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Large MDS Investor Tells Firm Not to Buy Out ABI, Instead Sell MS, Other Businesses

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One of MDS’ largest shareholders has rejected the idea of the Canadian company buying out Applied Biosystems’ stake in their mass-spectrometry joint venture, MDS/Sciex, warning the move would further dilute shareholder value in a company whose finances have already been battered.
 
The opposition came in a strongly worded letter sent to MDS on Oct. 30 by New York-based hedge fund Obrem Capital Management, which owns a 5.1-percent stake in MDS and is among MDS’ five largest shareholders. The note expressed a lack of confidence in MDS’ management and board in the face of a falling stock price, and suggests several ways the company could raise shareholder value. Selling MDS’ mass-spec business is one such recommendation.
 
The suggestion comes amid speculation over the future of the ABI/MDS joint venture as ABI takes the final steps in closing a $6.7 billion merger with Invitrogen.
 
While officials from ABI and Invitrogen insist they will not sell the mass-spec business, some analysts have said that the instruments will not fit in the structure of the new company, and that ABI could sell the business in the near future, most likely to MDS [See PM 06/19/08].
 
At an investor conference in September, MDS CEO Stephen DeFalco further fanned the fires of speculation when he told analysts that the company is reevaluating all its options with the joint venture, including selling or buying the mass-spec business, or just leaving it as it is [See PM 09/25/08].
 
But in last week’s letter, Obrem founder Andrew Rechtschaffen said that given the “destruction of shareholder value” that has already occurred, he is opposed to further spending of shareholder capital by MDS.
 
“Specifically, we are opposed to [MDS] expanding its footprint by acquiring the other half of the Sciex joint venture,” said Rechtschaffen. “We believe this view is shared by many of the company’s shareholders.”
 
Instead of buying out ABI, he recommends MDS carve up its businesses and sell them. Rechtschaffe said that while finding a buyer for the entire company may not be possible because the three divisions that make up MDS are too unrelated and did not “belong together in the first instance,” he believes a market exists for the individual divisions: MDS Analytical Technologies, MDS Nordion, and MDS Pharma Services.
 

“Specifically, we are opposed to [MDS] expanding its footprint by acquiring the other half of the Sciex joint venture.”

MDS Analytical Technologies, which houses the firm’s mass-spec business, would be the easiest asset to sell, Rechtschaffen said in his letter. He also recommended selling either of the two units comprising Analytical Technologies — Sciex, which develops mass spectrometers, and Molecular Devices, which makes other instruments — along with pieces of MDS Pharma Services, which he singled out as being an especially problematic business.
 
For its fiscal third quarter ended July 31, the most recent period for which figures are available, MDS said Pharma Services had an operating loss of $31 million. In July, MDS announced it was laying off 210 employees, the majority of them in MDS Pharma Services, in a bid to raise profitability
 
Rechtschaffen also suggested spinning out MDS Nordion.
 
Obrem’s letter is the hedge fund’s latest salvo as it tries to force MDS to take steps to stop its stock slide. Since the start of the year, MDS’ shares have dropped approximately 42 percent to about $11. In its fiscal third quarter, MDS reported that total revenues declined 4 percent year over year to $321 million. Losses for the quarter totaled $10 million, compared to a profit of $7 million during the third quarter of fiscal 2007.
 
Obrem disclosed in April that it had acquired a 5.1 percent stake in MDS, making it among the company’s five largest shareholders. Since then, Rechtschaffen said, Obrem has suggested that MDS hire a financial adviser to explore selling or spinning out parts of its company, and that management implement a “significant” share-buyback program.
 
It also has told management and board members to increase their ownership of MDS stock “to more closely align their interests with those of other shareholders,” Rechtschaffen said in last week’s letter.
 
Though MDS management and directors have listened to Obrem’s concerns and advised it to be patient, “we have been disappointed with the lack of action in response to our recommendations,” Rechtschaffen said. “We have not seen evidence of any strategic action taken to unlock value.”
 
Furthermore, he said he does not understand how management and board members can continue to express confidence with their strategy and business outlook, but own “so little stock” in the company.
 
In a statement e-mailed to ProteoMonitor this week in response to Obrem’s letter, MDS said that it welcomes constructive dialogue with Obrem and other shareholders.
 
“MDS has an active and engaged board and management team that continues to assess and respond to the needs and opportunities created by dynamic and challenging market conditions,” the company said. “Our board and management team regularly review our strategy against potential options and will continue to make business decisions to create shareholder value.”
 
Rechtschaffen also criticized DeFalco. While he didn’t explicitly call for DeFalco’s removal, he said that “the company’s poor operating performance and most importantly, the extremely poor share price performance” during DeFalco’s three years as CEO, “speak for themselves and indicate a different approach for creating shareholder value is needed.
 
“Action must be taken before there is erosion in the intrinsic value of MDS’ assets,” he cautioned.
 
Through a spokesman, DeFalco declined to comment.
 
Despite the current turmoil in the broader credit and equities markets, Rechtschaffen dismissed it as the reason for MDS’ stock weakness, saying the firm’s share price “began its precipitous decline in early summer after poor second-quarter operational results were reported.”
 
He added that despite the current stress in the credit markets, Obrem believes potential buyers exist who would not require extensive external financing to purchase any of MDS’ businesses.
 
According to Rechtschaffen, industry leaders, bankers, and competitors have told him that MDS’ businesses are “well-positioned in attractive markets. Moreover, these conversation have given us reason to believe that multiple strategic parties have a strong interest in acquiring specific assets of the company,” Rechtschaffen said.
 
He added that Obrem may call for a special meeting of shareholders during which it will seek to replace at least one board member and pursue a shareholder vote on its proposal to sell parts of MDS.

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