NEW YORK, May 14, 2014 /PRNewswire/ -- On May 12th, 2014, Tappan Street Partners Fund L.P., a private investment fund and owner of Nordion common stock, sent the Board of Directors a letter detailing our concerns with the recent offer to acquire the company at a price of $12.25 per share. A copy of the full letter is included below.
May 12, 2014
Board of Directors
Attn: Corporate Secretary
447 March Road
Ottawa, Ontario K2K 1X8
Ladies and Gentleman,
We are writing to you in our capacity as representatives of Tappan Street Partners Fund L.P., a private investment fund and owner of Nordion (the "Company") shares. While we commend the Board and management for engaging in a long strategic alternatives process with the hope of maximizing shareholder value, we are concerned that the current offer of $12.25 per share in cash from Sterigenics, an affiliate of private equity firm GTCR (collectively the "Acquirors"), materially undervalues the Company. Although we recognize the Company undertook a thoughtful process, we believe no natural buyer exists for all of Nordion's disparate assets, leading to a sub-optimal outcome for shareholders. In particular, we are concerned that the current offer was accepted prior to a material positive change in the sterilization industry that could greatly benefit Nordion, and we believe it ascribes no value to Nordion's medical isotopes business going forward, essentially giving the Acquiror a "free" option on new supply and a business that could be worth hundreds of millions of dollars in the future. Absent a material change in terms, we believe shareholders and the Board are better off rejecting this offer, as more value will likely accrue to shareholders from operating independently.
We believe the $12.25 per share offer from the Acquirors materially undervalues Nordion for the following reasons:
- Material Change to the Industry – We believe Nordion's sterilization business has many attractive characteristics: long-term supply arrangements, a razor/razor blade business model with high gross margins, regulatory barriers to entry, predictable and growing end-markets, very little capital expenditure requirements driving substantial free cash flow, and a very dominant market position in a duopoly industry structure. Subsequent to the merger announcement, we believe this business has only gotten better. On April 24th, 2014 Nordion announced that the other major supplier is "discontinuing supply of Co-60." As a result, the Company has raised its guidance for the sterilization segment from annual growth of 10-15% in 2014 to annual growth of 35-40%, a 25% increase. While we recognize that Nordion management expects the supply to come back online, the reasons for the discontinuation and any potential timing of the re-entry to the market are unknown. At least temporarily, Nordion's high quality business is essentially now a monopoly, which we believe warrants a very different valuation. At the very least, Nordion's cash flow generation from the sterilization business will be materially higher than contemplated at the time bids were originally submitted.
- Inadequate Multiple for Sterilization – As discussed above, we believe the sterilization business is a high-quality operating segment for several reasons. Even absent the near-term (and perhaps extended) monopoly market position, we believe the current price does not ascribe full value for this segment. Under reasonable growth scenarios for next year, excluding the bolus of sales from disruptions at the competition and potential sales from production irradiators, Nordion's sterilization business should be able to generate nearly $33mm of after-tax cash flow. For businesses with such dominant market positions, stable growth and significant barriers to entry, we believe cash flow multiples in the high teens are very reasonable. Valued at 17x, Nordion's sterilization business alone would be worth $9 per share. Coupled with the existing net cash, this alone would yield a valuation above the current price. Assuming the monopoly market position persists, we estimate fair value of sterilization to be nearly $3 per share higher than our $9 per share estimate that assumes the return of competitive supply. Importantly, we believe free cash flow, and not EBITDA, is the most relevant metric for this or any other business. Nordion's low capital expenditure requirements make EBITDA-based valuations much less appropriate. By way of comparison, the average business in the S&P 500 trades at a free cash flow multiple of 15x – 17x and we think the sterilization business is much higher quality than the average company. Additionally, as the merger proxy detailed, it seems some prospective buyers were interested in acquiring only one segment, which could be one reason that the overall bid may undervalue the company's individual segments.
- Little Value Given for Medical Isotopes – Given our estimates of fair value for sterilization, corporate costs and existing cash on the balance sheet, we think the current bid provides little more than run-off value for the Company's medical isotopes business. This is not particularly surprising given that the buyer is not in this business segment. Instead, we think Sterigenics is getting a largely "free" option on securing future medical isotope supply. Nordion has been a leading player in Mo-99 supply for many years and we think the Company has a very strategic position in the industry. With approximately 70 thousand medical procedures done daily that utilize Mo-99, we think this global shortage is likely to be resolved and Nordion should be a part of that solution. While we recognize that additional supply is not a guarantee, we also struggle to understand why shareholders should transfer this valuable option to the Acquirors for free. At even modest multiples of free cash flow going forward, the Medical Isotopes business could be worth another 40%-50% relative to the current offer of $12.25 per share. In fact, we think management agrees:
"Although the medical isotope business will be a new sector opportunity to Sterigenics, we are in agreement that the business offers an attractive market with growth potential and Sterigenics supports Nordion's efforts to secure long-term isotope supply." – Steve West, Nordion CEO – 3/31/14 Conference Call
- Conflicts of Interest with the Fairness Opinion – We were surprised to learn that the Company's advisor, Jefferies, had been seeking additional business from GTCR and has been engaged by GTCR on another assignment. While we understand that investment banks do business with a variety of constituents, we think the fact that Jefferies raised this potential conflict with management on March 25th, just three days before the deal was announced and after much of the process had been wrapped up, is cause for concern. In fact, the Company then excluded Jefferies from further discussion "in order to mitigate any perceived conflict of interests."
The Path Forward
We will not vote in favor of the merger arrangement under the current terms because we believe the $12.25 per share value significantly undervalues the Company. We would certainly entertain higher offers from either Party A or the Acquirors, but absent that, we believe shareholders are better off operating independently at least until the market dynamics around sterilization and long-term medical isotope supply are better known. While rejecting the offer may lead to short-term turbulence in the share price of Nordion, the Company has the best defense possible: significant cash on the balance sheet to buy back shares at an attractive valuation. Ultimately, shareholders will decide with their vote, but we strongly encourage the Board to reconsider the offer in order to ensure that shareholders receive fair value for their shares.
Prasad Phatak and Chris Koranda
Tappan Street Partners LLC
 Nordion information circular dated April 22, 2014, page 36.
SOURCE Tappan Street Partners LLC