rate of 7%.
Additional comments by Welling concerning Volcano late last year included such remarks as “Constructive talks continue,” so it remains to be seen if any negative feedback comes from the recent AtheroMed acquisition. However, we believe that Welling is receptive of this acquisition and believe the company is in the beginning process of being acquired.
Of the $500 million in cash the company once had, spending $200 million for a buyback and about $100 million for the acquisition still leaves it with an abundance of cash. Lately, activists have been quiet, just as was the case with both Solta and Obagi Medical, where soon thereafter their acquisitions occurred.
- Change of Control Filings
One thing that seems common among other imminent buyouts such as Valeant’s purchase of Obagi Medical is when SEC filings start to demonstrate change in ownership compensation clauses. Obviously, if directors and company executives start to suspect that a takeover may take place, they want to protect themselves or make it beneficial for them to stick around. Conversely, it is potentially in the company’s best interest to provide these types of arrangements, sometimes referred to as golden parachutes, so that everyone doesn’t just quit or start looking for other positions. If a potential deal fell apart or until a potential deal closed, the company would have a big problem if many employees fled. Also, even if the deal consummated, it’s important to have people around who know the most about the operations of the company and how to access financial and other valuable information.
In February of this year, an 8k SEC filing referred to compensation plans and included special clauses for high-level executives if “change of control” occurred. A noteworthy section of this 8k is below, with some areas in bold:
Amended and Restated Executive Employment Agreements with President and Chief Executive Officer and Chief Financial Officer
The Amended Employment Agreements also provide that in the event of a qualifying termination, Messrs. Huennekens and Dahldorf will also receive 24 months accelerated vesting of any equity awards with time-based vesting. Additionally, the Amended Employment Agreements provide Messrs. Huennekens and Dahldorf with100% accelerated vesting of all of their equity awards in the event of a qualifying termination that occurs within the period commencing 90 days prior to or ending 12 months following a change in control. The Amended Employment Agreements also provide that in the event of a termination of employment for any reason other than for cause, Messrs. Huennekens and Dahldorf will generally have a period of up to 12 months to exercise any vested options following the date of termination.
Officer Change in Control Severance Benefit Plan
On February 11, 2014, the Compensation Committee approved our Officer Change of Control Severance Plan (the “Severance Plan”). The Severance Plan provides for severance benefits to eligible officers whose employment is terminated within 90 days prior to and 12 months following a Change of Control, either due to a termination without Cause or a resignation for Good Reason (each, a “Covered Termination”). The Severance Plan provides that upon a Covered Termination, and provided the eligible officer timely provides us with an effective release of claims, he or she will be entitled to receive as severance benefits: (i) a lump sum cash payment equal to 100% of such officer’s annual base salary and target annual cash incentive bonus; (ii) payment for premiums for continued group health insurance coverage for a period of 12 months following termination, and (iii) immediate full vesting of all then-outstanding equity awards. The Severance Plan does not override any severance benefits provided under any individual employment agreement or severance agreement, but the benefits under the Severance Plan will be reduced by benefits under any such individual arrangement. The Compensation Committee will designate our officers, at or above the level of senior vice president, who are eligible to participate in the Severance Plan. Currently, each of our named executive officers is eligible to participate.
Obviously, the high-level executives at Volcano are doing what they can to gain protection and profit nicely if an acquisition does occur. This filing does not necessarily means that an acquisition of Volcano is imminent, but it does signal that upper management has added the correct corporate governance in case an acceptable offer comes to fruition.
One of the main issues with Obagi Medical was the fact that it failed in corporate governance — one of the main issues that activist firm Voce Capital complained about publicly. Volcano seems to have its corporate governance squarely in line here with its severance package.
- Unusual Options Activity
A couple of weeks ago, there was one single options trade of approximately 3000 contracts purchased for the June $17.50 call when the stock was out of the money. The call price was half of what it is now, yet the trader has not yet closed out their position. This tells us that this trader wants to be assigned a position in the stock, rather than to take the massive profit they have now. The open interest stands at a little over 3200 call contracts for the month, which will expire on June 21 — at the moment, these contracts are in the money.
- Potential Suitors
Many large medical device companies would be very interested in Volcano Corporation. Three below are companies that would make sense to us:
Boston Scientific (BSX) has a valuation close to $17 billion, and develops, manufactures, and markets medical devices for use in various interventional medical specialties worldwide. One of its segments focuses entirely on cardiovascular devices. In this area, the company provides many products, including stents, balloon catheters, wires, peripheral embolization devices, and vena cava filters to treat patients with peripheral disease. Additionally, it provides biliary stents, drainage catheters, and micro-puncture sets to treat patients with non-vascular disease. Volcano’s product line would be a nice fit for Boston Scientific.
Medtronic (MDT) is beginning to dwarf Boston Scientific a bit, with a valuation around $61 billion. Its Cardiac and Vascular group’s products include pacemakers, electrophysiology catheters, coronary and peripheral stents, heart valve replacement technologies, and open heart and coronary bypass grafting surgical products. Medtronic is another industry giant that has a lot of leverage and is looking to consolidate, and Volcano’s assets would make for a nice integration here.
Abbott Laboratories (ABT) has a similar valuation to Medtronic, coming in at about $60 billion. One of Abbott’s segments specializes in vascular products and provides coronary, endovascular, vessel closure, and structural heart devices. However, the company has a very wide scope of products and segments. Abbott should have interest in a company like Volcano, but likely a bit less than the prior companies we mention above. Nevertheless, Abbott is another big company with plenty of leverage at its disposal.
It should be mentioned that Valeant might have an interest in Volcano, but is not a likely suitor, due to the fact that its management is looking to merge with larger companies this year, as it clearly stated numerous times last year.
Volcano’s product line would fit nicely into these three in particular, as the companies are the leaders in the segment that Volcano does business in. All of the above companies have the necessary sale forces, leverage, and experience to get the most value out of Volcano, and could potentially increase sales by 30% or more. Additionally, while interest rates are at record lows and likely to increase next year, per Fed guidance, we are seeing a large amount of merger and acquisition interest throughout the market. Larger companies are snatching up these smaller ones at record rates. Because Medtronic and Boston Scientific focus heavily on medical devices, we lean toward those two as the top candidates to pursue a deal with Volcano.
While Volcano is certainly taking the correct steps to bring itself a higher value and to make itself more attractive to potential suitors, as Engaged Capital asked for, we believe its recent acquisition of AtheroMed using 100% cash brings its company value to what Engaged Capital is looking for. Also, as we mentioned, with interest rates being so low as at the current time, a great window of opportunity is in the near term for Volcano. Therefore, we think an acquisition will take place here before the end of this year — before interest rates are likely to rise.
Jefferies’ Raj Denhoy told Bloomberg, in the hands of a company like Abbott Laboratories or Medtronic, Volcano’s devices could be marketed as cost-cutting products for cash-strapped hospitals.
“If you look at where healthcare is headed in the United States and really around the world in terms of trying to improve outcomes and reducing the cost of therapy, this is right in that sweet spot,” Denhoy said.
- Conclusion and Price Opinion
With regards to the Valeant takeover of Solta Medical, we wrote in November of 2013 how the hiring of an investment banker indicated an imminent takeover. This ended up being about a month prior to the takeover taking place.
On May 21st and 22nd, it was reported that Volcano met with Oppenheimer. However, to-date, there has not been any admission by Volcano with regards to hiring an investment banker, and the company does not have to disclose if it has hired one.
In both the Obagi and Solta cases, it was extremely quiet prior to the deal, as most would expect. Activists who were very vocal in the past were quiet all of a sudden. We haven’t heard any further updates from Engaged Capital in months, and feel this is hopefully a good thing for Volcano shareholders.
With the worldwide scope of Volcano, it would be a good opportunity for any multinational company to immediately start generating a lot of additional revenue. The assets of Volcano would be used much more effectively with a strong sales and management team having access to more resources and large healthcare facility relationships. The company has generated pretty consistent and slightly increasing sales for several years, which should give any buyer confidence that this would continue. With the growth stagnant compared to the industry, however, companies such as Boston Scientific and Medtronic would seem like natural front runners that could benefit from Volcano’s product line. $23-$25/share would seem like a good bargain, while providing a fair premium.
If a bidding war was occurring behind the scenes, it would be possible to escalate from there. $23/share being on the low end of our price range would be approximately $1.2 billion for a company generating around $400 million in sales per year, along with a potentially significant amount more with its recent acquisition of AtheroMed, which falls in line with that Engaged Capital has asked for.
With companies such as Valeant and many others growing via mergers and acquisitions, we should see this trend continue. Additionally, we are seeing along of merger and acquisition activity this year throughout the broader market. This is likely occurring because of record low interest rates that are likely to be coming to an end sometime next year.
Since the cost to lever an acquisition is tied to the low interest rate, it makes sense for companies that have their eyes on growing to take advantage of these rates now, rather than wait until next year, when these deals would cost them substantially more capital.
There is no question in our minds that Volcano is likely to be acquired before the end of this year. The ultra-quietness here is actually is very “loud” to us. It would not surprise us if behind the scenes, an actual deal is being worked on as we speak.
