In April Charles River Laboratories (CRL) agreed to acquire WuXi for $1.6bn (€1.3bn) but some have questioned the wisdom of the deal. Jana has now put its concerns to CRL in a letter that has been filed with the US Securities and Exchange Commission (SEC).
Barry Rosenstein, manager partner at Jana, writes that his organisation has “serious doubts” about the deal because of “the high cost, significant integration risks and inopportune timing”. The letter was written after Jana met with James Foster, CEO of CRL, and Ge Li, CEO of WuXi.
A statement issued to Outsourcing-Pharma by CRL reads: “We have filed a preliminary proxy statement that fully outlines the strategic rationale and value proposition of the WuXi transaction. We continue to believe that the transaction as described will create long-term shareholder value.”
Rosenstein writes that the proposed price for WuXi “cannot be justified” because the China-based company has “declining margins and falling growth rates”. Gross margins have declined each year since 2003 and WuXi predicts its gross margin will fall again in 2010, writes Rosenstein.
Also, Jana believes that CRL relied on growth and margin assumptions that appear to be aggressive. For these and other reasons Rosenstein writes that $1.6bn is a high price for WuXi.
Rosenstein cites analysts from RW Baird and UBS Investment Research that have both questioned the likelihood of successfully integrated WuXi. The analysts’ concerns are underpinned by the difficulties CRL is perceived to have experienced in integrating Inveresk.
Having offered $1.5bn for Inveresk in 2004, CRL sold the acquired Phase II to IV operations to Kendle two years later. A number of other business units acquired from Inveresk were also divested. This experience, and integration difficulties across the sector, has made analysts wary.
The acquisition of WuXi also poses some different challenges. UBS analysts said the challenges associated with “combining different business models and cultures” mean they believe “the integration and execution risks are above average”.
Rosenstein also touches on this issue. He writes that achieving revenue synergies through the combination of discovery chemistry and biology “is an untested propositions” that might not fit with how clients purchase these services.
The timing of the deal is also questioned by Rosenstein. He writes that the anticipated “cyclical recovery in preclinical services” will boost the value of CRL shares. WuXi may also benefit, writes Rosenstein, but discovery services have fared better than preclinical during the downturn.
Also, Rosenstein asks why the deal needs to be performed now when there appear to be no alternative buyers for WuXi. This also raises concerns about the need to pay a premium for WuXi.
Despite these concerns Jana acquired 4.7m CRL shares in the last two weeks of May for $148.7m. Using this stake Jana intends to vote against a measure needed to complete the acquisition and believes it is likely the majority of shareholders will do the same.
Rosenstein writes that CRL has a “dominant position in the highly defensive research models market” but is underappreciated by the market. Consequently, Jana believes CRL will be well-positioned and have several attractive options if the deal for WuXi falls through.