For all investors, the key to success, is to buy an asset which is priced at less than its intrinsic worth. This applies whichever style of investing one considers – either value or growth. In "The Warren Buffett Way" by Robert G. Hagstrom, Buffett even goes as far as stating
that the difference is irrelevant:
"Growth and value investing are joined at the hip, says Buffett. Value is the discounted present value of an investment's future cashflow; growth is simply a calculation used to determine value".
Turning to a company highlighted in the ATPblog in May 2008, Kinetic Concepts (NYSE: KCI), I wrote about the Perils of M&A: Overpaying. In it was described why the acquisition of LifeCell Corp didn't make great sense for existing investors in KCI. Before the announcement was made, KCI's share price was around $50 in April 2008, had fallen to around $38 at the time of writing, hit a low of just over $18 in Dec 2008, and is currently at $27. This was accompanied by a fall in market cap from around $3.4 billion in April 2008 to $1.9 billion today – quite a drop, especially when you consider that LifeCell's market cap was $1.7 billion at the purchase price.
So, effectively this means the combined companies market caps were $5.1 billion pre-merger announcement, and down over 60% now to $1.9 billion as a combined entity. Sure, this also includes a large amount of debt taken on by KCI to fund the acquisition, so it's less severe when considered from an enterprise value perspective (try telling that to KCI investors) but still a big drop. And not all due to the recent credit crunch.
But where does this leave us now? Well, all of a sudden, KCI has both value and growth elements as a stock. On the value side, the shares are cheap with a forward P/E ratio at a very lowly 6.5x for full year 2010 (other value metrics are also cheap for the sector: price to book of 1.99x, price to sale of 1.00x). And yet, the story is one of growth opportunity with the newly acquired LifeCell providing future fillip from the regenerative medicine division. The return on equity (ROE) is also very respectable, projected at over 20% for both 2009 and 2010 – often the hallmark of a growth share. Infact, combining such metrics to find "good companies at bargain companies" can be a very powerful approach (as documented in Joel Greenblatt's "The Little Book That Beats The Market"). Potential pitfalls to still consider are that debt levels remain high, due to the debt used to fund the acquisition, though these trending in the right direction and are being paid off year by year.
So, in summary, there's still a long way to go for KCI investors who were in before April 2008, but perhaps the combination of the acquisition and the recession has created a fresh opportunity for new investors? As Buffett says, one where growth and value are "joined at the hip". And while we are in no way in the business of predicting the kind of stock collapses that have contributed, picking off individual situations can make for interesting opportunities. All good things come to those who wait…
(NB. Do your own research, and nothing in this blog is an investment recommendation).
This article was written by Raman Minhas. He is CEO of ATPBio, a consultancy firm providing strategic insight and transaction support to the life sciences industry.