NEW YORK, July 16 /PRNewswire/ -- JANA Partners LLC today
sent Charles River Laboratories International, Inc. (NYSE: CRL)
a detailed critique of Charles
River's revised investor presentation released earlier this
week, in which Charles River once
again seeks to persuade shareholders of the merits of its proposed
acquisition of WuXi PharmaTech (Cayman) Inc. (NYSE: WX).
In today's letter, JANA Partners Managing Partner Barry
Rosenstein makes the following points:
- Speculative Synergies. The revenue
synergies that Charles River claims
the transaction would create, which it has only recently attempted
to quantify in the face of shareholder opposition, are speculative
at best and run counter to industry perceptions of the transaction
as well as practical industry dynamics.
- Inadequate Returns. Even assuming such
synergies were plausible, given the excessive premium Charles River proposes to pay for Wuxi, this
transaction if completed would generate highly inadequate
returns.
- Poor Capital Allocation Track Record.
Charles River's prior acquisition history and inadequate
returns on capital despite significant expenditures over the years
are cause for further alarm in evaluating the proposed acquisition,
particularly given the significant strategic and integration risks
of a WuXi acquisition.
- Far More Promising Ways to Create Value. As
JANA has previously indicated, there are far more promising means
for Charles River to generate
greater immediate value for shareholders without strategic or
integration risk, including a significant share repurchase or
pursuing strategic alternatives.
A copy of the today's letter from JANA Partners to Charles River follows.
July 16, 2010
Mr. James C. Foster
Chairman, President and Chief Executive Officer
Charles River Laboratories International, Inc.
251 Ballardvale Street
Wilmington, Massachusetts
01887
Mr. Foster,
We have reviewed the revised investor presentation dated
July 13, 2010 prepared by Charles
River Laboratories International, Inc. ("Charles River" or the "Company") which again
seeks to justify the proposed acquisition of WuXi PharmaTech
(Cayman) Inc. ("WuXi"). Having done so, it is more apparent
than ever that this transaction is the wrong choice for
Charles River shareholders.
While we have detailed our opposition in prior letters (as
have other large shareholders), we wish to address the following
issues raised by the presentation.
Synergies Remain Speculative at Best
While the presentation focuses on WuXi's prospects for improving
falling growth rates and reversing recent margin erosion, any
Charles River shareholder can buy
WuXi stock without paying a large takeover premium. The
Company must show that the combination itself would create
incremental value, and we see little that is new and even less that
is credible to suggest this. Just weeks before the vote and
in the face of significant opposition, the Company for the first
time has estimated revenue synergies and offers unnamed customer
commentary as support. However, there is little risk now in
speculating about synergies far into the future, or for customers
to anonymously express potential interest in a combined product
offering without making an actual purchase decision, and such
predictions and sentiments run counter to general industry
perceptions, including the following recent analyst commentary:
- Raymond James:
"During our conversations with industry participants, the
subject of the Charles River-Wuxi proposed merger often emerged.
From the strategic perspective of synergies between discovery
services and existing preclinical capabilities, we did not
encounter a single individual who agreed with the transaction
and/or thought that it would clearly provide a benefit to the
resulting entity. In our view, this further validates investor
concerns over the merits of the transaction."(1)
- Deutsche Bank: "We view today's attempt by
management to place a medium-term target on revenue synergies as a
means of garnering additional support for a transaction that we
believe is not broadly favored by shareholders. We would also note
that revenue synergies tend to be elusive in nature and
particularly hard to capture relative to service based
transactions. Therefore, we expect shareholders to discount the
revenue synergy potential of the transaction and remain generally
against the proposed [WuXi] transaction."(2)
Our recent discussions with industry operators also confirm that
such synergy claims cannot be reconciled with practical industry
dynamics including the complexity in terms of time and location of
the R&D process. These discussions have verified that
Wuxi's discovery chemistry offering is too early in the process to
lead to significant cross-selling with Charles River's toxicology. Discovery can
last years, with less than 5% of compounds tested ever reaching the
preclinical safety testing stage performed by the Company.
Without knowing the viability of any compound that may emerge
from discovery and given the length of this process, it is unlikely
a customer would make a toxicology outsourcing decision when
deciding to outsource discovery. Even when outsourced
discovery does lead to promising compounds, these often go back
in-house to the customer for extensive optimization work such as
formulation, which can in some cases further separate discovery and
toxicology outsourcing decisions.
Such discussions have also strengthened our belief that most
large customers are not typically suited to purchase an integrated
offering given their often highly decentralized processes, which
are often divided between different decision-makers who may be
located in different facilities, cities or even countries, further
complicating the sales process. In fact, we have learned that
Charles River's existing research
models and preclinical sales efforts have not yet been fully
integrated despite the Company's efforts, further evidencing the
challenge of a combined offering. It is also not realistic to
ask the Company's existing sales force to sell an additional and
entirely new offering, discovery, to a new set of decision-makers
and still cover their existing markets. It is even less
likely that the Company can create the newly claimed revenue
synergies plus the anticipated sales and marketing cost synergies
when WuXi is contributing only a limited sales force, meaning
additional sales personnel would likely be required. We also
believe it is unlikely that Charles
Rivers' brand strength would lead to significant new
discovery sales given that WuXi is already well known in the
industry. Moreover, we continue to believe that any
integrated discovery and toxicology sales would likely come at the
expense of pricing, thus reducing the value of any such potential
revenue synergies, with potentially further revenue erosion
resulting from Charles River's and
WuXi's different pricing models.
Return on Capital is Inadequate Even Under Most Optimistic
Scenarios
However, even if one accepts the new and aggressive revenue
synergy assumptions in the presentation, the proposed purchase
price still cannot be justified. Assuming that both the
claimed cost synergies and newly estimated revenue synergies could
in fact be realized, our analysis set forth in Exhibit A shows that
by 2015 the return on this acquisition still would fall short of
the midpoint of WuXi's cost of capital (a crucial metric given that
the Company would be paying for WuXi's cash flows)(3) and would not
come close to the Company's previously stated mid-teens return
requirement. In other words, even using aggressive synergy
assumptions and discounting any strategic or integration risk,
after five years the transaction still would not generate an
acceptable return. In fact, the contemplated acquisition
would need to generate an additional $350
million in revenue synergies (more than doubling WuXi's
estimated 2010 revenue) just to reach the Company's stated return
hurdle rate.(4) Moreover, there is little to no margin for
error given that the Company has relied on aggressive WuXi growth
assumptions which exceed consensus street projections and WuXi's
own prior guidance (and yesterday's updated WuXi guidance), while
taking on significant added leverage to finance the attempted
acquisition. We find it particularly troubling that the
Company has only now sought to estimate potential revenue synergies
in the face of shareholder opposition, rather than reviewing such
estimates and the likely return on investment before the Company's
board of directors approved the proposed transaction.
Charles River's Capital
Allocation Track Record Does Not Inspire Confidence
Charles River's efforts to grow
its preclinical business through acquisition and capital
expenditures should serve as a cautionary tale. The Company
spent $1.5 billion for Inveresk
Research Group to enhance its preclinical business (which it had
unsuccessfully attempted to build through acquiring second tier
toxicology labs) and has also allocated approximately 75% of its
capital expenditures, or approximately $600
million, over the past 5 years to its preclinical
business. However, in the past 5 years it has never reached
an annual return of even 5% on this investment, far below an
appropriate cost of capital and a suboptimal use of the high return
on investment cash flow from its research models business.(5)
This spending binge resulted in a $700
million goodwill write-down and contributed to industry
overcapacity, and was followed by the unprecedented shuttering of a
costly toxicology facility by the Company shortly after its
construction. We believe capital allocation decisions like
these have led the Company's stock to fall over 30% in the last 5
years while the peer it compares itself to in the presentation,
Covance Inc., has more prudently sought additional business by
buying facilities from customers while simultaneously locking in
long-term business from such customers and seen its stock rise 12%
during the same period.(6)
We also note that the Company's claim that its shares began to
perform in-line with its peer Covance "once [the] market understood
[the WuXi] deal rationale" ignores that the recovery in its stock
price since the proposed transaction was announced is likely
largely the result of the anticipated demise of this transaction.
This is evidenced by the sharp increases in Charles River's stock price following the
announcement of our opposition to the transaction (which was
followed by similar announcements from other large shareholders)
and following the Company's statement in the presentation that it
would not pursue this transaction without shareholder approval, as
well as the widening deal spread in WuXi's stock price since the
proposed transaction was announced. Further, as one analyst
pointed out Tuesday, "If shareholders balk on the deal, or either
company employs a material change clause, [Charles River] shares would likely recover much
of the lost valuation since announcement."(7)
Other Avenues for Creating Shareholder Value are Far More
Promising
We have already pointed out that a share repurchase would create
substantial value immediately without integration risk, and that a
sale of the Company could also generate significant value.
Given Charles River's failure to extract value from the
combination of its existing businesses, others have also speculated
that a separation could also create substantial value:
"We estimate that a split of [Charles
River] could unlock shareholder value that is equivalent to
$47 per share in [Charles River] stock, representing ~30% of
upside from the current level. Specifically, we estimate that the
[research models] business, given its strong margins and steady
performance, is worth $32/share
stand-alone, while we estimate that the [preclinical] business is
worth $15/share. By our model,
a leveraged recapitalization could add up to $6/share."(8)
For these reasons, we continue to believe that the choice for
Charles River shareholders is clear,
and that a majority of them will reject this transaction. We
also still believe that Charles
River has numerous attractive options for creating
substantial shareholder value thereafter, and we hope to have a
constructive discussion in the future with the Company regarding
such alternatives.
Sincerely,
/s/ Barry Rosenstein
Barry Rosenstein
JANA Partners LLC
Managing Partner
Note: Quotation of analysts herein does not
necessarily indicate that such analysts support the views expressed
herein.
(1) "DIA: Exhibitor Conversation Takeaways"; Alexander Y. Draper and Jake Hausman; Raymond
James & Associates; June 17,
2010.
(2) "CRL updates synergy target and receives 2nd request from
FTC"; Ross Muken, Michael Cherny and Vijay
Kumar; Deutsche Bank Securities Inc.; July 13, 2010.
(3) WuXi cost of capital is based on mid-point of cost of
capital as calculated by JP Morgan as disclosed in Charles River's most recent proxy statement.
(4) These are additional revenue synergies (beyond the newly
announced revenue synergies) which would be required to achieve
Charles River's return requirement,
assuming a 30% operating margin and a 25% tax rate.
(5) Research models five year average return on capital exceeds
40%. Business segment returns calculated as the sum of (1)
tax-effected segment operating income divided by (2) average
segment long-term assets, adding back goodwill write-downs and
including other intangible assets.
(6) Returns are for the five years ending July 13, 2010. Looking more broadly, over
the past five years ending July 13,
2010, the Company's shares declined approximately 30%,
compared to an average increase of 86% for its comparably-sized
industry peers Covance Inc., Parexel International Corp., ICON plc
and Pharmaceutical Product Development Inc. All calculations
assume reinvestment of dividends.
(7) "CRL/WX: Incremental Detail in Updated Presentation";
Eric W. Coldwell and Nicholas Juhle; Robert W. Baird & Co.;
July 13, 2010.
(8) "CRL: Time to unlock value; we see $6/share from recap, $11/share from an RMS/PCS split"; Stephen Unger and William Hite; Lazard Capital Markets;
June 17, 2010.
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Exhibit A
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WuXi Acquisition Returns
Analysis (1)
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2011 2012 2013 2014
2015
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Return to Charles River
excluding synergies
7% 8% 9%
9% 9%
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Return to Charles River
including synergies
8% 10% 10%
11% 11%
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(1) Returns calculated by
dividing (1) the sum of GAAP net income and depreciation &
amortization by (2) the sum of Charles River stock and cash
consideration, conversion of WuXi options, WuXi net debt assumed,
deal related expenses and WuXi capital expenditures.
Synergies (a) incorporate the announced $20MM of pre-tax cost
synergies taxed at a 25% tax rate in 2011 and thereafter, (b)
assume a one-time pre-tax restructuring charge of $30MM which is
included in invested capital and (c) include newly announced
revenue synergies of $100MM in 2013 (the high-end of Charles River
synergy guidance) and initial revenue synergies of $33MM in 2011
and $67MM in 2012, in each case at an assumed 30% operating margin,
growing in-line with operating income projections thereafter and
taxed at a 25% tax rate. WuXi GAAP net income through 2012
based on adjusted operating income projections per Charles River's
latest proxy statement, 14% tax rate per midpoint of WuXi 2010
guidance, and assumes $9MM reduction for after tax share based
compensation per 2009 actual results. 2013–2015 WuXi
operating income based on Jefferies' research estimates. 2013–2015
WuXi operating income growth rate based on Jefferies' research
projected growth rate of operating income for the same period.
Depreciation expense through 2012 based on difference between
WuXi adjusted EBITDA and operating income estimates per Charles
River's latest proxy statement; thereafter assumed to grow in-line
with capital expenditure growth rate. 2011–2015 capital
expenditures per Jefferies' research estimates. Charles River
stock consideration valued per Charles River transaction
presentations, using Charles River closing price of 4/23/2010
(closing price prior to transaction announcement) and based on 75MM
diluted WuXi shares, for a total stock and cash consideration of
$1.6 billion. Conversion of WuXi options valued at $39MM per
Charles River proxy. Deal related expenses include Credit
Suisse seller advisory fee (not disclosed but assumed to be
equivalent to $12MM JP Morgan buyer advisory fee) and assumed $24MM
in financing fees related to Charles River's $1.2bn credit
facility.
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SOURCE JANA Partners LLC