Maybe it's just heightened visibility, but activist shareholders willing to publicly display their annoyances with how certain drugmakers have been managed seem to have been growing in numbers for the past couple of years. Yesterday, Endo Pharmaceuticals (NASDAQ:ENDP) became the latest to get a call for corporate change from an activist investor.
Drugmakers like Flamel Technologies (NASDAQ:FLML), PDL BioPharma (NASDAQ:PDLI), and Ligand Pharmaceuticals (NASDAQ:LGND) have all been subject to shareholders submitting SEC filings demanding changes from management. The call for a new direction with Endo comes from an institutional investment group holding 5.6% of outstanding shares.
The beef with EndoThe group's main issue with Endo is how it plans to use its more than $700 million in cash and investments. Endo has stated in the past that it wants to use this cash to make an acquisition.
The group would prefer that Endo leverage itself by adding on debt and buying back shares with a majority of the cash, which would then boost earnings per share by up to 20% under their buyback strategy and still leave Endo with enough money to make an acquisition if it found a cheap enough deal.
Without knowing what deals Endo has in mind for the cash or at what price they might be consummated, it's impossible to make a judgment as to whether an acquisition or buyback would be a better use of its cash.
Some of the group's reasons are shaky as to why there are may be few acquisition opportunities in the pharmaceutical sector. That said, in general I prefer to see free cash flow-generating drugmakers put their money to use in more direct, shareholder-friendly ways like buybacks or dividends rather than growing by acquisitions.
While studies have shown that acquisitions (especially all-cash deals) can drive share price growth for some pharmaceutical firms, buying out smaller drugmakers can also be a stock value-destroying proposition if done at too high a price.
Time to oust Endo's management team?While no mention was made in the shareholder SEC filing about whether it may be time for a change of management at Endo, it's always worthwhile to track how the leaders of a company you own shares in have performed recently.
In terms of its corporate behavior, I haven't seen anything particularly egregious from Endo's management team. The drugmaker is under investigation for how it has marketed its lead product, the pain patch Lidoderm, but the consequences of such investigations are generally fairly minor. If found guilty, it faces an average fine in the low- to mid-nine-figure range, like what happened to InterMune (NASDAQ:ITMN) earlier in the year (unless a particularly egregious violation is found).
In terms of Endo's financial performance, despite a declining stock price in 2006 over worries of Lidoderm facing generic competition, the drugmaker has performed well operationally last year and in the first quarter. So well, in fact, that I made it my top drug stock pick for 2007. Sales were up 24% year over year in the first quarter and are expected to be up 13% for the year as a whole, with adjusted earnings per share of $1.70 at the midpoint.
Alerting the management of public companies that shareholders will be closely watching any future maneuvers is undoubtedly a good thing. This sort of thoughtful watchfulness encourages shareholder-friendly behavior from management.
It could also be argued that many past corporate excesses -- for example, exorbitant CEO golden parachutes and pay packages -- at companies such as Disney or Home Depot could have been prevented by investors taking a more active role in the companies in which they own shares. Therefore, investors should see this increased scrutiny of Endo as nothing but a good thing.
InterMune and PDL BioPharma are Rule Breakers selections. Flamel is a Hidden Gems recommendation. Disney is a Stock Advisor pick, and Home Depot is an Inside Value recommendation. Your can take any of our newsletters for a free 30-day trial.
Fool contributor Brian Lawler does not own shares of any company mentioned in this article. The Fool has a disclosure policy.
