"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.