TAROPHARMACEUTICLINDSLTD(TARO) $45.

92onNov16,2012bymiser861
Price: SharesOutstanding(inM): MarketCap(in$M): NetDebt(in$M): TEV(in$M):
Description: Taroisasimplearbopportunitywith15%downsideand45%200%upside.IbelieveTarowilllikelybeacquiredinthenext6 12months afterSunonceagainsubstantiallyincreasesitsbidtoTarominorityshareholders.Tarohasbeenwrittenuptwicepreviouslyatlowerlevels, andhasrisenprimarilyonimprovedearnings,notmultipleexpansion.Atonly4.5xrun rateEBITDA,Taroisinfactatoneofthecheapest levelsithasevertradedat.Althoughmanyheremaybefamiliarwiththestoryonafundamentalbasis,Iwouldliketohighlighttheattractive arbdynamicsthathaverecentlyemergedthatarguablymakeTaromoreattractivethanithaseverbeen.ToreduceriskinTaro sunderlying business,youcanshortSun,ofwhichTaroisinexcessof50%ofTTMEBITDA.InadditiontothepriorwriteupsonTaro,Iwouldalso encourageyoutoreadtherecentlettersfromminorityshareholders,aswellasGrandSlam srecentlawsuitfiledthispastweekend. OverviewofSituation: TaroistheleadinggenericdermatologycompanyintheUS.SunPharmaowns66%ofTaroandhasmade3separatepublicoffersforthe companyoverthelast4years,eachtimeataprogressivelyhigherlevel.LastOctober,Sunbid$24.50forTaro,implyinga7.5xEBITDA multipleatthetime,whichTaro sspecialcommitteeeventuallyrejected.InAugust,Sunrevisedtheirbidto$39.50,implyingabout4xTTM EBITDA.Thistime,Taro sspecialcommitteeaccepted. Inordertopurchasethecompany,Sunneedstowinamajorityoftheminorityofshareholdersthatactuallyvote.Withthesharestradingat over15%abovethelatestoffer,anyonewhowouldvoteinfavorofthebidshouldbesellingtheirstockintheopenmarket,makingitdifficult toseehowSunwinsthevotehere.SunsabilitytobuyTaroisentirelyinthehandsofminorityshareholders.IbelieveTaroisworthupto $140asharetoSun.ThegapbetweenwhatTaroispotentiallyworthtoSunandwhereittradestodaycreatesaveryattractiveupside againstafloorof$39.50thathasbeensetbySunsrecentbid. WhySunwantsTaro: Tarotodayisabout48%ofSunsTTMEBITDAand44%ofitsnetincome(50%+ofthelatestquartersEBITDAadjustedforLipodoxgoing away).SunhasamarketcapandEVofapproximately$13B.Ittradesat18xLTMEBITDAand25xLTMearnings.Puttingthesesame multiplesonTaroyieldsavaluationof$140ashareonaTTMbasis.SunhasstatedaninterestinexpandingitsbusinessintotheUSand hasmadeTarothewayitplanstodothat.VeryseniormembersofSunsmanagementteamsitonTaro sboardandTarosmanagement teamisalmostentirelySun appointed. Scenario1:BaseCase SunisforcedtopayareasonablevalueforTaro: Ibelievethenextstep upinTarowillcomewhenSunisforcedtorevisetheiroffertosomethingmorein linewithrecentcomptransactions. Therehavebeenseveralrecentdealsinthegenericdermspacethatclearlysuggestavalueofatleast$65/shareforTaro: FougeraacquiredbySandozfor8xTTMEBITDAinJune2012 PaddockacquiredbyPerrigofor8.5xTTMEBITDAinJuly2011 Suns$24.50bidforTaroinOctoberimplied7.5xTTMEBITDA Perrigo(the#2playeringenericderm)tradesat14xTTMEBITDA AlthoughIcouldmakeanargumentforPerrigo(orSun)beingthebestcomp,tobeconservative,I dpointtotheFougeratransaction. Fougeraisthe#3playerinthedermspace,competeswithTaroinmanyofthesamedrugsand,likeTaro,hasbenefitedfrompriceincreases onavarietyofproductsinthelastcoupleyears.Despitetheseissues(whichSun&Tarofrequentlyhighlight),Fougerawasboughtoutless than6monthsagofor8xEBITDA.Fougerasmultiplewouldimplyavaluationofapproximately$67.50/shareforTARO,orup45%.This ReportGenerated: 11/16/2012 comparestoSunsbidforTAROof4.25xTTMEBITDA. Page 1 of 3

$45.92 46 2,050 374 1,676

EarningsPerShare: P/E: P/FCF: EBIT(in$M): TEV/EBIT:

2012 2013 $6.20 $7.10 7.4x 6.5x 7.0x 6.2x $325 $370 5.2x 4.5x

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Perrigo(the#2playeringenericderm)tradesat14xTTMEBITDA AlthoughIcouldmakeanargumentforPerrigo(orSun)beingthebestcomp,tobeconservative,I dpointtotheFougeratransaction. Fougeraisthe#3playerinthedermspace,competeswithTaroinmanyofthesamedrugsand,likeTaro,hasbenefitedfrompriceincreases onavarietyofproductsinthelastcoupleyears.Despitetheseissues(whichSun&Tarofrequentlyhighlight),Fougerawasboughtoutless than6monthsagofor8xEBITDA.Fougerasmultiplewouldimplyavaluationofapproximately$67.50/shareforTARO,orup45%.This comparestoSunsbidforTAROof4.25xTTMEBITDA. Scenario2:BullCase SunpayshighendmultiplesforTaro Although$67seemslikethelow endofafairprice,IcouldpointtoPerrigo svaluationorSunsownvaluation,whichwouldyieldvaluesfor Taroofbetween$110and$140ashareforTaro.PerrigoisTarosbestpubliclytradedcomp,ismostsimilartoTaroinsize,andderives nearly50%ofitsEBITDAfromitsgenericpharmabusiness.BecauseSunneedstheminorityvotetogainfullcontrolofTARO,thereisa veryplausiblescenariowhereshareholderscouldcontinueholdingoutforvaluationsattheselevelsandgettakenouthere. Scenario3:BearCase ThemostobviouswaytolosemoneyhereisifSunissomehowsuccessfulinpushingthedealthroughat$39.50.Thiswouldlikelyhaveto bedonethroughfraudconsideringwherethestockpricetradestodayanyrationalmarketparticipantcansellalltheirsharesintothe markettodayformorethantheycangetinascenariowhereSunwins. ThesecondwaytopotentiallyloseisifSunwithdrawstheirbidandthefundamentalofthebusinessdeteriorate(orifSunmakesthem deterioratetodepressTarosprice).TheeasiestwaytoprotectagainstthisriskistoshortSun,giventhemagnitudeofexposureSunhas toTaroanditsrelativelyloftyvaluation.ThisincentivehasexistedforSunfornearly4yearsandduringthattimeTarohasseenitsEBITDA increasemorethan4x,soIviewtheoddsofSunpurposelytankingTarosbusinessasreasonablylow.And,ifyouareworriedaboutthis, youcanjustshortSun,whichisnotpricinginanymeaningfuldeclineinTARO sbusiness. WhatmathdidSunusetojustifytheir$39.50bidandwhythatmathiswrong: Sun&TaroarguethatTarosales&earningsarelikelytodeclineoverthenextfewyears,andvalueTarobasedon2013EBITDAof$232M.

MgmtForecast NetSales COGS(exD&A) GrossProfit SG&A(exD&A) R&D EBIT Forex IntInc PBT Tax NetInc EBITDA

2011A 505.7 162.1 343.6 89.2 30.9 223.5 6.9 2.6 227.8 24.6 203.2

2012E 573.6 180.8 392.8 92.5 53 247.3 0.2 0.8 247.9 47.3 200.6 267.3

2013E 535.4 177.1 358.3 93.0 53.5 211.8 0 2.1 213.9 38.1 175.8 231.8

2014E 514.3 176.1 338.2 94.1 51.4 192.7 0 2.7 195.4 33.1 162.3 214.7

2015E 491.6 174.9 316.7 95.1 49.2 172.4 0 3.2 175.6 27.8 147.8 194.4

2016E 498.2 178.3 319.9 97.5 49.8 172.6 0 3.3 175.9 27.8 148.1 194.6

Thesefinancialswereputtogetherbyan independent3 rd party inJune2012,andwerethebasisoftheTaroboardacceptingtheSunbid. Thesefinancialshaveprovedwoefullyinaccuratedespitebeingputtogethersorecently.With3monthstogo,Tarohasalreadydone249M inEBITDA andisonpacetodoapproximately345MinEBITDAthisyear.ConsideringthattheplanwasputtogetherneartheendofQ2, TarosestimateshavebeenwoefullyoffcomparedtowhatTaroisonpacetoactuallyachieve:

MgmtForecast NetSales COGS(exD&A) GrossProfit ValueInvestorsClub SG&A(exD&A) R&D EBIT

Mgmt H212 269.3 89.7 179.5 45.8 31.7 102.1

Runrate H212 321.9 79.3 242.6 40.0 21.9 180.8

Delta H212 52.6 10.4 63.1 5.8 9.8 78.7

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MgmtForecast NetSales COGS(exD&A) GrossProfit SG&A(exD&A) R&D EBIT Forex IntInc PBT Tax NetInc EBITDA

Mgmt H212 269.3 89.7 179.5 45.8 31.7 102.1 0.2 1.3 103.2 13.6 89.6 112.1

Runrate H212 321.9 79.3 242.6 40.0 21.9 180.8 0.0 0.8 180.0 35.9 144.0 190.8

Delta H212 52.6 10.4 63.1 5.8 9.8 78.7 0.2 2.1 76.8 22.3 54.4 78.7

It sworthnotingthatthefinancialswereoffinbasicallyeveryrespectpossible Saleswerelight,grossmarginswerelight,andSG&Aand R&Dwerebothtoohigh.UltimatelyTaroislikelytooutperformH2projectedEBITDAbyabout70%. Further,Tarosfinancialadvisormadeamultitudeofotherquestionablejudgmentintheirfairnessassessment,including: 1)Usingacompsetthatincludesnondermatologygenericpeers(lowerqualitybusinesseswithlowerbarrierstoentrythaninderm) 2)UsingaP/EbasedvaluationthatdidnottakeintoaccountTaros$8.50pershareofcash. 3)Citinga103%controlpremiumbeingpaidbySuntowhereTarowastradingnearlyayearago,beforeSun s$24.50offer,ratherthan citingthemostrecentpriceofTaro,whichwasactuallyaboveSun smostrecentoffer. IsTarosbusinessdecliningand,ifso,doesthatjustifySun sbid? Taro/SunclaimthatTaroisseeingvolumedeclinesinselectproducts,that2013EBITDAshoulddecline,andthattheirofferisfairona 2013basis.GivenhowwildlyinaccurateTaro sprojectionshavebeen,Idontseehowtheycanberelieduponforaccuracy.Let sassume foramoment,however,thattheyaredirectionallyrightandthatTaro s2013EBITDAwilldecline15%.ThatwouldstillgetustoEBTIDAof around300M,oravaluationof$62ontheFougeramultiple.IwouldnotethatFougerahasbeenbenefitingfromexactlythesameprice increases/limitedcompetitiondynamicthatTaroisbenefitingfrom,andstillreceivedan8xmultipleonTTMEBITDAdespitethoseconcerns. IwouldfurtherpointoutthatFougerahadnearly1/3 rd ofitsrevenueandEBITDAfromImmiquimod,whichhasseenitssalesdecline66% sinceSandozboughtit.ImmiquimodwasadrugFougerahad40%shareinandwhichwasfacingclearincreasedcompetition,andmusthave beenaccountedforinSandozsbidforFougera.Sodespitewhatwillalmostcertainlybelower2013v.2012EBITDAforFougera,Sandoz stillpaid8x. Idonotholdapositionofemployment,directorship,orconsultancywiththeissuer. NeitherInorothersIadviseholdamaterialinvestmentintheissuer'ssecurities.

Catalyst: Shareholderrejectionof$39.50offer Higheroffer

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