Who will blink first to prevent UDG Healthcare deal flatlining?

It seemed that UDG Healthcare would be just another Irish company to exit the market with barely a whimper, when the group revealed four weeks ago that US private equity giant Clayton, Dubilier & Rice (CD&R) had agreed to buy it for £2.6 billion (€3 billion).

Some observers even questioned why it had taken so long for the New York firm to come knocking, given that the man it hired as an adviser in early 2017 to sniff out healthcare investments was UDG’s former chief executive, Liam FitzGerald.

FitzGerald transformed the company formerly known as United Drug from an Irish-focused pharma distribution business into an international healthcare services group during his time at the helm between 2000 to 2016.

Services

UDG's main unit, Ashfield, which provides major drugmakers with outsourced services such as sales reps and healthcare communications, may have been acquired by UDG months before FitzGerald became CEO in late 2000 for €21 million, the company's biggest acquisition at the time. But FitzGerald was the driving force behind its follow-on expansion through a number of deals.

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He opened up another avenue for growth in 2008 when UDG bought US pharmaceutical packaging group Sharp for the equivalent of €62 million.

And FitzGerald negotiated the sale of the group's low-margin Irish wholesale business – a legacy of its foundation in 1948 as a pharmacists' co-operative in Ballina, Co Mayo – in his final months at the helm as part of a €407.5 million deal. It allowed his successor, Brendan McAtamney, to keep the chequebook open to buy further businesses to fold into its two units.

The scale of the business may have grown under McAtamney, with earnings before interest, tax, depreciation and amortisation (ebitda) rising by two-thirds. But the broad strategy hasn’t changed.

UDG’s board should have suspected a year ago that CD&R might have the London-listed group in its sights when it acquired Huntsworth, a peer of Ashfield, and installed FitzGerald as its chairman. After all, UDG’s own investor presentations at the time were listing Huntsworth as a leading rival in what it considered a “fragmented market”.

It’s not clear when CD&R made its first approach. But UDG said in documents relating to the deal last week that it rejected an initial overture, forcing the private equity firm to come back with a further three proposals, before landing on the agreed price of £10.23 per share.

That marked a 21 per cent premium to UDG’s closing price the day before the announcement, and was 30 per cent above the average at which shares had been changing hands over the prior six months.

Closing price

It was also almost 7 per cent higher than UDG's all-time high closing price and valued the company at more than 17 times ebitda, which was described by analysts at Jefferies as "fair", Stifel as "strong", and Cantor Fitzgerald as "a very good price" given its 10-year stock market trading average has been less than 12 times.

That hasn't satisfied a number of major shareholders, including Allianz Global Investors and M&G Investments, who have decried the deal as undervaluing the company and rejected UDG chairman Shane Cooke's logic that it "secures the delivery of future value for shareholders in cash today".

US hedge fund Elliott Investment Management has also cropped up on the shareholder register with a 3.2 per cent stake, clearly looking to play the "bumpitrage" game of exerting pressure on CD&R to raise its offer at a time when the Covid-19 pandemic has made the healthcare sector one of the hottest areas for dealmaking.

Between them, the three investors own about 14.3 per cent of the stock. The private equity fund is seeking to push through the purchase via a so-called scheme of arrangement, which will require approval of 75 per cent of voting shareholders at an extraordinary general meeting on June 25th.

UDG shares spiked as high as £10.78 after the initial Allianz intervention three weeks ago and have continued to trade above the offer price. Vanguard, one of the world's largest investment companies and holding a stake of almost 4.7 per cent in UDG, has also been buying shares well above the offer price, suggesting it, too, sees room for CD&R to come back again one more time, with feeling.

Even the large investor that UDG originally had in the bag to support the deal can’t be counted on to the extent that was once hoped. Chicago-based Kabouter Management signed a letter of intent before the announcement that it planned to use its not-inconsiderable 5.5 per cent stake to vote in favour of the sale.

Temptation

However, Kabouter has since lowered its stake to 4.5 per cent, succumbing to the temptation to sell some of its holding into the active market.

Just two weeks out from the egm, something has to give. There are no signs of any rival bidders looking to wade in. It would be difficult for a public company to justify a higher buyout multiple, according to Cantor FitzGerald analyst Ian Hunter. And few in the private equity world would be able scrape out the synergies offered by a tie-up between Ashfield and Huntsworth.

If CD&R were to walk away, UDG’s shares could collapse to a little over £8.40, according to Jefferies.

Meanwhile, M&G, which has argued that there is a “material mismatch” between its opinion of UDG’s true value and what CD&R has on the table, has also been in the market in recent weeks – selling some of its shares at between £10.49 and £10.55.

Is that an indication of where activist shareholders would be prepared to back a deal? Or someone beginning to hedge their bets?