Tomorrow morning, shareholders will seal the fate of Motley Fool Hidden Gems recommendation Transkaryotic Therapies (NASDAQ:TKTX), the company that former CEO Michael Astrue pulled out of a frightening tailspin over the past two years, rejuvenating the stock from $4 per share in 2003 to $37 today.
Astrue resigned in strong opposition to what is an absurd merger transaction with Shire Pharmaceuticals (NASDAQ:SHPGY). During a conversation with The Motley Fool, Astrue said the deal is being led by two Transkaryotic board members who are partners at private equity firm Warburg Pincus: Jonathan Leff and Rodman Moorhead. The latter served as chairman of Transkaryotic during its swoon from $80 to $4, culminating in an SEC investigation of the firm. Warburg Pincus holds these two board seats by virtue of its 14% stake in the company. Though the board of a company has the duty to protect the interests of all shareholders, our opinion is that Leff and Moorhead have effectively accomplished something narrower: doing what's best for Warburg Pincus.
What transpired as a result of what we see as misplaced priorities among these board members is a deal that is substantially underpriced based on Transkaryotic's fundamentals.
In support of our "flawed deal" thesis, the two primary proxy watchdogs in America -- Institutional Shareholder Services (ISS) and Glass, Lewis, & Co. -- oppose this merger. Their move against a friendly deal is simply unprecedented. It makes an unambiguously negative statement about the acquisition at this price. Simultaneously, money managers Millennium Group and Porter, Orlin have filed votes opposing the merger on the grounds that the business should be sold at a minimum price of $45 to $50 per share, rather than the $37 on the table.
By these estimations (with which we agree), this deal -- if it clears -- will save Shire Pharmaceuticals more than $300 million off the intrinsic value of Transkaryotic Therapies, while helping Shire to diversify away from its overreliance on Adderall, a treatment for attention deficit disorder.
So why was the deal struck?
In our opinion, the deal was made because private equity firm Warburg Pincus, among others, wanted to protect against downside before test results were released for I2S, Transkaryotic's treatment for Hunter syndrome. Warburg Pincus holds a 14% stake in the business, which is worth around $200 million. Its representatives, Transkaryotic board members Leff and Moorhead, treated Transkaryotic as nothing more than a trading instrument, dealing it away for substantially less than its intrinsic value as an operating, growing business. The deal was structured to protect Warburg and other like-minded shareholders against the downside of poor I2S results. That effectively sidelined long-term shareholders (people like us, managing well-diversified portfolios) who happily embraced the risk-reward ratio of an Astrue-led company waiting on the test results.
In our opinion, the process of this merger represents a breakdown in the fiduciary obligation Transkaryotic's board of directors has to all shareholders. The likely result will be a feeding frenzy for appraisals by institutional investors in Delaware court and, perhaps, multiple class action lawsuits on behalf of small shareholders. Former CEO Astrue has told us that he chose not to sign a gag order with the board of directors, walking away from millions of dollars in the process. We expect that his critical opinions about the process will result in a flurry of legal action. Investors should expect to hear more from Astrue about the following:
- The laughable fairness opinion by SG Cowen.
- The weak attempt by the board to court competing suitors.
- Indications that Warburg Pincus would've sold at $30, instead of $37, and why (and that SG Cowen was apparently willing to provide a "fairness opinion" at that price as well).
- The consulting relationship between one Transkaryotic board member's firm and Shire Pharmaceuticals.
The sad reality is that if Warburg Pincus could have been patient -- letting Astrue and his team execute -- shareholders would be looking ahead to a multibillion-dollar orphan-drug business with a strong balance sheet, a superior approach to business in this industry, and a leadership team led by world-class executive Michael Astrue.
Instead, it appears the business will be given away at a steep discount to its fair value.
Founded 65 years ago by Eric Warburg, Warburg Pincus is a remarkably great private equity firm. Yet in the case of this one transaction, we say: "For shame." We'd suggest that shareholders of companies that have a Warburg-affiliated director be mindful of what has happened at Transkaryotic. Along with Transkaryotic, Jonathan Leff is a board member of InterMune (NASDAQ:ITMN), ZymoGenetics (NASDAQ:ZGEN), and Neurogen (NASDAQ:NRGN). While your boards of directors are supposed to represent you, consider it a warning that the other Transkaryotic shareholders have apparently been thrown under the bus when their interests came at odds with those of Warburg Pincus.
Transkaryotic Therapies is a Motley Fool Hidden Gems recommendation. You can take a 30-day free trial to Hidden Gems by clicking here.
None of the authors owns shares of any company mentioned in this article. The Motley Fool has a disclosure policy.
