Hologic’s acquisition of Gen-Probe for $3.8 billion was first reported in April and closed two days ago on 1st August. Was it a good deal for investors, and who did well from it?
Emphasizing both strategic and financial rationals, the press release states that by acquiring Gen-Probe, it will be able to:
“…capitalize on the fast-growing molecular diagnostics market.”
and also states the deal has:
“…attractive economics and is expected to be $0.20 accretive to Hologic’s non-GAAP adjusted earnings per share in fiscal 2013 and significantly more accretive on a non-GAAP basis thereafter.”
So, good news all round, for both Hologic and Gen-Probe shareholders? Maybe. Of course, press releases are designed to be positive and give a warm fuzzy glow. But as you well know, there’s usually more to the story. And so there is here too.
On the face of it the strategic rationale does make sense. Two diagnostics players joining forces – one with sales and distribution reach and existing product portfolio (Hologic) and the other (Gen-Probe) with a fast growing molecular diagnostics platform that could be further monetized through the buyers existing sales channels.
But what I really want to focus on in this post is the financial rationale. And in particular the phrase from the press release “…expected to be $0.20 accretive to Hologic’s non-GAAP adjusted earnings…”
When I first read the press release, without knowing really much about the deal, the statement about being earnings accretive screamed “look at me!” – I had to check it out.
Frequently, when a large buyer acquires a company for a strategic fit, citing fast growth markets, you usually expect them to pay a strategic buyer’s premium. Benefits for strategic buyers can include: the markets like growth stories (acquisitions are usually an easier route for large companies than organic); potential leverage through existing resources (e.g. sales channels); and even less sexy possibilities like cost synergies can help (these are included in the release too, indicated at $75 million within three years).
Diving into the numbers, Hologic’s presentation on announcing the deal suggests these are attractive, with margins over 30%:
The presentation also highlights that Gen-Probe has had a consistent compound annual growth in revenue and earnings before interest, depreciation and ammortization (EBITDA) of 9.4% and 9.5% respectively (from 2007-2011). That’s a healthy (rather than spectacular) growth rate, particularly if it lasts going forwards.
What interests me though, as an investor, is to think about how value was affected for shareholders in both Hologic and Gen-Probe. The following graph (Yahoo! Finance) shows what happened to Hologic’s share price and market capitalization pre-announcement, around the announcement, and after closing.
The share price fell 23% from $21.23 on April 27th (black arrow) to a low of $16.32 on June 1st, then bounced back to $18.83 on August 2nd (green arrow), one day after the acquisition completed. I’m assuming the number of shares issued stayed the same, at 264.61 million shares (the deal was an all cash and debt transaction, no mention noted of new share issues as part of deal). Based on this, the market cap suffered the same fluctuation, going from $5.62 billion on April 27th, to a low of $4.32 billion, then back up to $4.98 billion by August 2nd.
At its lowest point, nearly 5 weeks after the announcement, Hologic investors had lost some $1.3 billion in value. Even as the deal was consummated and the share price rose, market cap had still fallen some $640 million from pre-deal levels.
While it’s good to look at market cap, it’s much more interesting to look at enterprise value (EV) and EBITDA. The measure of EV/EBITDA gives us a view of what the deal valuation looks like to a buyer, and is irrespective of how much debt or cash is used in the transaction.
The following table shows these numbers – EV, EBITDA and the EV/EBITDA multiple (derived from SEC filings and Yahoo! Finance):
What do these numbers tell us? Well, they’re actually much more useful than saying earnings will be accretive by $0.20. It shows us the valuation fell post announcement (we’ve seen that already). It also shows us that Gen-Probe, at the buying price of $3.8 billion, was valued at more than double the EBITDA multiple for Hologic pre-annoucement. EV/EBITDA is a well-used measure of valuation. So, on this basis Gen-Probe’s valuation is twice as expensive as Hologic’s.
That’s a bit like saying $10 of Hologic would give you $1 earnings, while $10 Gen-Probe, would yield only $0.50 (granted, we’re talking EBITDA not net earnings, but useful as a truer measure of valuation not distorted by capital structure). Or looked at the other way, to buy $1 of earnings from Hologic would require $10 investment, versus $20 investment into Gen-Probe.
This is why I highlighted the statement about earnings accretive at the start of this post. Generally, in mergers and acquisition, a transaction will be earnings accretive if it adds to the earnings per share value, and dilutive if it reduces the earnings per share value. Some definitions inaccurately describe a transaction as being earnings accretive only when the price-earnings ratio of the acquiree is lower than the buyer (i.e. a cheaper valuation).
So, the implication of stating that a transaction is earnings accretive, is that shareholders of the acquirer are getting a good deal (i.e. buying a company with a lower earnings multiple). Don’t just accept such a statement at face value. As demonstrated above, this is not always the case. Look into the numbers, check out the EV/EBITDA multiple, and see if the story changes.
How much debt?
What’s also interesting is that Hologic have used $2.5 billion in new debt to pay for the transaction, with additional facilities if required. And it must have used a considerable amount of cash from its own balance sheet to make up the $3.8 billion purchase price.
I’m not saying this is necessarily bad for Hologic. But $2.5 billion in new debt (the company already had $1.54 billion in debt and $905 million cash and equivalents pre-transaction, giving a net debt load of $635 million) is a big burden for a company which has annualized EBITDA of $822 million.
Even if the Gen-Probe business continues to grow EBITDA at over 9%, in the next year it only adds around $18 million in 2013, and an additional EBITDA of around $100 million by 2017 (this is the time the first tranche of debt of $1 billion is fully payable; the second tranche, with current draw-down of $1.5 billion, is payable by 2019).
How good is a deal if it saddles the acquirer with huge debt in order to complete it?
Winners and (maybe) winners…
Back to our question at the start of this post: Was it a good deal for investors and who did well from it?
- Shareholders in Gen-Probe did very well. They got an all cash transaction at a rich EV/EBITDA mulitple of 20x (typically, private equity buyers pay for 7-10x). Management built a sound case, good technology and positioned it well. By being in a sweet spot for a strategic buyer, they achieved a very strong valuation. A good case history for any entrepreneur (diagnostics, medtech or broader).
- For Hologic shareholders, the case is less clear. Hologic may well be getting a good deal with Gen-Probe. If the growth plans, operational synergies and cost savings play into their favor as described, it could end up being a good long-term transaction. Maybe even one that transforms the company’s future. I hope it is. But Hologic shareholders paid a full price for Gen-Probe. A lot has to go right for it to work out well. Now all eyes are on Hologic’s management and board to see how well they make it work.
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This post is by Raman Minhas. Full disclosure: the author does not own shares in Hologic at the time of writing.