U.S. Securities and Exchange Commission
Washington, DC 20549
NOTICE OF EXEMPT SOLICITATION
1. Name of the Registrant: Charles River Laboratories International, Inc.
2. Name of person relying on exemption: JANA Partners LLC
3. Address of person relying on exemption: 767 Fifth Avenue, 8th Floor, New
York, New York 10153
4. Written materials. Attach written material required to be submitted
pursuant to Rule 14a-6(g)(1)
June 7, 2010
Mr. James C. Foster
Chairman, President and Chief Executive Officer
Charles River Laboratories International, Inc.
251 Ballardvale Street
Wilmington, Massachusetts 01887
VIA FACSIMILE AND OVERNIGHT DELIVERY
Mr. Foster,
JANA Partners LLC ("JANA", "we" or "us") beneficially owns more than 7% of
the outstanding shares of Charles River Laboratories International, Inc.
("Charles River" or the "Company") making us the Company's largest shareholder
based upon publicly available information. We acquired our position because we
believe Charles River is currently underappreciated by the market given its
dominant position in the highly defensive research models market, its attractive
valuation on a standalone basis, the expected cyclical recovery in preclinical
services and ongoing positive secular trends in pharmaceutical and biotech
outsourcing. We appreciated you and Dr. Ge Li, Chairman and CEO of WuXi
PharmaTech (Cayman) Inc. ("WuXi"), taking the time to meet with us last week to
discuss the Company's proposal to acquire WuXi. While we understand your stated
strategic rationale, we have serious doubts about the wisdom of pursuing this
transaction at this time. Even if the contemplated benefits can ultimately be
realized, we believe that the high cost, significant integration risks and
inopportune timing simply make the proposed acquisition the wrong path for
Charles River shareholders. For these reasons, we intend to vote against the
issuance of Company stock required to complete the proposed acquisition, and we
believe based on shareholder sentiment it is likely that a majority of the
Company's shareholders will do the same.
Despite WuXi's valuable assets and well-regarded chemistry operation, we
believe the proposed price, equal to approximately 16x estimated consensus 2010
EBITDA at announcement compared to approximately 8x for Charles River on the
trading day prior to the announcement, cannot be justified given WuXi's
declining margins and falling growth rates. WuXi's gross margins have declined
each year since 2003 and WuXi predicts its gross margin will fall again in
2010.(1) We believe these persistent margin declines are due to the
commoditization of WuXi's core discovery chemistry business, and evidence the
declining opportunity for labor arbitrage in China. WuXi's annual sales growth
rate also fell each year from 2006 through 2009, and the projected
reacceleration of future growth comes with significant added risk in the face of
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(1) Gross profit adjusted for amortization of intangibles.
growing competition in its core chemistry business and reliance on growth from
its fledgling toxicology business.
Despite such trends, the Company's recently filed proxy materials show that
the Company and its advisors relied upon what appear to be aggressive WuXi
standalone growth and margin assumptions in evaluating the contemplated
acquisition and in estimating that it would be neutral to earnings per share in
2011. In fact, analysts have pointed out that even WuXi's own 2010 guidance is
below the projections Charles River relied upon in formulating its offer. As
Jefferies & Co. analysts have noted, "We believe the credibility of the 2011 and
2012 estimates is low given that 2010 estimates are extremely aggressive
compared to [WuXi's] own guidance issued only three weeks ago."(2) Such
assumptions for WuXi are also well above consensus, and as Bank of America
Merrill Lynch analysts have pointed out would "require sustainable Lab services
growth and successful execution in two relatively early stage businesses
([toxicology] and manufacturing) while driving margin expansion in the face of
pricing pressure."(3)
The proposed acquisition would also pose significant integration risks
given the challenges of integrating a new business line located across the
globe. As Jefferies & Company analysts recently observed, "Investors must bet
against history to believe that [Charles River] can integrate [WuXi] without a
stumble, and at over 15x our 2010 EBITDA estimate, [Charles River's] bet is an
expensive one."(4) It is also important to note that to finance the proposed
transaction Charles River plans to assume significant additional leverage,
raising its total debt to EBITDA ratio to 3.3x, further eroding its margin for
error in integrating the two businesses. In addition, combining and integrating
a broad platform of discovery and preclinical services is a significant
distraction at a time when other public contract research organizations ("CROs")
have been lowering guidance and Charles Rivers' cyclically weak preclinical
business requires increased attention.
The timing of the proposed transaction is also highly inopportune for the
Company's shareholders. If this acquisition occurs now, WuXi shareholders would
walk away with a significantly larger portion of the pro forma entity than if
the proposed transaction occurred after the anticipated cyclical recovery when
Charles River shares should recover their value. While WuXi may benefit from
related cyclical trends as well, discovery services have not suffered declines
as severe as preclinical services like toxicology. In any case, as described
above Charles River has also already factored in aggressive WuXi growth
assumptions in its valuation. Finally with respect to timing, as disclosed in
the Company's proxy materials there appear to be no alternate buyers for WuXi,
which casts doubt not only on the premium value ascribed to WuXi but also on
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(2) "Putting on its Marketing Hat", David Windley, Timothy C. Evans, Andrew
Hilgenbrink, Ph.D.; Jefferies & Company, Inc., June 2, 2010.
(3) "Merger assumptions leave little room for error"; Eric Lo, Eric H. Chang,
Bank of America Merrill Lynch, June 2, 2010.
(4) "Putting on its Marketing Hat"; David Windley, Timothy C. Evans, Andrew
Hilgenbrink, Ph.D.; Jefferies & Company, Inc., June 2, 2010.
why this transaction is necessary now given that there is little risk of losing
WuXi to a competitive bidder.
Charles River's share price performance in recent years underscores the
danger for shareholders of inefficient capital allocation. Despite numerous
acquisitions and significant expenditures on new facilities (which in some cases
have been temporarily closed shortly after completion) over the years, the
Company has significantly and consistently underperformed peers.(5) For example,
in 2004 the Company acquired Inveresk Research Group ("Inveresk"), another large
transaction which like WuXi was hailed as a "transformational" acquisition and
was intended to provide a "broader strategic platform for growth."(6) However,
from the trading day before the Inveresk acquisition was announced until the
trading day before announcement of the proposed WuXi transaction, the Company's
shares declined approximately 19%, compared to an average increase of 108% for
its comparably-sized industry peers.(7) After failing to realize the goal of
combining early and late stage CRO services, the Company soon divested a
significant portion of the assets acquired in the Inveresk transaction and
incurred hundreds of millions of dollars in combined write-downs and losses.
While smaller tuck-in acquisitions have been more successful, as RW Baird
recently noted, "Past acquisitions haven't been [the Company's] strong point,
nor have the majority panned out across the industry."(8)
While we grasp the theory, we believe that in reality the promised
strategic benefits of the contemplated transaction are also far from certain
enough to justify the proposed price and timing. As one analyst has noted:
"We still see the valuation premium applied as aggressive and the rationale
for combination lacking enough supporting evidence to assuage all concerns.
We do believe that the combined entity will be competitively
differentiated, but we're unconvinced that it will be materially
competitively advantaged. We think China is an exciting market, and we
believe that a larger presence there is a long-term positive, yet we're
unsure of [Charles River's] ability to find synergies between
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(5) For the one, three and five year periods ending on the trading day prior to
the announcement of the WuXi acquisition, the Company's shares have returned
approximately 57%, (17)% and (17)%, respectively, compared to 106%, 8% and 110%,
respectively, on average for comparably-sized industry peers Covance Inc.,
Parexel International Corp., ICON plc and Pharmaceutical Product Development
Inc., and 46%, (12)% and 17%, respectively, for the S&P 500. All calculations
assume reinvestment of dividends.
(6) Charles River presentation prepared for joint conference call with Inveresk,
July 1, 2004.
(7) Such industry peers consist of Covance Inc., Parexel International Corp.,
ICON plc and Pharmaceutical Product Development Inc. The S&P 500 also
outperformed the Company, returning approximately 20%, during the same period.
All calculations assume reinvestment of dividends.
(8) Charles River Laboratories"; Eric W. Coldwell, Nicholas Juhle; Robert W.
Baird & Co., May 12, 2010. Analysts such as UBS Investment Research have
expressed similar doubts, noting that "given Charles River's mixed M&A track
record (especially the difficulties with the Inveresk acquisition) and the
complexity of the WuXi transaction as it relates to combining different business
models and corporate cultures, we believe the integration and execution risks
are above average." "A Closer Look at the WuXi Acquisition"; Derik de Bruin,
Ph.D., Daniel Arlas, Rafael Tejada; UBS Investment Research, May 13, 2010.
the eastern chemistry/manufacturing footprint of [WuXi] and its own western
biology business."(9)
More broadly, we believe that combining discovery chemistry and biology to
create revenue synergies is an untested proposition and may not mesh with how
customers currently purchase these services, which at least in some cases are
done on a decentralized basis. The Company relies upon a large global sales
force with multiple points of customer contact working within a highly regulated
framework, making the generation of sales synergies from a combination with
WuXi's sales force highly uncertain. It is also worth noting that WuXi is not an
unknown provider to pharmaceutical and biotech customers seeking to outsource
drug discovery, also casting uncertainty on whether significant revenue
synergies can be obtained by a combination. In addition, management's stated
intention to leave WuXi's ERP system in place for the foreseeable future (until
it can complete its own new ERP systems implementation), rather than rapidly
migrating them to the Company's own systems, will likely make sales synergies
more difficult to achieve as pricing a bundled offering will be more
challenging. Another concern with respect to the proposed strategy is that new
and existing customers may demand lower prices for a combined offering, meaning
that any potential revenue synergies could be eroded by deterioration in pricing
power on the larger components of the combined offering. Such pricing erosion
could be exacerbated by the divergent pricing models of Charles River and
WuXi.(10)
Simply put, we believe that there are much more promising and
straightforward means at present to create shareholder value than acquiring a
company with decelerating growth prospects and significant integration risks at
an expensive valuation using a large amount of the Company's undervalued stock.
For example, we note that the Company could employ the same multiple of leverage
to trailing EBITDA it would assume in a WuXi acquisition to repurchase
approximately 19% of its currently undervalued outstanding shares at a 10%
premium to the current Charles River share price, without any integration risk.
We believe that a share repurchase of this magnitude would result in accretion
to 2011 earnings per share of approximately 14%, and growing thereafter.(11)
Based on its history as a leveraged buyout, robust private equity activity in
the CRO space and recent published reports, we believe there could be
significant private equity interest in the Company, creating potentially
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(9) "Charles River Laboratories"; Eric W. Coldwell, Nicholas Juhle; Robert W.
Baird & Co., May 12, 2010."
(10) Bank of America Merrill Lynch for example has expressed concerns regarding
"potential cannibalization of sales from having a different pricing model in the
US/EU vs. Asia." "Merger assumptions leave little room for error"; Eric Lo, Eric
H. Chang; Bank of America Merrill Lynch, June 2, 2010.
(11) For purposes of our share repurchase analysis we have made the following
assumptions: 1) a share repurchase price of $36.26 (a 10% premium to Charles
River's June 4, 2010 closing price of $32.96); 2) 66.2 million shares
outstanding as of April 15, 2010 per Charles River's most recent 10-Q; 3)
standalone 2011 non-GAAP EPS of $2.70 based on Company guidance for pro forma
earnings and expected neutral impact to 2011 earnings from proposed WuXi
transaction; 4) total leverage of 3.3x trailing standalone EBITDA and a
borrowing cost of 4.5% (consistent with leverage level and borrowing rate of
proposed WuXi transaction); 5) termination fee of $25 million (pursuant to
acquisition agreement following Company shareholder rejection of the
transaction) paid out of excess cash with foregone interest of 1%; and 6) a tax
rate on incremental debt and foregone cash interest of 35%.
another means of realizing maximum shareholder value without significant
operating or integration risk.
Not surprisingly in light of these facts, many Charles River shareholders
have already expressed their displeasure with the proposed acquisition by
disposing of their stock, which contributed to a share price decline of almost
16% the day the proposed deal was announced. We believe that sentiment among a
significant percentage of current shareholders is also decidedly negative.(12)
If as appears likely the Company's shareholders reject the proposed WuXi
acquisition, we believe the Company is well-positioned for the future and has
several attractive options for pursuing future value creation for shareholders,
and we are prepared to assist management in exploring such options if we can be
of any assistance. In the meantime, we can be reached at (212) 455-0900 should
you wish to discuss any of these matters further.
Sincerely,
/s/ Barry Rosenstein
-------------------------
Barry Rosenstein
JANA Partners LLC
Managing Partner
BR/CP/SO/NM/SA
Quotation of analysts herein does not necessarily indicate that such analysts
support the views expressed herein.
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(12) For example, RW Baird noted that "we know that there is a large contingent
of shareholders unhappy with the valuation and strategy." "Charles River
Laboratories"; Eric W. Coldwell, Nicholas Juhle; Robert W. Baird & Co., May 12,
2010. Wells Fargo reported that, "We fielded multiple calls from investors
regarding the deal, and most of them expressed a general disdain." "CRL: Final
Thoughts on Q1 2010 And WX Deal"; Greg T. Bolan, Eric Hebert; Wells Fargo
Securities, April 26, 2010.