Small-Cap Drug Company in Activist Cross Hairs

Activist hedge fund Starboard Value, run by Jeffrey Smith, is one of the most active activist investors around.
The hedge fund got a lot of press, and fame, for taking on Darden Restaurants (NYSE: DRI), where it overthrew the entire board. In its 300-page presentation on how to fix Darden, it took to task the restaurant company for not salting its pasta water and offering patrons too many breadsticks.
Those tactics seem to have worked. Shares of Darden are up 26% over the last two years – double the return of the S&P 500.
The interesting thing about Starboard is that it has no qualms about taking on small-cap companies. In fact, Starboard’s sweet spot is companies with a less than $10 billion market cap.
The activist investor is now looking to overthrow the board of Depomed (NASDAQ: DEPO), which is a $1 billion market cap drug manufacturer. Starboard revealed a 9.8% stake in the small-cap drug company this month, as it announced plans to call a special meeting and put forth a slate of six directors to replace the entire board.
In a letter to Depomed, Starboard called for a complete overhaul of the company’s board of directors, saying that it and the management team were not acting in the best interests of shareholders. The table is set for a proxy battle and a push to get the company sold.

What Starboard Has Planned

Starboard moved quickly to put together a group of directors to replace the board, as the California-based drug company was looking to incorporate in Delaware, which would have made it harder to overthrow the board.
The planned move to Delaware was an attempt to help shore up its takeover defenses. Recall that Horizon Pharma (NASDAQ: HZNP) tried to take over the company last year, using the California corporate law to its advantage. In California, shareholders owning a 10% stake can call a special meeting to overthrow the board. In Delaware, the ownership threshold to call a special meeting is 25% – and shareholders can’t remove directors at such meetings.
Depomed has since abandoned its attempt to move to Delaware. However, Starboard is still not pleased and is moving forward with overthrowing the board. The fund says that Depomed is still misleading shareholders and trying to suppress shareholder rights.

Finding a New Buyer

Depomed’s drugs focus on the central nervous system and controlling pain – including migraines, cancer pain and acute pain. Shares of Depomed are off more than 50% from their 52-week high, which was near the $33 Horizon buyout offer.
Meanwhile, the overhang of the failed Horizon buyout has spooked a number of investors and pushed Depomed’s stock to below $17 a share. But it’s still a company that’s managed to grow revenues nicely over the years. It’s expected to bring in close to $500 million this year, compared with $340 million last year. Over the last five years, it’s managed to grow revenues at an average annual rate of 33%
There are a number of companies in the drug manufacturing and generic drug business that have no debt and could use Depomed’s strong growth to boost their own revenues. Trading at less than 11 times next year’s earnings estimates and below three times sales, Depomed is certainly one of the best opportunities in the drug industry from a buyout perspective.
Drug companies with no debt and slower revenue growth than Depomed that might be interested in a buyout include United Therapeutics (NASDAQ: UTHR), Taro Pharmaceutical (NYSE: TARO) and Neurocrine Biosciences (NASDAQ: NBIX).
Starboard feels that Depomed is undervalued and has opportunities to unlock value for shareholders. Starboard CEO Jeff Smith says that “significant opportunities exist to create value through better execution, improved capital allocation, and, potentially, a sale of the company.”
In the small-cap drug space, Depomed is one of the best bets, as it already has drugs on the market and is generating revenue. A buyout would unlock value relatively quickly, so look for the activist investor to make that a priority going forward.

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