Motivated by the recent LBO of IMS Health by TPG (the private equity group) and Canada Pension Plan, here’s an excerpt from our Q3 2009 report in which we discussed the company. We had been looking at it at least since 2007, when we started to look at the healthcare industry globally. Right after our text we link to other interesting articles on the deal.
IMS HEALTH
IMS is another global business (nearly two thirds of its revenue come from outside of the U.S.) focused on information and intelligence on the health market, mostly the pharmaceutical industry. Its main products are information on prescription, sales and the market share of medical drugs, which can be sorted by micro- geography, medical specialty, distribution channels and other criteria. Its main customers are pharmaceutical laboratories worldwide such as Pfizer (the largest customer accounting for approximately 5% of revenues) and biotechnology startups. It is the leader in this global business and sells more than USD2 billion per year.
The nature of this business brings many desirable features:
– It requires little capex. The company has less than USD200 million in physical assets (net of depreciation).
– Very high barriers to entry. Gathering detailed information globally is a tough task. The way this information is organized, the statistical treatment and the training for its interpretation and use, and the trust conquered during 50 years make a big difference.
In addition, the company features positive financial data:
– During the past eight years the company repurchased its shares aggressively, reducing the outstanding figure from 300 million to 180 million. The average price of these acquisitions was nearly USD18 – already adjusted to possible dilutions. Considering that the trading price in the period stood between USD15 and just over USD30, the acquisitions were made at a good price. The practical effect is that those who held their shares increased their participation in future earnings at good prices. (On September 30 the price was USD15.35).
– In general, between 2001 and 2008 the company:
— Generated USD2.8 billion of cash from operations
— Invested USD1.5 billion in its own business (investments + acquisitions + software), managing a USD1.2 billion increase in revenue (productivity of approximately 75% in a business that has on average 15% to 20% cash margin).
— Paid nearly USD2.3 billion to shareholders, of which USD2.1 billion was paid through repurchases (net of issuances) and USD170 million in dividends.
— The difference was “settled” in a debt increase amounting to approximately USD1 billion. It is important to note that this is a long-term financing at a low cost and with comfortable guarantees, which is payable with the company’s cash generation.
— The Enterprise Value (shares’ market value + net debt) was USD8 billion in 2001. Today it is USD3.5 billion. Meanwhile, earnings and cash generation more than doubled from USD130 million to USD310 million, and from USD190 million to USD450 million, respectively.
Obviously, such data leads us to think that something could be wrong. What is the “counter-case”?
We have been investigating this closely, contacting the company in the U.S., its offices in Brazil and their clients. We have also hired consultants that specialize in the sector. We identified four main points:
First, the turmoil in the health sector, particularly in the U.S. That is a fact, but the impact is not negative and perennial on all the participants. Given the projected changes for the sector, it is valid to think that information is highly valued in turbulent markets.
On one hand, the big pharmas are the largest clients (and these will lose their billion-dollar contribution of many blockbuster drugs in the next 3 years), on the other IMS has thousands of them, with annual revenue per client averaging more than USD500 thousand. Its clients include most producers of generic drugs and many promising specialty manufacturers in areas such as oncology, in addition to many regional companies (small and medium-sized) in emerging economies that have grown faster than the giants in more mature markets.
There is an interesting point, balancing the lack of visibility in the U.S. health policy. The company’s largest shareholder is Ariel Investments, with a stake amounting to approximately 7% according to the most recent available information. An article published in the Wall Street Journal shortly after Obama’s election is worth remembering: “Tuesday’s election transformed John Rogers from an obscure money manager who eats at McDonald’s every day into a confidant of the world’s most-powerful man, come January. Mr. Rogers is chairman of Chicago-based Ariel Investments, the largest African-American-owned investment firm in the country… Mr. Obama spent Wednesday – his first day as president-elect – at Ariel’s downtown Chicago office, huddling for six hours making calls and planning.” Ariel’s stake in IMS is the sixth largest in its fund, and it keeps growing while the five largest decrease.
Second, we identified that the company is trying to accelerate growth by creating more customized, higher value-added services, in line with the track record of the top management, who came mostly from IBM. However, the success of this initiative has been small, so far. The company hasn’t yet netted large, strategic contracts, in line with “helping companies use the precious data it supplies to jointly develop global market strategies”. But given current prices and implicit multiples, not only are investors not paying for the project but there is also a discount due to the risk of value destruction.
We are still unconvinced about this issue. Today this is where we allocate most of the margin of safety, which we believe that exists in the shares’ price.
Third, we have the omnipresent technology risk. Theoretically, the dissemination of online systems could be a threat. And they certainly are. E- prescription programs, where doctors prescribe through systems that are integrated with pharmacies, can facilitate competition. However, “facilitate” may sound like an euphemism. In fact, it would make possible something that was previously deemed impossible. But we have serious doubts whether it is feasible. Also, obtaining the data is just part of the story. Having the clients and getting them used to the products and standards is different. The more ambitious IT programs in the health sector have so far failed in terms of results (in general that is a great business for suppliers). We will get there one day, but we have lower expectations than the market in general. Barriers are not only technological. They have to do with semantics, standards, and processes. In the end, they are linked to interests, incentives and cultures. And as we know, that is much more difficult to change.
Ultimately, an annoying, albeit not eliminatory aspect is the low level of insider ownership. The company doesn’t have a clear owner, although some of its main executives have a relevant part of their net worth committed to IMS. This has an obvious impact on business and it would not be reasonable to expect from the company a level of commitment and focus as seen at AB InBev, for example. On the other hand, this has been the case for years. And while some benefits of a more incentives-prone structure are lost, we do not find evidence of this being something harmful, as seen in many other cases. Conversely, the considerable repurchase of shares throughout the years is nothing short of surprising under these conditions. Once again, the size of the position in Ariel Investments is an upside. Even if it does not act proactively as a controller, it certainly soothes risks linked to a potential agent conflict on the part of the executives.
(…) In addition to all the issues above, the market may be exaggerating the uncertainties in the U.S. market because the company is headquartered there, although this business is global. (…).
LINKS
With IMS Deal, Healthcare is Back on Top – WSJ’s Private Equity Beat blog
How do You Get Out of IMS Health – Barron’s (on what could be TPG’s exit strategy – independence is a very important feature of IMS’s business model, so pharma cies. are out of the picture. But who said TPG won’t try to go public with IMS in a few years?)
Tags: deal, Healthcare, imshealth, ipreports, lbo, privateequity, report, rx
