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Published: May 14, 2010
"Is it safe?" Those famous words repeatedly
uttered by Laurence Olivier in the 1976 thriller Marathon Man
are always on the mind of Food and Drug Administration (FDA)
regulators. In fact, the FDA mandates that any drug undergoing
clinical testing be assessed for its impact on the human heart.
And for many drug companies, eResearch (Nasdaq: ERES) has
the solution. The company is the leading provider of software
and hardware that monitors cardiac reactions to new, un-tested
drugs.
But management realized that this business, though
highly-profitable, had its limits. After all, the volume of new
drugs being tested each year is static, which explains why
eResearch’s revenues have stayed just north or south of $100
million for the last six years. The solution: use the cash
generated by the heart-testing business to acquire companies
that provide unrelated clinical test services.
During the past few years, eResearch has made a few small deals
to broaden its offerings, but earlier this month it pulled off a
far more significant deal. The company will pay $81 million, or
8.4 times trailing
earnings before interest, tax, depreciation and amortization
(EBITDA), in cash to acquire the research division of
CareFusion (NYSE: CFN). The unit, which had $50 million in
revenues last year, offers respiratory monitoring services in
drug development trials. The division was something of a
neglected child at CareFusion, which otherwise solely focuses on
the healthcare market. eResearch’s focus on the clinical testing
market should provide greater management attention to this
acquired business.
The key here is how the deal was paid for. eResearch’s hefty
cash balance will fund almost the entire deal, which means that
no new shares will need to be issued, and little debt incurred.
That’s why management, after integrating the acquisition in
2010, expects to sharply boost profits in 2011. Equally
important, eResearch has a broader suite of services to sell to
existing customers and gets to enter into the $1.3 billion
respiratory market.
Even as management finesses the newly-acquired business, the
core business is perking back to life. The company booked $40
million in new orders in each of the past three quarters, and
backlog now stands at a record $183 million. That should
help the core cardiac testing business grow nearly +10% this
year and next, as backlog is converted into sales. Including the
acquired revenue base, eResearch is on track for more than $150
million in revenue by next year, even if neither company were
growing. But the acquired CareFusion division is growing at a
+30% pace this year. (The deal should close mid-year, so only
half of that acquired revenue will be reflected in this year’s
results).
Analysts have already begun to raise their
2011 profit forecasts, which increasingly look set to exceed
$0.50 a share. That would be the best showing since 2004. The
deal is expected to generate $6 million to $10 million in annual
expense savings, half of which will be taken in 2011, and the
remainder in 2012.
Notably, analysts can’t yet forecast any real sales synergies
between the two companies, but cross-selling opportunities are
expected to be pursued by 2011. Coupled with the cost cuts, 2012
per-share profits could exceed $0.60. That projected +20% profit
growth stands in contrast to shares trading around 13 times that
2012 projection.
Looked at another way, shares trade for around 5.0 times
EBITDA, on an
enterprise value basis. Clinical research firms such as
Covance (NYSE: CVD) and PPDI (Nasdaq: PPDI) trade for
about eight times projected 2011 EBITDA, according to analysts
at Auriga Research.
Most important, most of eResearch’s revenue base is recurring in
nature, and the
business model is not dependent on the vagaries of the
economy. In response to Mr. Olivier’s question, yes, it’s safe.
-- David Sterman
Contributor
StreetAuthority |
