The company is a $10 billion enterprise that caters mainly to the life sciences (drug development) and industrial markets. Thermo is not dear to us for its state-of-the-art technology (albeit it does sport a couple of interesting high-end divisions in mass spectrometry and specialty diagnostics), nor for its powerful distribution channel drawn from the Fisher acquisition in 2006 – it’s for the combination of both strengths (the acquisition was largely misinterpreted by the markets at the time).

The article talks about the company’s definitive entry into the Brazilian market with sales force of its own and technical support staff, aiming at customers in mining, steel, oil & gas. This is an extension of Thermo’s global distribution network and a good opportunity for the company in high-growth emerging markets. The possibility of a future domestic manufacturing operation was also discussed. This could mean a great move on a country with such high import barriers for high-priced goods.

Links:

We’ve mentioned Thermo quite briefly here on Buysiders as it was one of the “picks and shovels” ways to play the increased healthcare spending trend.

The truth is that it’s way too early to assess the full effects, but analysts are already throwing around conclusions. When one thinks about it, most of the reform’s effects will happen after 2014, longer than most people’s investment horizons, which means most investors are either ignoring reform or using it as a means to speculate. Fixed income markets may be looking at greater future fiscal deficit, but haven’t acted on it yet.

IP’s position has always been to recognize our own ignorance and try not to depend on particular outcomes – without neglecting selective Healthcare exposure. We’ve chosen diversified companies over time, whose business is much more associated with a “picks and shovels” theme (such as Thermo-Fisher) or those in which there’s a strong consumer brand poised to benefit (such as Johnson & Johnson).

About the bill in general, politics can be a very volatile field – it’s a governance conundrum one could be happy to stay away from. The long debate on health reform ended with what seems to be a hard outlook for some health plan operators, but a broad tailwind for the general industry: plan coverage, by various means, should increase substantially going forward (estimated 32mm new enrollees over 10 years).

Large pharma companies are, at first, picking up the bill for the entire drug value chain (US$90 Bi fees over 10 years), which makes research equipment providers (upstream from pharma) as well as drug distributors (downstream) prone to benefit from increased coverage without a significant burden. Over time these fees should flow along the chain and, ultimately, to consumers.

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

The official press release

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?)

A few days ago Odontoprev and Bradesco announced a merger of their Dental care operations (Portuguese and English version of the PDFs), and we are part of the agreement. In summary, Bradesco Dental is integrating its dental plan assets (including cash) into Odontoprev in exchange for 43.5% of the new company. At the same time, ODPV is distributing its entire pre-deal cash hoard for shareholders of record before the deal. There will be shared control of the new company, but the ODPV executive team remains largely in place (and Randal Zanetti remains a significant owner with some 7.4% of the new company).

Instead of highlighting our investment rationale – we did that in earlier reports – we want to generalize a bit regarding the benefits of looking at industries globally rather than locally.

Rather than start with the concept, let’s give examples. One example is the advantage Brazilian investors had, for a while, over foreign investors when Interbrew “acquired” Ambev and InBev was formed. The difference in perception between what they saw (“who are these brazilian guys coming to run InBev?”) and our perception (“even discounting the tighter labor regulations in Europe, these guys will extract efficiencies in so many levels”) gave us an analytical edge. So from the Belgian investor perspective, knowing what was going on in arguably the world’s best-run beer company would have paid off handsomely. You can even say that it happened again in the Anheuser Busch – InBev deal.

With Odontoprev, which is just the latest example we can think of, the advantage was to see it as a brazilian peculiarity. Practically nowhere in the world could we see an independent dental care plan operator. In the US, for instance, the health insurers have over decades absorbed dental plans and have been offering it for ages as part of “ancillary services” – mostly tied to Vision care (something Brazil is yet to develop – entrepreneurs, listen up!). Of course, MetLife, the world’s largest dental plan operator is not a health insurer, but that company ties its dental offering to a series of other employee benefits. The distribution of dental plans, with its relatively low ticket, makes a lot more sense inside a larger organization. We always looked at Odontoprev as a candidate for some kind of association with companies with large distribution capabilities for corporations. While it’s true that the company could continue to pursue its independence, at the end of the day we saw that its top-notch management wouldn’t destroy value.

Of course, none of this would have mattered if the management wasn’t top-notch, the alignment between us and the owner-managers wasn’t great, if our thorough and relentless analysis of the company’s business didn’t point to Odontoprev as the sector’s class act – and, most importantly, if the price wasn’t right. We don’t invest in themes, we invest in companies. But we can greatly improve where and how we get our “building blocks” by looking abroad. We joke that it’s the “crystal ball that works” – we wish it was that good, but we find more and more over the years that we gain valuable insights.

Investing is looking for an edge, and analyzing industries globally simply allows one to form better opinions regarding their investment cases. In some cases, NOT doing it may blind you to risk factors not previously seen. In this case, it also allows us to see what huge advantages the new company has inside Bradesco. In the company’s own words, “The Association shall result in economies of scale and synergies through the combination of best practices of both companies in claims management, and, mainly, of the integration of the commercial platforms and access to Banco Bradesco’s nationwide distribution channels.”

We’ll finish by pointing that while we have been doing this for over 10 years and it’s a key aspect of our corporate culture, we don’t see many options. Investing is increasingly a global activity, as we’ve seen over the years in our local investments. The “foreigners” are doing their homework and the tools to obtain information are better than ever. The activity is changing, like it or not. Your competitor is or will be global in perspective, so choosing not to be global yourself doesn’t seem, well, the best rational and long-term view.