Investors line up against Charles River-WuXi deal

Leading investors are stepping up pressure on US-based contract research organisation (CRO) Charles River Laboratories (CRL) to scrap its planned US$1.6 billion acquisition of China’s WuXi PharmaTech.

Relational Investors and Neuberger Berman have joined Charles River’s largest shareholder, JANA Partners, in coming out against the deal. Critics say the price is too high and the claimed synergies are not sufficiently compelling to override the risks of integrating the two businesses.

The latest blow to the definitive merger agreement, announced in late April and billed as “a transformational transaction that sets a new standard in the outsourced drug development services industry”, is a Reuters interview with Glenn Welling, managing director of Relational Investors.

Welling is quoted as saying: “Between the stock price reaction and shareholders’ disapproval, it should be clear to management and the board that walking away from this transaction is the right thing to do. We hope they get the message”.

Under last April’s agreement, each WuXi American Depositary Share would be exchanged for US$11.25 in cash and US$10.00 worth of Charles River common stock, as determined by an agreed exchange ratio. Based on WuXi’s closing share of US$16.57 on 23 April 2010, the transaction gave WuXi stockholders a premium of 28%.

Welling’s comments will add weight to more detailed objections outlined in letters to Charles River from Neuberger Berman and JANA Partners in recent weeks. Neuberger Berman voiced its unease on 16 June, noting that the hope had been to see Charles River on a recovery path this year, following a difficult 2009 marked by declining profitability.

Instead, wrote the asset manager that owns around 6.3% of CRL’s outstanding common stock, shareholders “are being asked to approve an acquisition at a multiple of 16 times projected 2011 EBITDA [earnings before interest, taxes, depreciation and amortisation] … Without belabouring the point and put simply, the very rich price being paid for WuXi allows for no margin of error”.

In Neuberger Berman’s view, “the proposed transaction with WuXi represents an unacceptable elevation of financial and operational risks to CRL, and therefore, our investment”.

The investor also cites Charles River’s previous experience with its acquisition of Scotland’s Inveresk in 2004, which proved to be a short-lived and unsuccessful detour by the US CRO into fully fledged clinical research services.

That deal, Neuberger Berman points out, was also supposed to be ‘transformational’, “promising to accelerate the growth and size of available markets to the company. Instead, the transaction resulted in a US$700 million write-off, with growth and consistent profitability remaining elusive in the company’s preclinical operations”.

CRL’s management “needs to demonstrate that its current assets can generate returns well in excess of its cost of capital before being allowed to spend US $1.6 billion of capital,” Neuberger Berman argues. “We firmly believe that CRL’s shares are significantly undervalued and that a bright future lies ahead for the core businesses of CRL. In our view, a free cash flow-financed share repurchase programme would demonstrate confidence in CRL’s current asset base and be an excellent use of capital.”

The proposed acquisition “will in effect be a referendum on management’s capital allocation strategy, and as such should only be done with the approval of a majority of stockholders”, it adds. Any revision to the proposed transaction that bypassed a shareholder vote “could only result in a further impairment of CRL’s value and would amount to nothing more than a blatant affront and disenfranchisement of your stockholders”, the letter warns.

Wrong path

Two weeks ago Barry Rosenstein, managing partner of JANA Partners – which owns more than 7% of Charles River’s outstanding shares – wrote to the CRO saying that the “high cost, significant integration risks and inopportune timing” of the WuXi deal make it “the wrong path for Charles River shareholders”.

JANA intended to vote against the issue of CRL common stock for the acquisition “and we believe based on shareholder sentiment it is likely that a majority of the Company’s shareholders will do the same”, Rosenstein noted.

There are “much more promising and straightforward means at present to create shareholder value than acquiring a company with decelerating growth prospects and significant integration risks at an expensive valuation using a large amount of the Company’s undervalued stock”, he contended. These options included a share buyback or inviting in private equity.