- Valtech acquisition significantly
dilutes shareholders and adds unnecessary long-term business
risks
- Management can materially increase the
value of HeartWare by exclusively focusing on the attractive LVAD
market
- Failure to terminate the proposed
acquisition will leave shareholders with no choice but to campaign
against the approval of the Valtech acquisition and seek board
representation
Engaged Capital, an investment firm specializing in enhancing
the value of small and mid-cap North American equities, today sent
a letter to the Board of Directors (the “Board) of HeartWare
International, Inc. (“HTWR” or the “Company”) (NASDAQ:HTWR).
The full text of the letter follows:
October 5, 2015
Board of Directors HeartWare International, Inc. 500 Old
Connecticut Path Framingham, MA 01701
Ladies and Gentlemen:
Engaged Capital, LLC (together with its affiliates, “Engaged
Capital”) has recently become a top 20 shareholder of HeartWare
International, Inc. (“HTWR” or the “Company”). We established our
investment in HTWR following the Company’s recent announcement of
its intention to acquire Valtech Cardio, Ltd. (“Valtech”) – an
announcement that drove an immediate 20% decline in HTWR shares.
While we were able to establish our ownership position at prices
that we believe significantly undervalue the Company, HTWR’s
long-term investors have not been so fortunate.
Total Return Performance
1 yr 2 yr
3 yr 5 yr
HTWR (30 %) (25 %) (44
%) (19 %) Proxy Peer Group 36 % 41 % 68 % 173
% S&P 1500 Health Care 8 % 35 % 74 % 144 % S&P 1500 Health
Care Equipment 12 % 35 % 56 % 104 %
HTWR Relative
Returns vs:
Proxy Peer Group (67 %) (66 %) (112 %) (192 %) S&P 1500 Health
Care (39 %) (60 %) (118 %) (163 %) S&P 1500 Health Care
Equipment (43 %) (60 %) (100 %)
(123 %)
Source: FactSet as of October 2, 2015. The
Proxy Peer Group is from HTWR’s 2015 proxy statement.Proxy Peer
Group performance is based on an equal-weighted average
calculation.
HTWR shareholders have suffered through years of disappointing
returns. For numerous reasons, we believe the Valtech deal, if
consummated, portends a continuation of HTWR’s underperformance. We
urge the Board to walk away from this highly-dilutive, highly-risky
acquisition and return the Company’s focus to the core left
ventricular assist device (“LVAD”) business.
Further, the Board should be under no illusion that HTWR’s
destiny is anything other than an eventual sale to a larger medical
device company. There is no credible standalone plan that, on a
risk-adjusted basis, will generate as much value as a sale to a
strategic acquirer. The recent acquisition of the Company’s only
competitor and the significant interest shown in the asset validate
our assertion. However, the decision to approve the acquisition of
Valtech leaves us concerned that the Board does not understand, or
worse yet, is actively attempting to thwart, this inevitable
outcome.
The LVAD Market Is Attractive
We established our ownership position in the Company because we
agree with management’s thesis that the LVAD market is highly
attractive. This fact is plainly evident as LVADs address a
significant unmet need, receive strong reimbursement rates, and
target a massively underpenetrated patient population. As next
generation devices continue to improve clinical outcomes, reduce
adverse events, and possess ever-shrinking form factors, the
addressable market will expand tremendously; driving a sustained
period of what we believe will be double-digit growth for all
participants in the LVAD market.
Within the LVAD market, HTWR’s position is strong. HTWR’s
flagship device, HVAD, has taken significant market share following
its approval in the EU in 2009 and the U.S. in 2012. In fact, as of
the most recent quarter, HTWR holds 33% market share in the U.S.
and 60% market share in the international market. What makes these
market share gains even more impressive is that in the U.S., HVAD
has yet to be approved for use in heart failure patients eligible
for destination therapy (“DT”) – an addressable patient population
that is at least 15x the size of the bridge-to-transplant
population. HTWR should gain additional market share over time as
HVAD is approved for use in DT patients in the U.S. and HTWR’s next
generation device, MVAD, progresses towards approval.
Finally, the LVAD market is, and will be, a duopoly market
between HTWR and Thoratec for the foreseeable future. Unlike other
medical device markets, the barriers to entry are numerous and
significant. Between design challenges, clinical trial hurdles, and
the significant cost associated with each, we believe it would take
at least 10 years and hundreds of millions of dollars of investment
for another company to even attempt to enter the LVAD market – with
no guarantee of having an approvable device at the end of the
process.
The Valtech Acquisition Distracts from the Core
Business
Given the attractiveness of the core LVAD market and HTWR’s
position therein, we are puzzled by the Board’s decision to pursue
an acquisition of Valtech. Often when companies pursue
transformational acquisitions it is a reflection of a lack of
confidence in the acquirer’s core business. However, management has
repeatedly asserted post-announcement that their confidence in both
the core business and HTWR’s next generation device, the MVAD, has
never been higher. Additionally, HTWR and Thoratec’s most recent
quarterly results depicted a significant acceleration in the LVAD
market both in the U.S. and abroad. This fact set makes the
rationale for acquiring Valtech even more confounding.
Not only is Valtech an expensive and risky acquisition on a
standalone basis, but the risk Valtech presents is further
compounded by the numerous critical initiatives currently in
process at the Company. Management’s efforts to execute on the MVAD
clinical trials, improve regulatory compliance, and defend market
share all require management’s undivided attention. If consummated,
the Valtech acquisition will do nothing but compound these risks and add new risks of its own, including integration
risk and enormous clinical development risk. We are dumbfounded
that the Board would consider now to be the appropriate time for
HTWR to pursue a “bet the company” acquisition.
The Valtech Acquisition Dilutes Shareholders and Drains
Cash
Management stated that one of the reasons HTWR had to acquire
Valtech now was that HTWR’s “exclusivity period” was on the verge
of expiring in mid-September. This rationale is flawed for the
simple fact that Valtech needed only to wait two weeks to formally consider any competing
offers for the business. Like any option, the value of HTWR’s
exclusive agreement with Valtech declines to zero as the expiration
date approaches. With only two weeks remaining, the value of HTWR’s
exclusive option to acquire Valtech was essentially zero at the
time of the announcement. Additionally, if we take HTWR management
at their word that Valtech was receiving significant inbound
interest from other potential acquirers, it follows that HTWR may
have had to overpay for the asset in order to convince Valtech to
forego the option value of running a full auction process for the
company.
Indeed, Valtech was able to extract a huge upfront sum from
HTWR. The upfront equity dilution to HTWR shareholders from the
Valtech acquisition is ~30% - equivalent to $425 million based on
the closing price of HTWR prior to the announcement. Additional
milestones and equity warrants have the potential to more than double the total cost of the transaction
over time.
The cost of the Valtech transaction goes far beyond the purchase
price. In order to bring Valtech’s products to market, HTWR must
invest significant amounts of cash into added R&D expenses. By
management’s own admission, Valtech will increase HTWR’s operating
losses by $30 to $40 million annually over the next two years. This
is on top of HTWR’s already significant R&D expense of $120
million over the last twelve months – a sum
which represents a staggering 42% of revenue and is $10M greater
than HTWR’s main competitor, Thoratec, spent in R&D over the
same period, despite the fact that Thoratec generated 70% more
revenue than HTWR.
This cash drain only compounds the risk Valtech presents to HTWR
shareholders. Not only will Valtech take management’s focus away
from the core LVAD business at a critical juncture, the added
R&D burden will compete for HTWR’s limited cash resources. In a
worst case scenario, Valtech-related spending siphons needed cash
from the core LVAD business and increases the risk that HTWR must
raise capital at unfavorable rates.
Valtech Adds Significant and Novel Long-term Risks
Despite the large purchase price, Valtech is a collection of
unproven assets. While Valtech’s valve repair and replacement
assets may have the potential to generate significant revenues,
these assets will have to clear numerous clinical and regulatory
hurdles before providing any meaningful revenue. In fact, a
significant portion of the expected long-term revenue from Valtech
is from products that have yet to be fully designed, let alone validated in the
clinic. The enormous upfront dilution borne by HTWR shareholders is
completely incongruous with the colossal risk associated with
achieving management’s starry-eyed forecast for Valtech’s products.
It is entirely possible that shareholders will bear dilution in
excess of 30% for an acquisition that never generates any material
revenue for the Company.
The seriousness of this risk can be seen in HTWR’s own limited
M&A track record. HTWR’s only acquisition of any significance,
Circulite’s SYNERGY pump, has experienced numerous delays and
design changes despite management’s assurance at the time of the
acquisition that it was a “straightforward logical fix” to make the
design change necessary to bring the SYNERGY pump back into the
clinic. Now, nearly two years post-acquisition, there is still no
timeline for returning SYNERGY to the market. Management’s failure
to execute upon the Circulite acquisition, a far smaller and less
complex asset than Valtech, gives us no confidence that
management’s assessment of the clinical and commercial timelines
for Valtech will be achieved.
From a strategic standpoint, the Valtech acquisition represents
a “poison pill” for many of the logical strategic acquirers of
HTWR. Abbott Laboratories, Edwards Lifesciences and Medtronic have
each recently acquired mitral valve replacement companies that will
directly compete with Valtech’s valve replacement assets. These
companies – all of which are logical acquirers of HTWR – would
assign little to no value to these duplicative assets for which
HTWR is paying hundreds of millions of dollars.
Additionally, these potential competitors all have significantly
more resources and expertise than HTWR. Even if HTWR is successful
in bringing Valtech’s valve replacement assets to market, HTWR
would likely be the fourth or fifth market entrant competing with
some of the largest medical device companies in the world;
companies with sales and R&D budgets many times that of HTWR.
This is in stark contrast to the core LVAD market, where HTWR has
competed in a virtual duopoly with a similarly-sized peer.
Shareholders Have Effectively Already Voted “No”
We cannot recall any acquisition announcement in the healthcare
industry that drove a more negative stock reaction than the Valtech
announcement. On Sept 2nd (the day following the Valtech
announcement) HTWR’s market capitalization declined by 20%, or
nearly $300 million on an absolute basis. Since then, HTWR shares
have continued to decline and the total loss in market
capitalization since the announcement now stands at 34%, or a
staggering $479 million. The market has already shown the Board
that acquiring Valtech makes HTWR a significantly less attractive
asset for investors. We are confident that there is hardly a
shareholder who owns HTWR for any reason other than their
conviction in the long-term growth potential of the LVAD market. By
acquiring Valtech, the Company is diluting HTWR shareholders’
exposure to the very market they likely desired to invest in when
they purchased HTWR shares. Rather than waste management time and
shareholder capital attempting to defend an indefensible
acquisition, the Board should move immediately to terminate the
proposed transaction.
HTWR is a Desirable Asset
Our conviction in the attractiveness in the
LVAD market is validated by St. Jude’s recent announcement of its
intention to acquire Thoratec, HTWR’s only real competitor.
Additionally, Thoratec’s recent SEC filings describing the sale
process indicate there were multiple parties who evaluated a
competing bid for Thoratec during the go-shop period. Our research
and discussions with industry participants (bankers, executives,
analysts, and shareholders) leads us to the conclusion that these
same parties would aggressively compete for HTWR should the Board
decide to pursue a sale – especially considering HTWR’s superior
growth rate and the duopolistic structure of the LVAD industry. If
any potential acquirer wants a place in the LVAD market, HTWR is
truly the last seat at the table.
EV / Sales Multiples THOR
2014 2015E 2016E 2017E 2018E
'15-'18 CAGR 2015E 2016E 2017E Revenue $478
$504 $546 $602 $606
6.3% 6.8x 6.2x 5.7x Growth
(5%) 5% 8% 10% 1%
HTWR 2014 2015E
2016E 2017E 2018E '15-'18 CAGR 2015E
2016E 2017E Revenue $278 $282 $317 $377 $456
17.4%
3.2x 2.9x 2.4x Growth 34% 1% 12% 19% 21%
Source: FactSet consensus estimates as of October 2, 2015.
If HTWR were to receive THOR’s valuation of 6.2x estimated 2016
revenues in a transaction, HTWR shareholders would receive $105 per
share, a premium of 94% to HTWR’s current trading value. Further,
HTWR’s superior projected growth rate would support a premium
multiple to Thoratec in a transaction.
While we are wholeheartedly opposed to the Valtech acquisition,
we agree with management’s vision that an integrated heart failure
company can create significant value for patients and shareholders
alike. However, the correct way – the value-creating way – to create such an
organization would be through selling HTWR to an acquirer who
already owns a portfolio of heart failure assets and the
infrastructure to leverage them, not by building such a company
independently through a high-risk, prohibitively expensive
acquisition strategy.
The Board Must Heed Shareholders
Management recently stated that “we love building this business
and fully intend to continue building this business well into the
future… we now have the capabilities to carry this company forward
independently, really indefinitely.” We are compelled to remind the
Board and management that a company’s independence is not a right;
independence must be earned through sustained, consistent value
creation. Despite HTWR’s strong position in a duopoly market,
HTWR’s lack of value creation calls into question the Company’s
ability to generate returns for shareholders as an independent
entity. Further, the decision to pursue an acquisition of Valtech –
when the promise of the Company’s core LVAD assets has yet to be
realized – spawns credible doubt in the Board’s commitment to
upholding its fiduciary responsibilities.
We therefore call upon the Board to immediately terminate the
ill-conceived acquisition of Valtech. If the Board fails to do so,
shareholders will have no choice but to campaign vociferously
against the approval of the Valtech acquisition and seek board
representation to ensure the commitment in the boardroom to
maximizing shareholder value is paramount.
Sincerely yours, Glenn W. Welling Managing Member
About Engaged Capital:
Engaged Capital, LLC (“Engaged Capital”) was established in 2012
by a group of professionals with significant experience in activist
investing in North America and was seeded by Grosvenor Capital
Management, L.P., one of the oldest and largest global alternative
investment managers. Engaged Capital is a limited liability company
owned by its principals and formed to create long-term shareholder
value by bringing an owner’s perspective to the managements and
boards of undervalued public companies. Engaged Capital manages
both a long-only and long/short North American equity fund. Engaged
Capital’s efforts and resources are dedicated to a single
investment style, “Constructive Activism” with a focus on
delivering superior, long-term, risk-adjusted returns for
investors. Engaged Capital is based in Newport Beach,
California.
View source
version on businesswire.com: http://www.businesswire.com/news/home/20151005005564/en/
Investors:Engaged Capital, LLCGlenn W. Welling,
949-734-7900orMedia:Bayfield Strategy, Inc.Riyaz Lalani,
416-907-9365rlalani@bayfieldstrategy.com
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