Quick idea

Type of situation: Activist investor pushing for strategic alternatives with potential sale of company

Market cap: $8.6B – Share price at publication: $48.38

Why look at this?

Catalent, Inc. (Catalent Pharma Solutions) is a global contract drug maker that has recently seen Elliott Management take an activist stake in the company. Elliott has reached a settlement with the company’s management on August 29, allowing the activist to install four new directors, along with an agreement to explore strategic alternatives for the company whose share price has fallen around 50% over the past year and is down 60% from its all-time high in 2021.

Catalent has been subject to a number of rumors for a potential take-private late last and early this year at potentially significantly higher share price levels. The involvement of Elliott, their swift win in discussions with the board, general problems at the company that may be resolved soon and the possibility of a sale of the company make this a name that could seriously be “in play” at this time.

Company Profile

Catalent essentially provides contract production to major pharmaceutical companies. Headquartered in Somerset, New Jersey, it employs more than 14,000 people, including approximately 2,400 scientists and technicians. The company manufactures products for third parties in over 50 locations around the world.

The company was formed in April 2007 when affiliates of Blackstone (NYSE:BX) acquired the core business of the pharmaceutical technologies and services (PTS) segment of Cardinal Health, Inc. (NYSE:CAH). Cardinal Health created PTS through a series of acquisitions in 1998. In 2014, Catalent became a public company and was listed on the New York Stock Exchange.

The company was recently in the news as it was the sole contract manufacturer for Novo Nordisk's (OMXCOP:NOVO_B) highly popular weight loss drug Wegovy, which uses the same ingredient as its diabetes drug Ozempic (Link). Catalent ran into production missteps in two of its plants that fill Wegovy injection pens. Catalent had also allegedly breached U.S. sterile-safety rules in certain production processes and staff had failed to perform required quality checks. Since then, Novo was reported to have hired Thermo Fisher (NYSE:TMO) as a second contract producer for its Wegovy drug (Link).

Given how prominent GLP-1 drugs have become, I suggest a read-up on these new “blockbuster” drugs by a favorite newsletter of mine, Citrini Research (Link) or listen to a recent Odd-Lots episode (Link).

During the Covid-19 pandemic, Catalent produced Moderna Inc's (MRNA.O) COVID-19 vaccine.

Shares of Catalent have been under pressure this year as the company in April reported that slow production at three of its facilities would impact the fiscal 2023 results and that the firms’ CFO would step down (Link). The company also this week announced that it was delaying its annual report for 2022 under Rule 12b-25, stating it needed additional time to complete procedures related to “management’s assessment of the effectiveness of its internal controls and other closing procedures” (Link). The company, however, added that it did not expect any material changes to financial information as prepared in its financial statements for the year so far.

Previous rumors of a buyout

In the course of the past 12 months, a number of rumors on potential buyers for the company were going around:

• In December 2022, vague rumors circulated that Catalent was a potentially attractive target to German science and technology conglomerate Merck KGaA (XETR:MRK). However, no news regarding this particular potential buyer ever materialized afterwards (CTLT share price then: $44.90).

• Rumors went around in February 2023 of interest by industrial conglomerate Danaher (NYSE:DHR), although the deal never materialized. Danaher went on to acquire protein tool producer and distributor Abcam plc (NYSE:ABCM) this week for a $5.2B consideration (CTLT share price then: $71.50)

• In May 2023, a firm named TRC Capital Investment Corporation issued a tender offer for 2,000,000 shares in CTLT at a 10% discount to its then share price. CTLT put out a press release (Link), advising investors against the tender offer. It is unclear to me what the motivation behind the tender-offer move was, though, as it accounted for only 1% of all shares outstanding (CTLT share price then: $47.75).

Elliott deal, avoidance of proxy fight and announcement of strategic alternatives

The Wall Street Journal (Link) first reported that activist investor Elliott Investment Management had taken a “significant” stake in Catalent and was pushing for a shake-up of the company’s board on July 19. The activist was said to have spoken to potential director candidates about joining a slate of nominees to run in a proxy contest.

A month later, on August 29, news hit that there had been a “settlement” between Catalent and Elliott, a proxy contest avoided and that they were implementing a number of changes after pressure from thee activist:

• According to a press release by the company, Catalent will add four new directors to its board. Three of them pharma industry executives and one senior Elliott executive. Two of the four new directors were picked by Elliott and the other two were mutually agreed upon by Catalent and the activist.

• The company will add John Greisch, who has served on the board since 2018, as executive chairman. Greisch will also be heading a new internal committee that will be tasked with exploring all strategic options for the business.

It is interesting to note that Elliott pushed for such a role and a potential sign that they are serious about taking action on a potential shareholder value-enhancing step.

Observers have also noted that it was unusual for Elliott to put one of its employees onto a board and that the move signals to investors how committed the firm is in helping guide management to fix mistakes and unlock value for shareholders.

The new board members that will be joining the board of Catalent include Elliott's own global head of engagement, Steven Barg, a former Goldman Sachs banker, along with former Pfizer chief financial officer Frank D'Amelio, former Genzyme executive Stephanie Okey and Michelle Ryan, a former Johnson & Johnson executive.

Recent performance of activist stakes by Elliott

The “2023 class” of activist investments by Elliott has resulted in attractive value for the activist and tag-along shareholders (total return from day after news outlets reported a new stake (‘)/initiation of strategic review (*)) up until August 30, 2023:

• Salesforce’ (NYSE:CRM) – January 23, 2023 – 35.7% return (Link)

• Dai Nippon Printing’ (TYO:7912) – January 24, 2023 – 30.3% total return – (Link)

• Constellation Brands’ (NYSE:STZ) – July 20, 2023 – -2.63% total return (Link)

• Syneos Healthcare* (NYSE:SYNH) – February 27, 2023 – 5.8% total return (Link)

Particularly interesting in this list of 2023 engagements by the activist is the case of Syneos Healthcare (NSQD:SYNH). Syneos is in the process of being taken private by a consortium led by Elliott (Link). Syneos is not a contract manufacturer compared to Catalent, but rather a contract researcher. Although their business models and commercial focus are slightly different, both types of companies essentially play in similarly connected arenas. Rumors on a potential sale hit the wires in February and the official announcement of the transaction came through on May 10, 2023.

Elliott operates a private equity arm alongside its public activist hedge fund, named Evergreen Coast Capital. The group around the Syneos take-private includes Evergreen, former KKR & Co. dealmaker Jim Momtazee’s Patient Square Capital and buyout firm Veritas Capital.

Syneos will be taken out at a valuation of $43/share, down 58% from its all-time high in December 2021. Shares in Catalent, even after accounting for the increase in share price after news of the Elliott deal hit 65% lower than its all-time high in September 2021.

It is quite interesting that Elliott must have built their stake in Catalent after they had agreed to pursue the take-private transaction of Syneos. Some scenarios here:

• They simply like this line of business following their extensive DD during the deal for Syneos (which of course has a slightly different business model being a CRO), and as valuations have retracted so much compared to 2021/2022.

• The activist likely has deep understanding by now of the sector and sees it can add significant value to the operations of Catalent that have undergone severe production mishaps recently.

• They are already exploring a sale of the company or a take private with an expedited timetable.

Valuation & Conclusion

Super quick and dirty valuation shows that Catalent has quite some room to run should it return somewhere close to its pre-problems EPS which were in the region of $3.00/share and have since come down to just $1.00.

In the CDMO space, there are a number of listed companies trading in Switzerland, the US, China and South Korea.

All listed firms command significantly higher multiples compared to a pre-production problem Catalent with multiples ranging between 21.3x to 59.3x NTM EPS estimates.

(EPS NTM for CTLT normalized at $3.00 to illustrate potential re-rate)

Without going into too much detail here on the nuances of the valuations, I do see that should Catalent be able to get its production related problems under control and be able to produce EPS in the $3 region again, a modest multiple of 23-25x EPS could result in a per share valuation of the firm between $69 and $75 or an implied upside of 40-50%. Extra kick (timewise) could come out of a take-private or sale of the firm following the strategic review.