Last month’s article, Lessons from Medtech, looked at certain investment characteristics of invasive medtech companies and considered how these might be attractive to other life science and healthcare companies, particularly biotech. Chief amongst these was building revenues and profits, early into the business plan, and hopefully over time building these into a steadily growing earnings per share (EPS) base to justify solid valuations. This follow-on article highlights several non-invasive medtech companies and life science supplies companies with similar traits. And, it considers, do these traits lead to other benefits with investors and for exits?
The industry sectors considered include diagnostics, picks and shovel companies (e.g. instruments, tools) and suppliers of kit and reagents for commercial and research purposes. As before, the search started with looking for US listed companies with certain attractive investment characteristics. These included a high return on equity (ROE), strong balance sheet with low debt, and a history of positive and steady upwards earnings growth over a decade. This was then overlayed with a requirement for reasonable or low valuation, thereby capturing both growth and value elements.
The companies that made the cut were: AmerisourceBergen (NYSE: ABC); Haemonetics (NYSE: HAE); IDEXX Laboratories (NASDAQ: IDXX); Johnson and Johnson (NYSE: JNJ); Kinetic Concepts (NYSE: KCI); Life Technologies (NASDAQ: LIFE); McKesson (NYSE: MCK); Patterson Companies (NASDAQ: PDCO); ResMed (NYSE: RMD); and Henry Schein (NASDAQ: HSIC). Two slight anomalies from this group include KCI which only has data from 2002 and LIFE which actually had negative earnings in 2001 but began its upward trend from then (though neither of these detracts from showing EPS growth over time). The link below goes to a graph of the 10 year earnings of the highlighted companies:
The compound annual growth rate (CAGR) of EPS for these stocks ranged from 10% from HAE through to 27% for both KCI and LIFE, with a mean average of 17% (Note, these are not CAGRs for stock performance, but still present quite impressive fundamentals. Also, growth rates for LIFE were calculated from 2002, the first year in the period with positive EPS). These stocks were then reviewed to identify opportunities which were also good value at current prices (based on PE ratio, EV/EBITDA, and PCF) highlighting LIFE which I added to my portfolio. LIFE was formed from the merger of Invitrogen and Applied Biosciences in November 2008. Its business focus is providing tools, reagents and services for the life sciences research market (both scientific and commercial). The other stocks from the screen were added to a watchlist since they have already exhibited growth and quality factors. Then it’s just a case of being patient and waiting until specific value situations present themselves.
Importantly, as with invasive medtechs highlighted in the previous article, none of the companies in this group are dependent on binary type events affecting a small number of assets. They’ve each been selling products or services into a commercial marketplace from very early on in their respective histories. This commercial reality forces a company to focus on not just what is a potentially great idea, but actually test it in the market and see what’s selling; What will cause customers (whether patients, healthcare providers or pharma) to part with cold, hard cash?
There’s no reason why biotechs cannot act in the same way. Admittedly, they may not have a rich pipeline of products to offer early on, but core expertise can still be monetized in multiple ways. Early on in life, biotechs can use multiple sources of non-dilutive funding (also useful as a proxy for commercial market testing) and fee-for-service or risk shared collaborations on non-core programs. Other creative ways of getting much further on less include developing assets as far as possible in a pre-company (academic or other company) environment so that while the company may be new, the assets may have significant development work behind them already (this will be discussed in a future blog on frugal innovation). Perhaps biotechs could adopt a new industry mantra? “De-risk, validate, repeat”.
For a deeper view on investor challenges within biotech, why the industry has gotten so cash hungry, and what it can do to reverse the trend, Bruce Booth (Atlas Venture and @LifeSciVC) has written a simply excellent piece: “Culprits of Biotech’s Malaise: Let’s Also Look in the Mirror”.
Finally, a new development occurred this month with one of the selected watchlist companies, Kinetic Concepts. KCI develops and markets woundcare and regenerative medicine products with sales of $2billion and earnings of around $300 million and growing. The company was highlighted in the previous article as being subject to a private equity bid from ConvaTec that ultimately fell apart due to financing pressures, though its valuation held up fairly well due to its robust revenues and earnings. However, KCI is now working out a new financing deal to enable a leveraged buyout to proceed with the original private equity bidders including Apax. This again highlights the value of having strong revenues and earnings growth – both from a valuation perspective and by providing alternative options with new investors (both financial and for M&A). It’s also raises a question to all involved in trying to build great companies with scalable products: Is it enough just to build a great asset to sell – Or should the focus be on building a great company (with earnings growth) and then the buyers will come?
Related article: Lessons from Medtech?
Nothing in this post is an investment recommendation. Investors should do their own research.
This post was written by Raman Minhas. Raman is the CEO of ATPBio, a consultancy providing business development and corporate development support to biotech and medtech.