As one of the largest and longest-tenured shareholders of Given Imaging, we are writing to urge you to take two immediate actions for the sake of all shareholders; (1) implement a $50 million share repurchase or dividend to take advantage of the expiring “Trapped Profits Law”, and (2) pursue a subsequent sale of the Company to a larger strategic buyer that will recognize Given Imaging’s inherent strengths and value.

Given Imaging has until November 15, 2013 to elect to participate in the “Trapped Profits Law,” an amendment to Israel’s “Investment Law” which governs the taxation of the Company. The “Trapped Profits Law” will allow Given Imaging to take advantage of reduced corporate income tax rates while returning up to $50 million in excess cash to shareholders. We recommend that the Company utilize a fixed-price tender offer or Dutch Auction share repurchase to disgorge its excess cash, as opposed to a dividend, in order to capitalize on Given Imaging’s depressed share price. We expand on these alternatives later in this letter.

Immediately following the share repurchase, we also strongly urge the Board to initiate a comprehensive and complete process to sell the Company. Given Imaging has been chronically undervalued in the public markets during the past several years primarily due to mismanagement. As evidence, this letter will present four major areas in which management has squandered the fair value of the Company: (1) Failed Execution of Business Strategy; (2) Weak Financial Performance; (3) Loss of Management Credibility with Investors; and (4) Inefficient Capital Structure. Despite the mismanagement of the Company, we are not calling for a change in management. A sale to a strategic buyer is the most timely and compelling means of maximizing shareholder value. Excluding the impact of a potential share repurchase or dividend, our detailed valuation analysis shows that Given Imaging could reasonably achieve a value of $26 to $30 per share in a company sale.

Discovery Group invested in Given Imaging because of its transformative and disruptive technology, as well as the large untapped end-markets related to Crohn’s monitoring and colorectal cancer screening. However, we no longer believe the Company can attain its true intrinsic value in the public markets. By returning excess cash to shareholders and conducting a full auction process to sell the Company, the Board will remove the execution risk that we believe exists under the current management while providing shareholders with an attractive return.

Discovery Group is a long-time shareholder, initially investing in the Company in early 2011. We currently own approximately 4% of the common stock outstanding and have consistently been one of Given Imaging’s largest shareholders. We have maintained a high degree of interaction with the Company since our initial investment, including over 25 in-person meetings and conference calls with Mr. Homi Shamir, Chief Executive Officer and Mr. Yuval Yanai, Chief Financial Officer, and other senior management; two visits to the Digestive Disease Week trade show; conversations with representatives from IDB Holding Corporation, the Company’s largest shareholder; and due diligence calls with various GI physicians.

It is common for the public market to discount micro-cap companies relative to their inherent values since their small float, limited trading volume, and general lack of research coverage lead to low institutional investor interest. In Given Imaging’s case, we believe the discount is exacerbated due to mismanagement of both the business and investor expectations. Since the beginning of Mr. Shamir’s tenure as CEO the stock has declined approximately 10%, significantly underperforming the NASDAQ Composite during the same time period. Managements’ response to this fact is that Given Imaging is burdened by its location in Israel. However, the Company’s stock has also significantly underperformed the TA-100 Index of the 100 most highly capitalized companies listed on the Tel Aviv Stock Exchange.

●

The Company received updated clearance from the FDA for its PillCam SB capsule in March 2011, allowing it to be utilized in the monitoring of inflammatory bowel diseases such as Crohn’s disease. Despite increased sales & marketing activities, the impact on revenue has been minimal due to limited reimbursement and an inability to convince medical practitioners to adopt the technology. In the first six months of 2013, the number of PillCam SB capsules sold in the Americas region declined 5% compared to the same period in 2012.

In our conversations with management, they have placed the blame for the stagnant growth on the global financial crisis and its impact on procedure volumes. However, softer procedure volumes is an issue impacting the entire medical device industry. As demonstrated in the chart below, Given Imaging has severely underperformed the industry in terms of growth whether measured over the last one, three, or five years.

Management has also claimed that the longer reading times required by the PillCam SB hampered market adoption. While this may be true, management’s failure to achieve broad reimbursement is a significant contributor to the poor market adoption. Less than 20% of the U.S. population has coverage for capsule endoscopy of the small bowel for diagnostic re-evaluation of Crohn’s disease.

In their defense of the poor Bravo performance, management has again pointed to issues affecting the industry as a whole: (1) changes in Medicare reimbursement rates; and (2) limiting of payment for procedures performed in Ambulatory Surgical Centers as a result of the Affordable Care Act. The second rationale especially rings hollow since the change in payment did not take effect until the second quarter of 2013, well after the Bravo product had experienced a significant decline in revenue.

●

Given Imaging has long touted the market opportunity for PillCam COLON, particularly in the U.S. and Japanese markets. The Company initially communicated that a clinical trial for FDA submission would commence in the second half of 2010 with potential commercialization in 2012. The trial was ultimately delayed over a year from initial expectations. The Company and its shareholders are still waiting for FDA approval. Even if Given Imaging receives FDA approval in the near-term, management has indicated commercialization is several years away since the Company will need to first establish reimbursement coverage.


$ in thousands; FYE 12/31	Fiscal Years Ending
	2006		2007		2008		2009		2010		2011		2012

Revenue	$	95,029	$	112,868	$	125,108	$	141,763	$	157,809	$	177,955	$	180,501
Reported Growth		9.5%		18.8%		10.8%		13.3%		11.3%		12.8%		1.4%
Organic Growth		9.5%		18.8%		10.1%		2.1%		(1.3%)		9.3%		1.1%

Cost of goods sold		24,154		29,721		33,001		33,145		37,629		41,466		42,971
Gross profit		70,875		83,147		92,107		108,618		120,180		136,489		137,530
Gross margin		74.6%		73.7%		73.6%		76.6%		76.2%		76.7%		76.2%

Research and development, net of grants		10,811		16,448		18,296		16,733		20,218		25,016		24,188
% of sales		11.4%		14.6%		14.6%		11.8%		12.8%		14.1%		13.4%
Sales and marketing		50,732		55,446		60,902		61,428		67,114		75,014		76,272
% of sales		53.4%		49.1%		48.7%		43.3%		42.5%		42.2%		42.3%
General and administrative		16,027		20,981		19,320		18,919		24,452		23,078		22,746
% of sales		16.9%		18.6%		15.4%		13.3%		15.5%		13.0%		12.6%
Total operating expenses		77,570		92,875		98,518		97,080		111,784		123,108		123,206
% of sales		81.6%		82.3%		78.7%		68.5%		70.8%		69.2%		68.3%

Operating profit		(6,695)		(9,728)		(6,411)		11,538		8,396		13,381		14,324
Operating margin		(7.0%)		(8.6%)		(5.1%)		8.1%		5.3%		7.5%		7.9%

Management asserts that Given Imaging is unique in that it has a global infrastructure that no other comparably-sized medical device company possesses. In a detailed analysis of dozens of large and small medical device firms which we shared with management, we found no meaningful difference in their respective geographic breakdown of revenue when compared to Given Imaging.

The Company’s public market valuation has also been severely hampered by repeatedly mismanaging expectations with respect to future financial performance. Given Imaging has either missed guidance or revised guidance downward in five of the seven fiscal years that Mr. Shamir has been CEO. Just recently, the Company significantly missed its Q4 2012 guidance (roughly 15% revenue miss) and drastically underperformed expectations during Q1 2013.

Revision

% Below Initial

Date

Period

Measure

Initial Guidance

Revision

Actual

Guidance Mid-point

07/26/06

FY2006

Revenue

$110M - $120M

$92M - $97M

$95M

-17%

10/31/07

FY2007

Revenue

$114M - $119M

$109M - $112M

$112.9M

-3%

11/11/08

FY2008

Revenue

$130M - $136M

$125M

$125.1M

-6%

11/11/08

FY2008

GAAP EPS

$0.34 - $0.42

$0.25

$0.13

-66%

11/03/10

FY2010

Revenue

$167M - $174M

$154M - $157M

$157.8M

-7%

11/03/10

FY2010

GAAP EPS

$0.44 - $0.52

$0.18 - $0.23

$0.28

-42%

Management also publicized long-term P&L targets in 2011 that they now concede will be tough to achieve and significantly overpromised on the timing with respect to commercialization of the colonoscopy opportunity. Finally, after growing revenue only 4.3% in the first half of 2013, Given Imaging will need record revenue growth of 16.7% in the second half to hit the mid-point of its guidance. Based on recent history, we are expecting another disappointment.

This repeated history of not delivering on financial targets undermines the Company’s credibility with investors. In fact, during the past two years almost all of Given Imaging’s top-ten shareholders have either lowered or completely exited their respective ownership stakes in the Company. IDB Holding Corporation, which owns roughly 49% of common stock, also recently attempted to sell its stake.

Given Imaging is carrying an excessive amount of cash on its balance sheet, approximately $130 million or 21% of the Company’s market capitalization. The excess cash is especially acute when considering Given Imaging routinely generates annual operating cash flow in excess of $20 million. Carrying a large cash balance implies a lack of management confidence in future performance and/or a lack of regard for shareholder resources.

		Share		Market		Enterprise									Net Cash /
Company	Ticker	Price		Value		Value		Cash		Debt		Net Cash			Market Cap

Given Imaging Ltd.	GIVN	$	19.21	$	608.1	$	479.1	$	130.3	$	1.2	$	129.0			21	%

Large Cap Med Device
Johnson & Johnson	JNJ	$	86.73	$	244,411.5	$	242,908.5	$	25,481.0	$	23,978.0	$	1,503.0			1	%
Abbott Laboratories	ABT		33.14		51,503.7		56,017.3		9,651.9		14,073.9		(4,422.0	)		-9	%
Medtronic, Inc.	MDT		53.00		52,865.8		51,644.8		12,416.0		11,195.0		1,221.0			2	%
Covidien plc	COV		60.96		28,041.5		30,998.5		2,119.0		5,076.0		(2,957.0	)		-11	%
Stryker Corporation	SYK		67.65		25,580.6		23,637.6		4,714.0		2,771.0		1,943.0			8	%
St. Jude Medical Inc.	STJ		52.39		15,046.0		17,289.0		1,610.0		3,613.0		(2,003.0	)		-13	%
Zimmer Holdings, Inc.	ZMH		82.30		13,953.9		14,390.1		1,255.6		1,688.1		(432.5	)		-3	%
Intuitive Surgical, Inc.	ISRG		367.46		14,591.8		11,761.3		3,027.2		196.7		2,830.5			19	%
CR Bard Inc.	BCR		115.74		9,161.2		9,774.8		869.5		1,483.1		(613.6	)		-7	%
Edwards Lifesciences Corp.	EW		68.79		7,723.3		7,353.7		596.9		227.3		369.6			5	%

						Mean		$	6,174.1	$	6,430.2	($	256.1	)		-1	%
						Median		$	2,573.1	$	3,192.0	($	31.5	)		-1	%

Small Cap Med Device
DexCom, Inc.	DXCM	$	27.23	$	1,943.6	$	1,904.9	$	46.4	$	7.7	$	38.7			2	%
Thoratec Corp.	THOR		36.92		2,123.9		1,850.7		273.2		0.0		273.2			13	%
Volcano Corporation	VOLC		23.68		1,292.7		1,198.8		500.9		407.1		93.9			7	%
Endologix Inc.	ELGX		15.98		1,008.8		969.0		39.8		0.0		39.8			4	%
Abaxis, Inc.	ABAX		41.47		925.6		824.9		106.5		5.9		100.6			11	%
Luminex Corporation	LMNX		20.12		832.8		793.5		48.1		8.7		39.4			5	%
ABIOMED, Inc.	ABMD		18.75		709.6		624.8		88.8		4.0		84.8			12	%
MAKO Surgical Corp.	MAKO		29.48		1,386.4		1,330.0		67.1		10.7		56.4			4	%
The Spectranetics Corporation	SPNC		16.61		678.1		560.7		119.4		1.9		117.4			17	%
AtriCure, Inc.	ATRC		10.96		229.9		202.4		34.9		7.4		27.5			12	%

						Mean		$	132.5	$	45.3	$	87.2			9	%
						Median		$	78.0	$	6.6	$	70.6			9	%

After patiently waiting several years for better management performance and for Given Imaging to achieve its potential in the public markets, we feel the time has arrived for the Board to take decisive action. To remedy the situation, Discovery Group strongly recommends that the Board take the following steps to achieve the Company’s true intrinsic value: (1) stop hoarding cash and instead return the capital to shareholders; and (2) conduct a comprehensive and competitive sale process to solicit bids for the Company.

Step 1 – Share Repurchase: The Company should utilize the “Trapped Profits Law” to return $50 million to shareholders. Even with the one-time tax payment of 10%, either a dividend or a share repurchase is preferred to the current capital structure. At the very least, it guarantees a partial return of capital to shareholders in the event management and the Board fail to consummate a sale.

Our preference is for a fixed-price tender offer or Dutch Auction share repurchase, with either option having numerous benefits. A share repurchase allows individual shareholders to decide whether or not to participate. For those that choose to participate and sell shares, it reduces their respective risk and provides capital to invest in competing opportunities. For those shareholders that choose not to participate, a share repurchase accretes their ownership position, resulting in a higher return when the Company ultimately pursues a value recognition event such as a change-of-control.

It is important to note that we are not advocating a share repurchase plan with the hopes of increasing Given Imaging’s stock price. Instead, we are calling for a more efficient capital structure which will optimize the financial return in a change-of-control transaction. In an eventual sale of the Company, acquirers will not pay a premium for excess cash sitting on the balance sheet. Therefore, the overall reported premium paid for Given Imaging would be low unless the excess cash is disgorged.

Step 2 – Proper Change-of-Control Process: Given Imaging ran a sale process in late 2012 and early 2013 at the behest of IDB Holding Corporation that we believe was limited in scope and half-hearted. Considering the circumstances – IDB Holding Corporation’s perceived financial condition, recent history of guidance misses, pending regulatory approvals – we agree with management that the timing was not ideal. However, we believe the proper time for an earnest sale process is now upon us.

Given Imaging recently received regulatory approval for PillCam COLON in Japan and is anticipating reimbursement coverage in early 2014. The Company received FDA approval and Japanese regulatory approval for the PillCam SB3 in August 2013 and September 2013, respectively. The Company is also expecting FDA approval for PillCam COLON prior to year-end. Once Given Imaging receives this final regulatory approval, it should conduct a full and thorough auction, which will allow an efficient market to develop for the Company’s true value. This process should include both direct competitors and additional medical device companies, as well as pharmaceutical companies that already focus on the gastrointestinal and/or oncology markets. It is imperative for the Board to recognize that a change-of-control transaction will eliminate the execution risks that have repeatedly plagued Given Imaging in the past several years.

The differential between the Company’s current value and a potential change-of-control value is significant. As shown in the table below, which excludes the impact of our proposed share repurchase, Given Imaging could reasonably achieve a value of $26 to $30 per share from a strategic buyer. This valuation is comprised of two elements: roughly $22 to $26 per share for the existing business, and a potential incremental $4 per share for the Crohn’s and colonoscopy opportunities. At the mid-point, the expected change-of-control value equates to a 45+% premium to the current stock price and almost 6.0x the Company’s LTM Gross Profit.

We believe a change-of-control transaction provides an attractive value for shareholders while also eliminating continued execution risk. It is important the Board maintains a realistic view of the amount a strategic buyer is willing to pay. As discussed earlier, a strategic buyer will only pay 100 cents on the dollar for cash on the balance sheet. In addition, a strategic buyer will unlikely pay full value for the Crohn’s and colonoscopy market opportunities as it will be implementing the commercialization strategy and bearing the corresponding risk.

Discovery Group believes that Given Imaging possesses best-in-class technology and participates in a market that has significant long-term growth potential. However, it is our strong opinion that the Company has been mismanaged and its intrinsic value will not be recognized in the public markets. By returning excess capital to shareholders and engaging in a competitive sale process, shareholders will achieve an outcome that we believe is far superior to, and presents significantly less risk, than the status quo.

We have held discussions with potential strategic buyers. Consistent with our observations, these companies recognize the same missed opportunities and failed management. Most importantly, the strategic buyers also recognize the compelling opportunity which still exists and are eager to participate in a formal and legitimate sale process. Absent the commencement of a share repurchase and proactive sale process, Discovery Group will withhold support for the Board, management, and approval for matters put to proxy votes and will urge other shareholders to do the same.

	Average Revenue Growth
	1-Year			3-Year			5-Year

Given Imaging (reported growth)		1.4	%		8.5	%		9.9	%
Given Imaging (organic growth)		1.1	%		3.0	%		4.2	%

U.S Exchange-Traded Medical Device Companies (Market Cap > $100M: 91 Companies)
Top Quartile		16.5	%		17.6	%		16.0	%
Median		9.7	%		11.1	%		9.8	%
Bottom Quartile		2.6	%		5.1	%		4.8	%

Source: Capital IQ

	Mark Buckley
	1 312 265 9607
	mbuckley@thediscoverygroup.com