Obagi: Over-Hyped Aquisition Target Or Worthy Investment? Print
By Scott Matusow, Contributor   
Thursday, 05 July 2012 01:58
icon_closerlookThere has been abundant buzz on a company whose shares have been rising steadily since February. Obagi Medical Products (NASDAQ:OMPI) shaw shares hit $16.03 last week as speculators took positions during the latest round of buy-out chatter

I was first alerted some months ago to this company as a potential buyout candidate and informed by sources that larger companies and pharmas were interested in acquiring the company. Lately, speculation of a buyout has become stronger based on the poison pill being voted down by shareholdersby over a 2 to 1 margin at the recent annual shareholders meeting.

As well, Voce Capital Management, a major shareholder of Obagi publicly revealed its opposition to the poison pill implemented by the Board of Directors of Obagi. But what if a buyout does not occur soon? Examining this company, I have really liked what I have found. For starters, the company has a tiny market cap for its stock price of around $15 a share, coming in at roughly $280M.

Obagi's products are hot to say the least - strongly catching on with many women; Obagi Nu-Derm® Systems, Obagi Condition & Enhance® Systems, and Obagi-C® Rx Systems just to name a few. Google these products and visit the Obagi website to cross reference the rest of the company's products.

Capitalizing on the social media and networking craze, Obagi also has its own Facebook page with over 64,000 'likes.'

Last quarter Obagi raked in record revenue:

Income Statement

Revenue :


Revenue Per Share :


Qtrly Revenue Growth (yoy):


Gross Profit :


Rather impressive for a company with a market cap of less than $250M which is looking at explosive market acceptance of its skin care products.

There has been chatter from writers on both sides about Obagi, and recently on the Yahoo news feed, an article upset longs because the author felt investors should be worried about a single factor when it comes to Obagi. Unfortunately, his take was short-sighted and arguably incorrect:

"A company ramping up for increased demand may increase raw materials and work-in-progress inventory at a faster rate when it expects robust future growth. As such, we might consider oversized growth in those categories to offer a clue to a brighter future, and a clue that most other investors will miss. We call it 'positive inventory divergence.'

"On the other hand, if we see a big increase in finished goods, that often means product isn't moving as well as expected, and it's time to hunker down with the filings and conference calls to find out why.

"Let's dig into the inventory specifics. On a trailing-12-month basis, finished goods inventory was the fastest-growing segment, up 48.6%. That can be a warning sign, so investors should check in with Obagi Medical Products' filings to make sure there's a good reason for packing the storeroom for this period. On a sequential-quarter basis, finished goods inventory was also the fastest-growing segment, up 33.3%. That's another warning sign."

The author made a general observation about Obagi's finished goods inventory on the rise, yet ignored the fact that last quarter, Obagi saw record revenues and profits, But the main factor that makes his observation on finished goods in Obagi's inventory completely null is this:

Obagi recently resolved regulatory issues related to Hydroquinone with Texas and resumed selling Rx drugs within that state.

This is likely why finished goods were up in inventory; Obagi has just started to resume sales of its products containing hydroquinone, which include their Nu-Derm®, Obagi-C® Rx, and ELASTIderm® brands. Therefore, an increase in finished goods was to be expected as these products were finished and waiting to be shipped to Texas.

Did the author take this key factor into consideration? With Obagi seeing record revenue and market acceptance, does it make sense that inventory is on the rise because as this author implies, demand is down across the board, or as mentioned prior, make more sense that Obagi had extra finished inventory on hand because it was backed up inventory that was originally slated to be delivered to Texas before the ban?

Also, Texas sales makes up for around 9% of Obagi sales, yet without Texas sales, the company was still able to rack in record revenues. Profit margins were down likely because of the cost of inventory having to be held in supply, instead of being delivered to retail stores in the state of Texas. I would think because these products are now allowed in Texas again, revenues and profits should shatter analysts' expectations from Q3.

Concerning Obagi being bought out soon, Obagi is a perfect company for acquisition by a larger player in this field- a player that has the money to effectively market these products worldwide. The right company can easily increase the above revenues 5 to 7 fold with correct capital flow committed to marketing. Personally, I think selling this company for $20 a share is way too low looking forward. I would prefer to see an infusion of investment capital to grow this company into a monster.

According to Investopia.com, in early March, rumors surfaced that Obagi was a takeover candidate because it introduced a rights plan to treat all shareholders equally should a third party attempt to obtain part or all of the company. The rumors died down, but now seems to have resurfaced. Analysts at Cantor Fitzgerald, Canaccord Genuity and Roth Capital all have "buy" ratings on its stock and word is the company is entertaining several offers including a $20-plus offer from a major cosmetics company.

I have been hearing that at least 2 larger players in the beauty and skin care segment have approached shareholders in Obagi about tendering their shares. Now that the poison pill has been voted down by the shareholders, and according to the buzz I have been hearing from various sources, a hostile buyout offer announcement could be forthcoming very soon between $19 and $23 a share.

Also of note, VOCE capital, who was the main opponent against the poison pill Obagi management instituted which was voted down by shareholders, has now stopped answering phone calls from investors inquiring as to what may be going on with a potential buy out offer for Obagi.

Often times larger companies seek to acquire smaller ones to add greater market penetration and value to their company. In one such recent case, AstraZeneca PLC (NYSE:AZN) bought Ardea Biosciences, Inc. (NASDAQ:RDEA) for $1.3 billion ($ 32 per share at 54% premium) mainly for its gout drug Lesinurad in phase III trials.

Also of note in the bio pharma segment, Arena Pharma (NASDAQ:ARNA) and Amarin Corp. (NASDAQ:AMRN) have been mentioned as possible acquisition targets of larger pharmas like Pfizer (NYSE:PFE) and Johnson and Johnson (NYSE:JNJ), so we can expect more consolidation to occur in the pharma segment before the year is up.

According to all the buzz and people I have been talking to, the following companies are all likely bidders for Obagi.

Avon Products Inc. (NYSE:AVP) In my opinion, would greatly benefit from acquiring Obagi as it would receive a very popular skin care line which it would be able to better utilize its $1.24B in cash, using its cash for a strong marketing campaign in order to gain greater market exposure of Obagi product lines, resulting in the company realizing substantial revenue and profit.

Avon has seen turbulent times lately, consistently underperforming for the past few years with revenues, net income, ROE, profit margins and EPS all decreasing over time.

Allergan Inc. (NYSE:AGN) may also have an interest in acquiring Obagi. Allergan discovers, develops, and commercializes specialty pharmaceutical, biologics, medical device, and over-the-counter products for the ophthalmic, neurological, medical aesthetics, medical dermatological, breast aesthetics, obesity intervention, urological and other specialty markets worldwide. Allergan offers a number of leading aesthetic types products, including: BOTOX® (onabotulinumtoxinA), RESTASIS® (cyclosporine ophthalmic emulsion) 0.05%, LUMIGAN® (bimatoprost ophthalmic solution) 0.01%, BOTOX® Cosmetic (onabotulinumtoxinA), the JUVÉDERM® family of dermal fillers, and the LAP-BAND® Adjustable Gastric Banding System.

Allergan may be interested in supplementing its already successful line of products with Obagi's ever growing-in-popularity products to add to its already huge market presence. Allergan has $2.64B in cash - more than enough to seamlessly acquire Obagi for $350M, or roughly $20 a share.

Cantor Fitzgerald analyst Irina Rivkind believes another possible candidate is Medicis Pharma (NYSE:MRX).

Medicis Pharma recently announced $450 million in new financing that COULD be used for M&A activity. Medicis may find the OMPI internet pharmacy initiative strategically interesting to further innovate its "alternative fulfillment" program and generate additional revenue in its acne franchise. Medicis is a specialty pharmaceutical company, engages in the development and marketing of various products for the treatment of dermatological and aesthetic conditions in the United States and Canada.

L'Oreal (OTC: LRLCY.PK) offers various consumer products, such as skin care, make-up, hair color, hair care, and styling products under the L'Oréal Paris, Le Club des Créateurs, Garnier, Maybelline New York, Softsheen Carson, and Essie brand names. L'Oreal could also benefit from acquiring Obagi.

Valeant Pharmaceuticals (NYSE: VRX) a leading developer, manufacturer, and marketer of pharmaceutical products in the areas of neurology, dermatology, and branded generics has also been reported to have interest in OMPI.

Whether or not Obagi gets acquired (and certainly there are many signs that it will be), we can see it is a growing company with products that are causing buzz among many women who want to look and feel their best. It's my opinion that investors should consider doing extensive due diligence here concerning all the factors mentioned here, and others which exist outside of this article.

I think those who do the due diligence will agree that Obagi is a strong buy, whether it is acquired soon or not.

Disclosure: I am long OMPI

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