Starboard Value’s letter to Perrigo Company’s CEO, John Hendrickson.
Perrigo Company plc
Lower Grand Canal Street
Dublin 2 Ireland
Attn: John Hendrickson, Chief Executive Officer
cc: Board of Directors
Starboard Value LP, together with its affiliates (“Starboard”), has an ownership interest of approximately 4.6% of the outstanding ordinary shares of Perrigo Company plc (“Perrigo” or the “Company”), making us one of the Company’s largest shareholders. We believe that Perrigo is deeply undervalued and significant opportunities exist to create value for the benefit of all shareholders based on actions that should be within the control of management and the Board of Directors (the “Board”). We believe changes are needed to reverse the trajectory of poor operating and financial performance and reposition Perrigo for future success. We are writing to you and the Board to share our preliminary thoughts on issues facing the Company and opportunities for improvement, and to begin what will hopefully be a constructive engagement with the goal of driving value creation for the benefit of all shareholders.
In April 2015, Mylan N.V. (“Mylan”) made an unsolicited proposal to acquire Perrigo for cash and stock worth approximately $205 per share, more than a 25% premium at that time. Even at current market prices for Mylan shares, this combination would have resulted in a current value of approximately $167 per share, or 88% more than the current Perrigo stock price of approximately $89. Management and the Board went to great lengths to oppose this proposed combination, spending more than $100 million in advisor fees relating to its defense, and promising shareholders that their standalone strategy would produce more value than the transaction given the robustness of Perrigo’s future prospects. In order to convince Perrigo shareholders to reject Mylan’s offer, management and the Board made aggressive promises of drastic improvements in both financial and stock price performance.
Unfortunately, since that time, results have gone decidedly in the wrong direction, and management’s promises have been woefully unfulfilled. Specifically, the Company has severely mismanaged the Omega Pharma Invest N.V. (“Omega”; now Perrigo’s Branded Consumer Healthcare business) integration, committed numerous execution errors, and significantly lowered financial guidance on the past two earnings calls. This has resulted in Perrigo shares losing more than half of their value since the Mylan offer. In addition, contrary to shareholders’ interests, members of Perrigo management received special bonuses for their role in thwarting Mylan’s offer.
Despite these recent missteps, which have badly damaged the credibility of management and the Board, we believe that Perrigo has a strong franchise with valuable assets.
The core Consumer Healthcare (“CHC”) business is the largest provider of store-brand over-the-counter (“OTC”) products in the U.S. with a dominant market share of approximately 70%. Its significant manufacturing scale and breadth of distribution provide high barriers to entry. This business has produced steady improvements in adjusted gross margin and adjusted operating margin through continued penetration of store-brand OTC products supplemented with new product introductions.
Branded Consumer Healthcare
The Branded Consumer Healthcare (“BCH”) business is a market leader in European OTC, and complements CHC’s OTC leadership position in the U.S. Similar to the CHC business, BCH possesses significant market share in several large European markets where it maintains high levels of brand awareness. The combination of CHC and BCH provide Perrigo with a unique global OTC market position.
In addition to Perrigo’s core OTC businesses, Perrigo also owns several valuable, but non-core assets.
The Prescription Pharmaceuticals (“Rx Pharmaceuticals”) business develops and manufactures generic and specialty pharmaceutical products with a focus on extended topicals. It is expected to generate approximately $1.0 billion of revenue and adjusted operating profit margins in “the low 40% range” in 2016. Despite the recent increase in both manufacturer competition and customer consolidation, this business maintains strong margins with proven innovation capabilities. We believe that there are limited synergies between the Rx Pharmaceuticals business and the core OTC businesses. We also believe this would be a valuable business to several strategic acquirers.
Perrigo owns a royalty interest on global sales of Tysabri®, a leading therapy for the treatment of multiple sclerosis marketed by Biogen Inc. Perrigo is entitled to 18% royalty payments on annual sales up to $2.0 billion and 25% royalty payments on annual sales above $2.0 billion. We estimate that the royalty is forecast to generate approximately $360 million in revenue with approximately 96% adjusted operating margins for Perrigo in 2016. While non-core in nature, the royalty produces substantial and, we believe, durable cash flows for the Company. This is purely a financial asset as Perrigo has no involvement in the marketing and sales of Tysabri®.
Based on our analysis, we believe that both of these non-core assets have considerable value which is not being reflected in the current stock price. As management and the Board evaluate operational and strategic opportunities for improvement, we believe the Company could benefit from outside advice from a reputable investment bank or advisor on non-core asset divestitures or other broader strategic alternatives.
Core Business Opportunity
In addition to the opportunities highlighted above, we also believe a significant opportunity exists to improve performance in Perrigo’s core businesses. For example, we estimate that BCH adjusted operating margins declined from approximately 18.8% in 2014 to 14.8% in 2015 and are expected to further decline to “low double digits” in 2016 based on management’s most recent guidance. We fail to see why this should be the case – especially given the significant synergies between CHC and BCH – and believe that this illustrates a clear lack of focus and execution in the core business. Based on our analysis, we believe that there is a substantial opportunity to improve BCH adjusted operating margins above prior peak levels.
We believe the misguided confidence of management and the Board followed by deteriorating operating performance, which has been well below promised levels, has hurt the credibility of management and the Board, and, we believe, has resulted in a drastic rerating of Perrigo’s once premium multiple. Historically, Perrigo traded in-line with well-performing consumer staples companies given the consistency of the Company’s market-leading OTC businesses. However, the lack of focus and execution in the core business has severely depressed Perrigo’s valuation. As illustrated in the chart below, from 2011 to 2015, Perrigo’s valuation multiple was highly correlated with the valuation multiples of consumer staples companies. Unfortunately, since the operational and financial missteps began in 2015, Perrigo’s valuation multiple has plummeted, trading nearly in line with specialty pharmaceutical companies that possess far different financial and risk profiles. The change in multiple implies that shareholders have lost confidence in the Board’s oversight of management as well as management’s ability to execute and think strategically on behalf of shareholders. We believe that with the proper portfolio changes, significantly better execution, and thereby renewed confidence in management and the Board, the multiple should rightfully be in line with peers that also operate high-quality assets.
Extremely Expensive Defense
Given Perrigo’s possession of such high-quality