Via BlueRidge Capital
In May 2013 we published our research on Hospira (HSP) concluding with some suggestive commentary around the value the company might represent to a potential suitor:
Conventional wisdom in the investment banking world would suggest that once a high quality operating segment is spun-off from a larger conglomerate, it is only logical that it be reacquired years down the road. Academic research suggests that conventional wisdom may be on to something as spin-offs are five times more likely to find themselves the target of an acquisition. Coincidentally, Hospira recently implemented a “Change in Control” document for CEO Michael Ball and other named executives which is set to expire in 2015. We would note that most of Mr. Ball’s options are struck around $35 per share, so he has plenty of incentive to consider a “change in control.” At the same time, many large global pharmaceutical companies, struggling for growth, are building out generic portfolios to drive future profits as blockbuster drugs come off patent.
We believe Hospira would be a particularly good fit for many of these businesses looking to acquire a large share of an attractive market at a bite size which could be easily swallowed. If Hospira can’t fix their problems themselves, it’s likely that other, bigger fish have noticed that the problems are fixable. In recent years, the average price paid for similar companies has ranged from 11x to 14x EBITDA. Using the midpoint of this valuation and applying it to our estimate of normalized EBITDA, would value the deal at $13.8 billion, or $83 per diluted share – more than 150% above current levels.
This week, Pfizer agreed to acquire Hospira for $15.2 billion, roughly $90 per share. It’s been quite a nice ride for HSP shareholders from the lows below $30 in early 2013. Of course, we hopped off this ride a bit too early as the stock quickly rallied toward our base case estimation of fair value. We often invest in securities where we see substantial optionality above and beyond our conservative estimate of net worth, but we rarely depend on that upside to drive performance. We underwrite each investment to our base case, leaving plenty on the table for positive surprises while focusing most of our attention on what could go wrong to ensure we are comfortable taking the associated downside risk. We are often scaling out of positions as they increase toward our estimate of fair value as expected returns decline from higher prices. From time to time, we may miss out on the occasional home run delivered by a slow-growth slugger with a huge cash hoard, but over time, proceeds reinvested in businesses trading at wider discounts to net worth have offered much more attractive expected returns. In any case, we certainly hope a few of our “less-disciplined” friends held on for the full ride here!