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Carl Icahn is Increasing His Stake in Forest Laboratories

In the past two weeks, activist investor Carl Icahn has purchased nearly 420,000 shares of Forest Laboratories, Inc. (NYSE:FRX) worth a total of $14.5 million. The transactions, which occurred in seven separate Form 4 filings with the SEC, are part of a larger bullish trend over the past month. Since August 17th, Icahn has increased his position in the pharmaceutical company by 13.9%, and currently holds $1.05 billion of Forest Laboratories’ outstanding shares.


Icahn’s most recent round of purchasing activity comes on the heels of a slight victory in his ongoing fight against Forest Laboratories’ existing management. In a vote early last month, the company’s shareholders reelected nine of ten board members, giving the tenth spot to Icahn’s nominee, Pierre Legault. The election of Legault, though not the four spots Icahn had originally wanted, still represents an improvement over last year’s vote, which yielded a zero percent success rate.

In an announcement made shortly after the voting results were tallied, Icahn mentioned his satisfaction in the shareholders’ decision, proclaiming that he was “very pleased with the tremendous support that [his] nominee” received. The magnate also added that he was surprised with the victory, emphatically stating in that Forest Laboratories’ “proxy system is set up in such a way that the deck is stacked heavily in favor of incumbent management.”

Since Icahn’s statement, which was made two days before his bullish Form 4 fillings began coming in, shares of Forest Laboratories have risen a modest 2.8%, outpacing peers like Pfizer Inc. (NYSE:PFE) and Teva Pharmaceutical Industries Ltd (NYSE:TEVA), which have each returned 0.3%.

Despite these gains, the company is still heavily undervalued, as it trades at a Price-to-Earnings ratio (12.1X) below the industry average (25.2X), Pfizer (20.6X), Eli Lilly & Co. (NYSE:LLY) at 12.9X, and Allergan, Inc. (NYSE:AGN) at 26.1X. More importantly, Forest Laboratories’ earnings valuation is also below its own 5-year (12.6X) and 10-year (18.7X) historical averages. In fact, over the past decade, the pharmaceutical company’s bottom line has traditionally traded at an 11% premium over the S&P 500. This year, earnings are much cheaper, trading at a 19% discount.

This undervaluation is also prominent when analyzing Forest Laboratories’ operating cash flows, which have grown by a solid (13.2%) but not spectacular rate over the past three years. The company’s stock sports a Price-to-Cash Flow ratio of 8.1X, which is below the industry average (14.0X), Pfizer (11.2X), Teva Pharmaceuticals (9.3X), Eli Lilly (8.4X), and Allergan (20.6X). In comparison to historical averages, a similar picture is painted.

Now, it’s important to realize that Forest Laboratories is still recovering from the loss of its patent on antidepressant drug Lexapro, but a strengthening cast of FDA approvals – most notably its Alzheimer’s drug Namenda – warrants investors’ optimism. The company’s most significant drug in its pipeline is Cariprazine, an antipsychotic drug that can be used for the treatment of schizophrenia and bipolar disorder. The drug is currently in Phase III development.

It appears that the Street has a shared confidence in Forest Laboratories’ future prospects, as analysts are expecting the company to finish 2012 with earnings of $0.70, before hitting the $1.56 mark by the end of 2013. If these year-ahead forecasts are met, fairly valued shares of Forest Laboratories can flirt with $40 a share in the next 12-16 months. They currently trade in the $35 range.

Aside from Carl Icahn, other hedge fund managers that are bullish on Forest Laboratories include Jim Simons, Ken Griffin, Israel Englander, and Cliff Asness. Of these four managers, Simons has employed the largest position in the company, holding $54.7 million worth of Forest Laboratories’ stock. Here’s a full list of the hedge fund industry’s interest in the pharmaceutical company.

To recap: Carl Icahn has been increasing his stake in Forest Laboratories in recent weeks, a move that is likely the result of the magnate’s victory in a boardroom election earlier last month. Shares of the company have responded favorably to the news, and can still provide individual investors with future price appreciation, assuming that year-ahead earnings estimates can be met.

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