Jana Partners Sees Transformation In Pharma; Targets JNPR

Jana Partners Sees Transformation In Pharma; Targets JNPR
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Jana Partners is making headlines again, this time for pressuring Juniper Networks, Inc. (NYSE:JNPR) with their shareholder activism, but not every relationship the group has with management teams is so adversarial. In fact, according to the latest performance update for the Jana Partners Master Fund, a copy of which was obtained by ValueWalk, there appears to be a transformation going on in the pharma industry.

“Endo Health Solutions Inc (NASDAQ:ENDP) was the third largest contributor to performance in the quarter and a top 15 contributor for the year,” the company wrote. Jana Partners started watching Endo Health Solutions in January and grew more interested when the pharmaceutical company announced the hiring of CEO Rajiv De Sila, who had previously overseen the integration of $13 billion in acquisitions at Valeant Pharmaceuticals Intl Inc (NYSE:VRX) (TSE:VRX).

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Upon becoming CEO, De Silva bought $7 million in ENDP stock for himself and announced that he was going to implement shareholder value creation strategies including cost cutting, selling off non-core assets to free up cash and making acquisitions that leverage the company’s infrastructure. Jana Partners was sold and initiated a position with Endo Health Solutions Inc (NASDAQ:ENDP) shortly thereafter.

“We wish every CEO we invested behind had as much conviction and skin in the game as Rajiv,” the company writes. But it turns out that De Silva may be part of a sector-wide trend.

ENDP a case study in shareholder value creation

“We have come to recognize from studying Endo Health Solutions Inc (NASDAQ:ENDP) that certain executives in the pharmaceuticals business have adopted the same shareholder value creation strategy that has worked so successfully in other stable, cash flow generative industries like media and the midstream pipelines,” says the performance letter.

The company sees more pharma management teams using low cost debt financing, cost cutting measures, and deleveraging to improve their balance sheets to allow for future acquisitions. “When combined with a low corporate tax rate that decreases cash outflows and lowers the cost of capital, the virtuous cycle is enhanced and the underlying free cash flow per share growth is accelerated,” they write.

MNK reinforces the pharma transformation thesis

Jana Partners mentions Mallinckrodt PLC (NYSE:MNK) as another example of “the over-arching pharma transformation thesis.” MNK management is talking about getting out of the imaging business to become a pure pharma company, and they have around $2 billion ready for acquisitions and are identifying possible targets. Throw in the company’s low Irish tax rate and some progress with FDA drug approvals, and Jana Partners thinks Mallinckrodt could even be an acquisition target for another pharma company in the future.

Mallinckrodt PLC (NYSE:MNK) was a top ten contributor to Jana Partners’s fourth quarter performance and “if we combine it with Endo Health Solutions Inc (NASDAQ:ENDP), as the largest positions in our ‘pharma transformation basket’ the combined MNK/ENDP would have been a top ten contributor for all of 2013.”

Jana Partners Targets Juniper Networks

In the letter to shareholders, Jana Partners had the following to say about Juniper Networks, Inc. (NYSE:JNPR) and the potential for activism there:

Juniper Networks, Inc. (NYSE:JNPR) is a leading provider of telecom network infrastructure products and services. It was one of our largest new commitments in the fourth quarter, and we are now one of the largest shareholders. We were attracted to Juniper Networks, Inc. (NYSE:JNPR)’s undemanding valuation, the tailwind of a favorable telecom spending cycle on required network upgrades, a frustrated shareholder base and the potential for a change of perspective and sense of urgency from new CEO Shaygan Kheradpir. We have engaged with the company on the multiple avenues we see to unlock shareholder value. The most obvious is a glaring cost opportunity. We estimate as much as $300 million of potential savings ($0.40 to EPS) that could reverse the trend of declining margins despite increasing revenues. Meaningful growth in R&D spend to a level of revenues much greater than peers has had no demonstrated benefit to earnings or returns on capital, and the elaborate expense of JNPR’s new Sunnyvale, CA campus is as good an illustration as any of the opportunity for greater cost consciousness. The current product line up is unfocused and dilutes the effectiveness of marketing and sales support by diverting resources to peripheral product offerings. Rationalizing products through business line divestitures would help restore focus. Segment profitability is not properly tracked or measured by a newly instituted reporting framework that leaves 30% of revenues unallocated. The balance sheet is over-capitalized, even by Silicon Valley standards, with $3 billion of net cash, or $6 per share (30% of the market cap at our cost). A large capital return program should be an immediate priority, and coupled with the introduction of a meaningful dividend, would help address concerns about capital allocation. Management compensation is misaligned with shareholder returns; incentives should be recast to map against returns on capital and total shareholder return, rather than the nebulous objectives that have led to an unfocused product line up, a lazy balance sheet and share price underperformance. We believe the board would benefit from the addition of new directors with a fresh perspective.

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