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Posted on 6th June 2016

Hartmut Retzlaff falls victim to barbarian hordes

The announcement today that Hartmut Retzlaff has stepped down as CEO of Stada ‘due to a serious long-term illness’ comes as something of a surprise, but the reasons are not hard to discern. For weeks, activist investors in the form of a group called Active Ownership have been putting pressure on Stada, initially proposing a slate of five directors for election at the AGM, which would have given them a majority of the nine-member board. After some negotiations, this number was reduced to three, with the tacit understanding that their election would not be opposed by Stada, but the company then abruptly changed tack, postponing its AGM from mid-June to the end of August and announcing that it intended to renew the entire Board with suitably qualified people and that the candidates proposed by Active Ownership were welcome to apply (but with no guarantee of success).

This did not go down particularly well with the company’s larger shareholders and the next flurry of news items concerned Stada entering talks with potential private equity investors, with CVC being named in particular. It is worth noting at this point that Stada has periodically tried to give the impression that it was about to be taken over, possibly as a way of trying to boost its share price, but in the past the supposed suitors have always been big pharma companies. It is known that Mr Retzlaff does not like PE and has never offered any support to their historic approaches. In fact, until recently he had pretty much stopped even meeting them. But desperate times call for desperate measures, so it is reasonable to assume that some meetings have taken place. However, this does not mean that PE is going to be ready to pay a big premium to a share price that has already risen sharply since Active Ownership came on the scene. The success of private equity investing comes at the exit, so any purchaser is going to have to believe that they can achieve some pretty dramatic operating improvements at Stada if they are going to make a decent return.

The background to all this, of course, is the company’s chronically weak financial performance relative to its peers, coupled with very poor corporate governance. Specifically, Stada appears to be less profitable than other companies operating in European generics and to be achieving little or no organic growth. Of much more concern to us, though, is its lack of cash generation. Pharmaceuticals ought to be a very cash-generative business unless you operate in markets with very long payment times, such as Romania or the Spanish hospitals market. Stada, however, has the biggest part of its sales in Germany and in other western European markets where payment is usually quick and although it does have a large business in Russia, this is mostly OTC which means that it is cash in hand to the pharmacist. Serbia may be a different matter, but taken overall, Stada ought to throwing off a lot of cash and it isn’t. And what cash it does generate is immediately spent on acquisitions, the cumulative effect of which has mostly been to keep profits stable rather than actually grow them. This is odd as well, because while serial acquisitions are a hallmark of the larger generic companies, the usual scheme is to buy something and then to use the additional cash that it generates to leverage up and buy something bigger. Actavis is a classic case in point. Back in 2007, Actavis was the same size as Stada. Now what is effectively still the old Actavis business but with a lot of bolt-ons (including Watson, which technically bought Actavis rather than vice versa) is being sold to Teva for more than $40bn. An even better comparison is Hikma, which has remained under the control of the Darwazah family since its creation and does not have access to the US capital markets. In 2007, Hikma’s sales were around a third the level of Stada’s; this year the two companies will report sales that are much the same as each other, with Hikma enjoying a market cap that is close to twice that of Stada.

On the corporate governance side, Active Ownership had a number of concerns, mainly around the extensive length of time that the members of the Supervisory Board have been in place and the lack of any effective control by them over the executive. Mr Retzlaff’s pay has been the subject of numerous press articles in Germany, as has the fact that he has appointed his own son in a senior position. Add to this the belief that many management positions have been filled by people whose main qualification was being a friend of either Mr Retzlaff or his wife and top if off with the fact that there have frequently been only two – or at the most three – people in the top team overall, and you clearly have the potential for sub-optimal management of the company.

While we do not have the precise answer to where Stada’s problems lie, there are some lines of enquiry that the new Board would do well to consider. First and foremost is the highly decentralised structure of the company, which involves massive duplication of functions at the HQ and country levels and also probably results in top management having much poorer insight than they should into how things are actually being run on the ground (think back to the Serbia disaster some years ago when it turned out that the local management had been engaging in spectacular channel-stuffing, seemingly without anyone in head office even noticing). The second point is the sort of business in which Stada is engaging. In Germany, the company has made a massive push into the tenders despite not being fully back-integrated in most of its products. Winning a lot of tenders has made turnover look better but is almost certainly doing nothing much for profits. Elsewhere, Stada has decided that OTC is the way of the future, possibly in part because the company might be a more attractive takeover target if it were seen as an OTC play rather than a generic one. OTC business is often a useful adjunct to generics as pharmacists are the customers for both, but OTC is heavy on promotion and marketing, so the push that Stada is making here may partly explain why margins are depressed. And finally there is Russia overall. This business has historically been the main growth engine for Stada, but the recent collapse in both the rouble and the Russian economy is putting pressure on all manufacturers and we suspect that Stada’s local operations may currently be under water financially. In addition, Russia is the prime suspect in the hunt for Stada’s missing cashflow, as we harbour suspicions that the company has been driving reported growth in part through exactly the same tactics that went so disastrously wrong in Serbia.

Hartmut Retzlaff has been CEO of Stada for the last 23 years, so it is hard to lay blame for the company’s woes at the door of anyone else. And with the barbarian hordes now aiming a battering ram at that same door, his decision to take a hospital pass makes some sense. We see his named successor, Dr Matthias Wiedenfels, as a placeholder pending the AGM that will finally appoint a new Board and presumably then a new executive. Irrespective of whether that meeting also removes the current poison pill that makes it so hard for anyone to take Stada over and regardless of whether or not Stada is ultimately taken out by PE, a new day is surely dawning in Bad Vilbel.

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