FrontFour Capital Sends Letter To Innophos Holdings

Recommends Immediate Implementation of Action Plan to Improve Shareholder Value

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Oct 07, 2014, 08:15 ET

GREENWICH, Conn., Oct. 7, 2014 /PRNewswire/ -- FrontFour Capital Group LLC, a significant shareholder of Innophos Holdings, Inc. (NASDAQ: IPHS), announced today that it has delivered a letter to Innophos Holdings recommending that the Board of Directors take immediate action to implement a detailed action plan to improve shareholder value.

The full text of the letter follows.

October 7, 2014

Mr. Randolph Gress
Chairman of the Board and CEO
Innophos Holdings, Inc.
259 Prospect Plains Road, Building A
Cranbury, NJ 08512

cc: The Board of Directors, Innophos Holdings, Inc.

Dear Randy:

Thank you for meeting with us on August 14, 2014 at Innophos' headquarters. We appreciate the time you took to communicate to us your strategy and long-term goals for the Company in greater detail. However, we came away from the meeting highly concerned with the lack of clarity around your strategic path. Additionally, you offered no prescription for closing the significant valuation gap between Innophos' current share price versus comparable publicly traded specialty chemical companies with sizeable exposure to the food, beverage and pharmaceutical end markets. While you conceded that current industry M&A valuations are expensive, you expressed no willingness to potentially explore taking advantage of this dynamic by selling the Company at a significant premium. To the contrary, we left our meeting concerned that you may pursue an expensive, value destructive acquisition or similar transaction that would clearly not be in the best interests of all shareholders.

FrontFour Capital Group LLC is a significant Innophos shareholder with a current stake of approximately 3.3% of the outstanding shares. Our initial investment in Innophos was made based on our belief that management was focused on improving operational execution given past phosphate rock supply disruptions, as well as production issues at the Coatzacoalcos facility in Mexico. It was our expectation that this improved execution would lead to enhanced shareholder returns given Innophos' strong North American-centric franchise, duopoly-like market structure and robust-free cash flow generation. We continue to believe that there is a significant opportunity to improve operations, optimize the current capital structure and pursue strategic alternatives for the separation of the financial exposure within the Granular Triple Super Phosphate ("GTSP") segment and/or the Company in its entirety, given today's robust M&A activity and attractive multiples paid in the food ingredients space over the last 12 months. In light of management's past operational challenges, we question your ability to successfully pursue a transformative acquisition within the nutritional ingredients market, which is already challenging given the limited number of acquisition targets available, elevated valuation multiples and limited operational synergies that we mutually agreed would not accrue to the Company given its current lack of scale in that business segment.

We believe that Innophos' stock price does not reflect the true value of this dominant franchise. Innophos is a high free cash flow generative business with stable end markets and an over-capitalized balance sheet, which in our view should trade at a more fulsome valuation than its current ~8x 2015 estimated EBITDA. Current net leverage is less than 1.0x, which is significantly below historical leverage levels, and also below your own stated targeted range of 2x – 3x. As you are also aware, it is the strong free cash flow nature of this business that enabled it to successfully operate under significantly higher leverage levels and deleverage rapidly, following its 2004 LBO by Bain Capital.

Most alarming to us coming away from our meeting, aside from the points mentioned above, was your apparent lack of conviction and views on valuation and peer analysis when asked directly. In contrast, we believe there is a clear and executable path that will drive the long-term value of Innophos for all shareholders.

In order to set Innophos on the right path to create value for all shareholders, we outline below the following actions, which we recommend being taken immediately and which should not be considered mutually exclusive:

I. Pursue All Available Options to Reduce GTSP Exposure: GTSP has historically and continues to drive volatility in the Company's otherwise stable and predictable revenue streams. Additionally, GTSP also receives an inordinate amount of focus and attention from concerned investors on quarterly calls and at presentations despite its now negligible financial exposure to the Company. As a result, the segment drives a significant discount in Innophos' trading multiple versus peers, as investors resultantly assign a commodity/agricultural-like multiple to the Company. Immediate action is needed to pursue a transaction within GTSP by either converting it to a cost-plus offtake agreement or forming a joint-venture and selling a controlling interest in this co-product. We strongly believe that a successful separation of the GTSP exposure would catalyze a multiple re-rating in the stock.

II. Improve Financial Disclosures Regarding Capital Spending: The Company's disclosures regarding capital expenditures is poor and in need of improvement. 2014 capex guidance is for $35 – $40 million, which you have stated is roughly split between spending for growth and maintenance projects. This guidance was even higher prior to your Q1 2014 earnings call, when you reduced it due to the timing of various projects. From 2005 through 2009, the Company's total capex spend averaged below $20 million, and it has been significantly elevated since. We understand that part of the elevation is attributable to improvements made at the Coatzacoalcos facility, but with those projects now behind us you have yet to provide any granularity on specific initiatives, timing or their projected returns on investment associated with your growth capex. While we fully endorse capex spending to support your various growth initiatives where attractive returns can be garnered, we urge you to provide better disclosure on a go forward basis.

III. Implement a More Attractive Dividend Policy: Although we acknowledge Innophos' recent dividend policy increases, given the Company's substantial free cash flow generation, it could target a payout ratio of approximately 80%, or at least $3.00 per share annually on a forward-looking basis. Based on current market price levels, applying a conservative dividend yield range of 4.00% – 4.25% (versus the current dividend yield of ~3.3%), would result in a stock price of approximately $70 – $75 per share. It is important to note that our payout ratio is derived off $40 million in projected capital expenditures, which is significantly north of stated maintenance capital expenditures of $20 – $25 million. Importantly, we believe that if the Company were to revert to more normal historical spending patterns around capital expenditures, and applying the same dividend yield as above, it would result in significant incremental equity value. In either case, we believe this increased payout structure would enable the Company to pursue a more robust and thorough M&A strategy with the increased stock currency.

IV. Accelerate Share Repurchase Activity: The Company has repurchased stock over the past several years only to offset dilution from long-term incentive stock grants. We believe this strategy further evidences management's and the Board's short-sighted view on valuation and in turn shareholder value. For the reasons discussed above, including minimal leverage and an extremely attractive valuation, we believe an acceleration of stock repurchases is warranted and would be highly accretive to shareholder value. At current trading multiples, we view immediate and substantial share buybacks and the resulting share shrink as the preferred path to value creation, especially as compared to the pursuit of acquisition opportunities that carry execution risk, and as you stated, would likely be expensive versus your current valuation and not accretive to earnings.

V. Explore Strategic Alternatives for the Entire Company: In light of the Board's and management's failure to address the issues set forth in this letter, we strongly believe Innophos should consider hiring an investment bank to explore the sale of the Company at a meaningful premium to current share prices. We believe there would be several interested strategic parties as Innophos' end market exposure remains of high interest to potential acquirers due to stricter food regulations, the rising, global middle-class and strong financing markets. These strong secular trends and recent M&A activity have resulted in Innophos' peer group trading at an average 2015 EBITDA multiple of ~11x in the public markets. We also note, as you did during our meeting, that recent M&A transactions in the marketplace have occurred at multiples within this range, and even higher. A sale of Innophos at an 11x multiple, which is on par with what Balchem Corporation paid for Sensory Effects earlier this year, would result in a realization of approximately $80 per share, or 45% upside from current trading levels without assuming any stock buybacks.

We have had the opportunity to speak to other sizable shareholders, many of whom share our thoughts and suggestions. We look forward to continuing our discussions with you to ensure that maximum value is created for all of the Company's shareholders.