SAN FRANCISCO--()--Voce Capital Management LLC (“Voce”) announced today that it has sent a letter to the Board of Directors of Obagi Medical Products, Inc. (“Obagi”) (Nasdaq:OMPI) criticizing the Board’s recent adoption of a poison pill and demanding immediate action to address corporate governance deficiencies and to evaluate strategic alternatives.
“guard against abusive tactics to gain control of the Company”
Voce’s letter states that it believes Obagi has spurned recent overtures to acquire the Company, and further cites pervasive corporate governance deficiencies that explain the Board’s unwillingness to consider those proposals. Voce also expresses concern over the Board’s recent decision to adopt a poison pill, citing it as further evidence of the Board’s entrenchment.
In the letter to the Board, Voce’s Managing Partner, J. Daniel Plants, said “We have grown increasingly concerned by the Company’s lack of progress in broadening its product portfolio and expanding its reach. In our view Obagi would be much more valuable in the hands of a larger and more skilled operator, and indeed we believe that interested strategic parties have approached the Company only to be consistently rebuffed by a Board unwilling to even entertain discussion of an acquisition proposal.”
Mr. Plants went on to state in the letter:
“To date, we have enjoyed regular and candid dialog with Obagi and have refrained from publicly questioning or criticizing its leadership. However, we believe the Company’s deficient corporate governance is a key contributor to its refusal to consider acquisition offers it has received and explains the actions the Board has taken to entrench itself. While we would have preferred to continue these discussions in private, the Board’s decision to adopt a poison pill – two days before Christmas and in sight of the notice deadline for shareholder actions at the annual meeting – leads us to conclude that the Board’s interests have become so misaligned with those of the Obagi shareholders that public disclosure of these matters is not only warranted but required.”
Voce’s letter also questions the Obagi Board’s independence, particularly the undue influence of Stonington Partners and the absence of meaningful stock ownership by directors. “The Board appears to be preeminently interested in its self-perpetuation and the maintenance of its insular and clubby nature.”
Specifically, Voce calls upon the Board of Obagi to immediately:
- commence a review of the Company’s strategic alternatives, including good faith consideration of the strong strategic interest in acquiring the Company;
- overhaul the Obagi Board, including the removal of Directors Fitzgibbons and Bartholdson and their replacement with proper independent shareholder representation; and
- commit that it will put the poison pill to a vote at the 2012 annual meeting, and that it will not adopt another poison pill or any other anti-takeover device should the shareholders not ratify the pill at that time.
About Voce Capital Management
Voce Capital Management LLC is an employee-owned investment manager and the adviser to Voce Catalyst Partners LP (the “Fund”). The Fund is a long/short equity investment partnership which invests in small capitalization companies.
The full text of Voce’s letter follows.
February 10, 2012
Members of the Board of Directors
Obagi Medical Products, Inc.
3760 Kilroy Airport Way, Suite 500
Long Beach, CA 90806
Attention: Corporate Secretary
Voce Capital Management LLC (“VCM”) is the investment advisor to Voce Catalyst Partners LP (“VCP” and, together with VCM, “Voce”). VCP has been a shareholder of Obagi Medical Products, Inc. (“Obagi” or the “Company”) continuously since June 2, 2011. We write in response to the decision by the Obagi Board of Directors (the “Board”) on December 23, 2011 to adopt a “Preferred Share Purchase Rights Plan”, more commonly known as a “poison pill”.
We have grown increasingly concerned by the Company’s lack of progress in broadening its product portfolio and expanding its reach. In our view Obagi would be much more valuable in the hands of a larger and more skilled operator, and indeed we believe that interested strategic parties have approached the Company only to be consistently rebuffed by a Board unwilling to even entertain discussion of an acquisition proposal.
To date, we have enjoyed regular and candid dialog with Obagi and have refrained from publicly questioning or criticizing its leadership. However, we believe the Company’s deficient corporate governance is a key contributor to its refusal to consider acquisition offers it has received and explains the actions the Board has taken to entrench itself. While we would have preferred to continue these discussions in private, the Board’s decision to adopt a poison pill – two days before Christmas and in sight of the notice deadline for shareholder actions at the annual meeting – leads us to conclude that the Board’s interests have become so misaligned with those of the Obagi shareholders that public disclosure of these matters is not only warranted but required.
* * *
Since its founding in 1988, Obagi has built a distinctive franchise. Its flagship Nu-derm® product line is universally acclaimed, and the Obagi brand commands loyalty from consumers and doctors alike. Obagi has an extremely valuable physician distribution network and a recurring revenue stream with no reimbursement risk. As a result, Obagi enjoys premium margins and cash flows.
Obagi has not, however, been able to grow beyond its original success with meaningful new products, nor has it adequately monetized its distribution platform. Despite repeated attempts, it has stumbled in efforts to develop new applications and treatments. After years of discussion about potential international opportunities, non-US revenues still comprise only about 16% of the Company’s net sales. And we’ve seen little traction in terms of in-licensing or acquiring complementary products that could be sold through Obagi’s network.
Obagi has not posted double digit revenue growth since 2007, and it is expected to grow only 2% for 2011. While not an abject failure, these results are hardly cause for celebration given all of the time and capital that has been invested in trying to grow the Company. We believe the investment community broadly shares these concerns.
There is no sign that the appointment of Mr. Hummel as CEO has changed any of this. Perhaps owing to his experience as a “big pharma” executive, Mr. Hummel initially talked about rejuvenating the Company’s research pipeline. On the last quarterly call, however, he shifted the Company’s strategic focus to a new plan to launch a nationwide internet pharmacy. This latest idea was short on details and presumably would be expensive, complex and time consuming to implement.
And yet Obagi’s key strengths – its core product line, brand equity, unique distribution and sound business model – are undoubtedly attractive to strategic acquirers which are better positioned to monetize these assets. We believe Obagi would field significant strategic interest from potential buyers in the following industries: pharmaceutical (aesthetic, specialty and integrated categories alike); aesthetic energy (lasers); beauty and cosmetics; and health and wellness. Many of these players are much larger than Obagi and would pay a significant premium to control this unique property. Moreover, while the strategic rationales differ by category and by individual acquirer, there are significant cost and revenue synergy opportunities. Based on our analysis a purchase price well in excess of Obagi’s 52-week high is not only achievable but is the likely outcome in the event of a transaction.
Indeed, we believe that potential acquirers have recently approached Obagi only to be rebuffed by the Company. In our view, the Board’s fiduciary duties require it to consider in good faith any serious interest in acquiring the Company, and it appears that the Board has abdicated its responsibility here. The Board is so adamantly opposed to a sale that it apparently ousted the previous CEO (Mr. Hummel’s predecessor) over his advocacy of a sale of the Company.
We believe the only credible alternative for the Board at this juncture is to undertake a legitimate review of the Company’s strategic alternatives, with the advice of reputable legal and financial advisors. If the Board truly believes that its own strategic plans will create the highest value for shareholders then those plans can be evaluated and quantified and compared against the results of a thorough process. A competitive process will also likely elicit more and better offers than those received to date, as some parties (particularly larger acquirers) will only invest the time in a potential transaction if it appears that a deal is a legitimate possibility.
* * *
We are also compelled to take issue with the lax corporate governance at Obagi. How can a company that derives the overwhelming majority of its revenues selling pharmaceutical products to women through the physician channel not have a single female or doctor on its Board? Or at least someone with executive experience in beauty or cosmetics? Moreover, while the Company touts its efforts to cultivate a trendier image through viral marketing and social media, and talks of its plans to broaden its appeal to younger consumers, the average age of the men on the Board is over 60 years old.
The Board’s hiring of Mr. Hummel as CEO – himself a director at the time of his appointment – is also troubling. Mr. Hummel is concurrently the chief executive of another company, Cobrek Pharmaceuticals, Inc. (“Cobrek”), based in suburban Chicago. How can the CEO of a public company also be the CEO of another company in another city at the same time? Moreover, since Mr. Hummel has taken over as CEO of Obagi the Company has begun making payments to Cobrek for unspecified “consulting” services. While the Company has previously responded to us that these matters have all been disclosed in public filings, their disclosure does not clear their unseemly air let alone make them appropriate actions for a publicly-traded corporation.
But the most glaring governance deficiency is that the management and Board of Obagi own almost none of its common stock. Collectively, the six members of the Board (including Mr. Hummel) own less than 1% of the Company’s common stock. To our knowledge, none of the directors have ever purchased a single share of Obagi stock in the open market, including when it touched multi-year lows in 2009 and including when the Board thought the stock was a compelling enough value that it authorized the Company to repurchase shares.
This lack of alignment with shareholder interests is succinctly illustrated by the continued Board membership of Messrs. Fitzgibbons and Bartholdson. These gentlemen are both executives of Stonington Partners (“Stonington”), a leveraged buyout firm. They, along with Mr. Hummel, obtained their Board seats after the acquisition of Obagi by Stonington but prior to its IPO. While it is not uncommon for a financial sponsor to retain board representation following an IPO if it continues to hold a significant ownership position, Stonington sold all of its remaining Obagi shares (primarily back to the Company) in 2010. To permit these gentlemen to retain their seats after the disposition of all but a token amount of their ownership suggests that their actions are primarily motivated by a desire to retain the prestige and perquisites of sitting on a public Board.
In addition to the direct connection between Messrs. Fitzgibbons and Bartholdson – who remain business partners at Stonington and have worked together for many years – the Stonington reach in this boardroom extends even further. All of the “independent” Obagi directors have sat together on the boards of other Stonington portfolio companies. Messrs. Fitzgibbons, Badie and Grant all served together on the board of Merisel Inc., a Stonington investment. Messrs. Fitzgibbons and Duerden were members of the Dictaphone board, another Stonington portfolio company, where Mr. Duerden also served as the CEO – effectively making him a Stonington employee at the time. This same group of “independent” directors constituted Obagi’s Board at the time Obagi repurchased Stonington’s shares in 2010.
Far from being an academic exercise in good corporate housekeeping, these governance failures are at the heart of what precludes serious consideration of the Company’s strategic alternatives. Quite simply, the Board appears to be preeminently interested in its self-perpetuation and the maintenance of its insular and clubby nature. This misalignment has prevented a frank assessment of the likelihood that the Company’s best option to create shareholder value is to sell itself to a larger and more skilled operator. We believe this explains the Board’s hostility to any proposals to acquire Obagi and its ongoing efforts to entrench itself through actions such as appointing one of its own in Mr. Hummel as CEO and the adoption of a poison pill.
Unfortunately, this list of Obagi’s governance deficiencies is not exhaustive. While there are many other steps the Board should take to strengthen itself, at a minimum we call upon the Obagi Board to immediately remove Messrs. Fitzgibbons and Bartholdson and replace them with independent directors whose ownership of common stock in the Company aligns their interests with the broader Obagi shareholder base.
* * *
Finally, we return to what prompted this letter. While the preceding list of operating and governance issues had concerned us, the Company’s recent adoption of a poison pill left us with no choice but to come forward. The decision by this Board – with its rank governance failures and misplaced priorities – at this time, while it apparently refuses to even consider offers that might create meaningful shareholder value – is unacceptable.
It also bears repeating that Company decided to implement the Obagi poison pill on December 23 – while the majority of the investing world and press were already home for the holidays. It did not issue a press release nor reflect it on the investor relations page of its website. It chose to mail notice of this action to its shareholders on January 10, 2012 – just a short time before the deadline for the submission of shareholder proposals and nomination of director candidates for the 2012 annual meeting.
It is clear from the circumstances surrounding the enactment of the Obagi poison pill that it is not, as Mr. Hummel claimed in his transmittal letter to shareholders, designed to “guard against abusive tactics to gain control of the Company” nor to prevent “unfair treatment by an acquirer”. Likewise, it is disingenuous for Mr. Hummel to defend the poison pill as “intended to encourage anyone seeking to control or acquire the Company to negotiate with the Board”, when we believe the Board steadfastly refuses to engage in such negotiations with anyone who approaches it and has spurned all such overtures. In this context, the adoption of the poison pill appears to be a desperate move by the Board to send a signal that Obagi is not for sale at any price and to stifle further acquisition interest.
We call upon the Board to commit irrevocably to bring the poison pill to a shareholder vote at the 2012 annual shareholders’ meeting, and further commit not to adopt another poison pill nor institute any other anti-take-over devices if the shareholders do not ratify the poison pill at that time.
* * *
As stated at the outset, Voce’s bias would have been to continue expressing our concerns to Obagi outside of public view. However, the Board’s decision to institute a poison pill at this time and in this manner has convinced us that a public airing of these serious issues is necessary. Furthermore, while we invite the Board’s response to what we have written and would welcome the opportunity to meet to amplify our concerns, our objective is to see that the three demands set forth herein are immediately met.
To repeat, we call for:
- the commencement of a review of the Company’s strategic alternatives, including good faith consideration of what we believe to be strong strategic interest in acquiring the Company;
- the complete overhaul of the Obagi Board, including the immediate removal of Messrs. Fitzgibbons and Bartholdson and their replacement with proper independent shareholder representation; and
- the Board’s irrevocable commitment that it will put the poison pill to a vote at the 2012 annual meeting, and that it will adopt another poison pill or any other anti-takeover device should the shareholders not ratify the pill at that time.
If these actions are not taken, we reserve the right to take any and all steps that we believe will unlock value for Obagi’s shareholders.
VOCE CAPITAL MANAGEMENT LLC
By: /s/ J. Daniel Plants
J. Daniel Plants