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Voce Capital Management Goes Hardball With Proxy Fight Against Obagi Board

Another chapter has been written on the nearly year long effort by Voce Capital management to get Obagi Medical Products (OMPI) sold, when on Monday, 12/3/12, Voce made public another letter sent to the Obagi Board of Directors (BOD)

In the latest letter, Voce criticized the BOD for continued mismanagement of the Company, its refusal to address Voce's demands for corporate governance reform, and its unbending hostility toward all acquisition interest. Directly addressing Obagi's Board members, Voce stated in its letter:

Your failings as a Board are many and varied. But they all stem from a common flaw: Your incentives are misaligned with, and in many ways adverse to, those of shareholders. You have but a de minimis economic stake in Obagi's success and it appears to us that your paramount objective is perpetuating your control over the Company at all costs. As a result of Stonington Partners engulfing influence, none of the normal checks and balances exist to hold you accountable or to keep you honest. Accordingly, we have concluded that the only way to fix Obagi - indeed, to save it - is with the replacement of the Board with new, independent directors.

In my last article that covered this on-going issue, I had some strong words of criticism for Dan Plants, Managing Partner at Voce Capital management:

I have to ask what good does Dan Plants of VOCE think another public "thrashing" of the Obagi BOD will do this time? VOCE not only holds Obagi shares, but also acts as a proxy for some shareholders. My question to Dan is, why can't you convince shareholders to vote the BOD members out who clearly do not have the shareholders' best interests at heart?

Sources tell me that Plants now has the needed support to ouster the board of directors in question who have in my opinion, neglected their fiduciary duty by not exploring the possible sale of the company.

Albert Hummel, CEO, Director, and President of Obagi is in his late 60's, and I have to wonder if a man of his age really wants to engage in a potentially costly proxy battle with what anonymous sources tell me is a majority of shareholders ready to vote him off the Obagi BOD. Mr. Hummel, along with the rest of the BOD could also face multiple lawsuits from shareholders on the basis of the board failing to dutifully fulfill its fiduciary duties towards them.

Part of fiduciary duty that BOD members must legally uphold is "The duty of loyalty" which imposes on the board an affirmative duty to protect the interests of the corporation, and also an obligation to refrain from conduct which would injure the corporation and its shareholders. Directors must avoid any conflict between duty and self-interest. Undivided allegiance to the corporation's best interest is required.

Consistent with the view that the duty of care and the duty of good faith are different, the duty of good faith is a subset of the duty of loyalty. Board members must therefore refrain from self-dealing. Self-dealing occurs when one uses her position for personal profit at the expense of the company.

Plants seems to suggest that Mr. Hummel might be guilty of "self-dealing" in its open letter from February, 2012:

The Board's hiring of Mr. Hummel as CEO - himself a director at the time of his appointment - is also troubling. Mr. Hummel is concurrently the chief executive of another company, Cobrek Pharmaceuticals, Inc. ("Cobrek"), based in suburban Chicago. How can the CEO of a public company also be the CEO of another company in another city at the same time? Moreover, since Mr. Hummel has taken over as CEO of Obagi the Company has begun making payments to Cobrek for unspecified "consulting" services. While the Company has previously responded to us that these matters have all been disclosed in public filings, their disclosure does not clear their unseemly air let alone make them appropriate actions for a publicly-traded corporation.

It appears in my opinion, that certain Obagi BOD members fail to realize that their company is a publicly traded one. Not only is it likely that the BOD here would lose a proxy battle, but also face potential lawsuits for what Voce again suggests; engaging in self-dealing.

Hummel, and the other board members in question are older men. I fail to see what they have to gain here by continuing to refuse to explore the possible sale of the company -- what the majority of Obagi shareholders seem to want. It's my opinion that the BOD would be wise to hire an investment banker as soon as possible, and avoid risking further peril to themselves and Obagi's shareholders.

Plants goes on to remark from its February, 2012 letter:

We believe the only credible alternative for the Board at this juncture is to undertake a legitimate review of the Company's strategic alternatives, with the advice of reputable legal and financial advisors. If the Board truly believes that its own strategic plans will create the highest value for shareholders then those plans can be evaluated and quantified and compared against the results of a thorough process. A competitive process will also likely elicit more and better offers than those received to date, as some parties (particularly larger acquirers) will only invest the time in a potential transaction if it appears that a deal is a legitimate possibility.

Another factor Mr. Hummel and the Obagi board should consider, is the involvement of David Callan, a large shareholder of Obagi stock who is known to be an "activist shareholder."

Callan has had success as a shareholder activist in the past with other public medical companies generating sales similar to Obagi in excess of $100 million dollars. In 2007 he was actively involved in the sale of E-Z-EM for $240M to Bracco Diagnostics, Inc., the US based subsidiary of Bracco Diagnostics.

I have personally spoken to Callan before, and he indicated to me that if necessary, he would engage in legal action himself -- not only does the Obagi BOD face a fight they are likely not to win against Voce; they also face potential legal action by Callan.

The Obagi BOD needs to fully understand the laws that govern a publicly traded company. To date, it certainly seems to me they just don't "get it." Selling the company now ensures the current board gets a nice bonus -- but losing a proxy battle with Voce would ensure the same board members lose their seats -- which means they lose any and all benefits from an acquisition. This is a no-win situation for these aging board members, which could leave them financially in shambles, should successful lawsuits ensue from shareholders like David Callan.

Potential suitors to aquire Obagi:

Avon Products Inc. (AVP) seems to be in a similar situation in Obagi's segment, and might have interest in acquiring Obagi according to my anonymous sources.

Avon could 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 the cash for a strong marketing campaign in order to gain greater market exposure for the Obagi product line, especially sales outside of The United States.

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.

L'Oreal (LRLCY.PK), which 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, could also benefit from acquiring Obagi. L'Oreal recently reported a rise in third-quarter 2012 sales, yet growth slowed, excluding currency effects, as the company's luxury goods division showed signs of cooling. An acquisition of the Obagi line of products would give the company an additional product line to market globally, kick starting its growth again.

Valeant Pharmaceuticals (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. Recently, Valeant acquired Medicis Pharmaceutical Corp. for $2.6B in September of this year. An Acquisition of Obagi could give Valeant additional leverage in its market segment, notwithstanding that the company has a solid track record of aggressive acquisitions.

Allergan Inc. (AGN) should have an interest in acquiring Obagi as it 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. Allergan might be feeling additional pressure to acquire Obagi because of Valeant's recent acquisition of Medicis, forcing Allergan to protect its large dermatology sales interest by keeping Obagi out of the hands of Valeant.

Recently, Fougera was sold for 3.55 times sales, suggesting an offer could be as high as $23 a share should one appear. A buy out price of $20 a share would equate to a total cash deal of approximately $345M based on Obagi's 18.73M shares outstanding - a dirt cheap price considering the value Obagi would bring to all the companies mentioned above.

It's my strong opinion that the best option for Obagi now, would be to actively seek selling the company, avoiding a proxy battle it cannot possibly win. Hummel and other board members aren't getting any younger, and I think the last thing these older gentlemen would need is the stress of potential lawsuits and a costly proxy battle.

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