Vision Check-up - BOL, EYE, and COO

By Dr. Duru written for One-Twenty

May 28, 2007


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It has been a while since I last wrote about the eye-care sector, but my interest remains. With the recent buy-out offer for Bausch and Lomb (BOL) and the potential counter-offer from Advanced Medical Optics (EYE), I figured it was time to write a few of my own words on the action. I will summarize by stock.

BOL
On May 16, 2007, BOL agreed to a buy-out offer from Warburg Pincus of $65/share. The stock closed that day up almost 10% to $67.50 as the market assumed other bidders would step in. The apparent premium of this buy-out offer would have been much higher except rumors of M&A action surfaced in April and sent BOL up on April 23 for a one-day gain of almost 13%. The rumor then was that Pfizer (PFE) would be the bidder. We can only assume the market suspects PFE may yet step in with a bid. On Thursday morning Advanced Medical Optics (EYE) confirmed interest in making a bid for BOL with the following statement:

"We believe it is only logical to explore this opportunity given the highly complementary nature of our two businesses. Consideration of this potential transaction is consistent with our existing strategy to provide a full range of products that address vision care needs of people of all ages. We believe that the current transaction with Warburg Pincus undervalues Bausch & Lomb, and we plan to enter the go-shop process with the intention of exploring a superior offer for the company. Of course, we will only proceed with a transaction if after conducting thorough due diligence, our Board of Directors determines it is in the best interest of AMO stockholders. There can be no assurance that the exploration of this opportunity will result in any transaction. The company does not anticipate any further public comment on this issue unless and until it deems further public comment to be necessary and appropriate."

BOL ended the day on this news at $70, almost an 8% premium on the Warburg Pinucs offer. BOL has now made a complete recovery from the product recalls that clobbered the stock in the first half of 2006. The "gold rush" on the stock makes for a fitting cap on the BOL drama. Back in May of 2006, I flagged BOL as a "buy the despair" opportunity. For the next 9 months or so, I moved in and out of the stock as it chopped its way to a slow and steady recovery. Unfortunately, I did not even consider the possibility that some institution or company would also recognize the value in BOL shares and make a move. So, my impatience in this case blinded me to the real opportunity and cost me a very nice return. Let's just call this another lesson learned! (See disclaimer here.)

Advanced Medical Optics (EYE)
As mentioned above, EYE is now considering taking out BOL. I flagged EYE in my last piece on the eyecare sector, but I did not recommend it as a "buy on the despair" case. Back then, I was afraid that this company had some serious financial issues on top of the bacterial contamination issues which forced them to do a voluntary recall of the "12-ounce COMPLETE(R) MoisturePLUS(TM) multipurpose contact lens care solution and Active Packs." This one-two punch seemed to indicate that things would get worse before they got better. The stock is up about 14% since then. I was wrong about the direction of the stock, but I think I was correct that holding the stock was not worth the risk given all the churn in the stock over the last 6 months. Moreover, the company is taking on a tremendous risk in considering a buy-out of BOL. First of all, EYE's finances still appear shaky. An analyst at Lehman confirms some of the business risks involved for EYE on this M&A talk:

"...because the financial and integration hurdles are significant and the potential payoff well into the future...EYE will likely remain at or below current levels for the foreseeable future if it makes a successful bid for BOL. Also, if the company wins the BOL asset, it would have to integrate both ILSE and BOL, simultaneously. Strategically, firm views the potential acquisition of BOL by EYE positively as it represents EYE's best opportunity to become a much broader based and better positioned competitor in the ophthalmology space, which firm considers to be one of the most attractive markets in Healthcare over the next five to ten years." (from Briefing.com)

EYE's stock fell 3% on the M&A news. But later that same day, the CDC revealed that it has singled out Complete MoisturePlus as the likely source of a rare fungal infection. The stock dropped another 2% on that news on Friday. This infection is different from the keratitis that forced BOL to recall some of its own solutions. Perhaps a combined company would be in a better position to take on these infection issues. But I have to wonder about the wisdom of doing such a merger with these kinds of outstanding product problems. Regardless, it seems to me that EYE has put a cap on its stock for the time-being. The stock has gone nowhere for 3 years after quadrupling for the first two years of the stock's trading life. I think there should be some room for more discounting.

The backdrop here is the safety of contact lenses and the contact lens solutions. Not only do the eyecare companies need to tighten up manufacturing standards, but they have to more rigorously encourage proper use of these products. If you wear contact lenses, I think you would do well to heed these warnings! The CDC is targeting EYE as a follow-up to important research done at the University of Illinois at Chicago, led by two professors in opthamology, Charlotte Joslin and Elmer Tu. The paper is titled "Epidemiological Characteristics of a Chicago-area Acanthamoeba Keratitis Outbreak." It suggests that Acanthamoeba keratitis could be on the rise.

Cooper Companies (COO)
Perhaps I can be forgiven for dropping the ball on BOL given that I had become so focused on staying the course on COO. The stock had some incredible volatility in the last half of 2006, and I somehow managed to avoid getting hurt on the downside of the volatility with several trades. The stock has been moving on earnings news and occassional rumors of M&A. After the market responded to COO's March earnings with a 5% uptick, I put COO on watch. The stock soon closed that gap, but after COO recovered and surpassed the post-earnings pop, I got in. The logic here was largely technical. I figured the market was showing more positive interest in the stock and the downside risk was very small compared to the upside potential of the stock at least regaining its highs of 2006 as the business finally looked to be stabilizing. (Also interesting to note how strong the stock has been for much of the last 14 years!). Over the ensuing 2 months, analysts have reiterated and upgraded the stock, and COO has been a secondary beneficiary of the M&A action involving BOL. After the second strong gap up, I decided to sell into strength. The strong open on May 21 pushed COO to my initial price target of the 2006 highs. The burden is now on COO to have follow-through good news. If time goes on without a bid coming in for the company and/or earnings in June disappoint again (or even worse, the company warns before those earnings), I am figuring to get back into COO at much cheaper prices. Essentially, I think the downside risks have begun to outweigh the remaining upside potential in the near-term. Time will soon tell, right?

In the meantime, be careful out there!

DrDuru, 2006