F&P Healthcare a tasty target for US rivals

By Shoeshine

Friday 27th February 2004

It's hard to think of another New Zealand company that has gained as much traction in the giant US market as Fisher & Paykel Healthcare.

The company last week said it would have March-year sales in the US of $US127-130 million and gave details of another US distribution deal.

Picking each year's profit number is a tricky business because of the effect of the company's comprehensive currency hedging but operating cashflows are ripping along nicely.

As Healthcare is travelling so well, one implication of F&P Appliances this week selling its 19.3% stake is pretty obvious. With no cornerstone shareholder standing in the way, Healthcare is now wide open to takeover.

The most likely suspects are of course Healthcare's arch-rivals in the US market, Respironics and Resmed.

As it happens, both are in a particularly good position right now to go shopping and, at the current share price, Healthcare looks like a particularly attractive buy.

In terms of assets and earnings the three are in the same league.

In the June 2003 year New York Stock Exchange- and ASX-listed Resmed made a $66.8 million profit.

With total assets of $672 million, the ratio of equity to assets was 62.3%, so the company wasn't highly geared and had plenty of room to raise debt to fund an acquisition.

Nasdaq-listed Respironics made a $68.1 million June 2003 profit on total assets of $851 million. With an equity-to-assets ratio of 73.3% it was even more lightly geared.

Healthcare, after a disappointing first half, is forecast to make a March 2004-year profit of about $52 million. It has no net debt cash in the bank, in fact and also makes the highest return on equity by miles. Total assets last year were $229 million.

Looking at the three companies' market capitalisation reinforces the argument.

In common with many US companies, Respironics' share price has climbed sharply over the last year, from $US30 to about $US52, giving it a market cap of $2.2 billion.

Resmed has fared less well. On the ASX its Chess depositary receipts neared $A7 last June but are now trading at just under $A6. Those prices give the two companies, respectively, price-to-earnings ratios of 38.1 and 34.1.

Healthcare's adjusted earnings a share last year were 48.6c. With a share price at the time of writing of $11.75, above the $9.70 of a year ago but well below the $16 it reached directly after the split from F&P Appliances, it's trading on a multiple of "only" 24 times.

In short, it will look cheap to Resmed and Respironics.

All this is of course pure speculation. And in the fabled perfect market the valuation imbalance would correct itself before too long.

For one thing, the sale of the Appliances stake to a number of institutions will considerably increase trading liquidity.

The 19 million shares sold will be added at the end of March to Healthcare's "free float," giving it a higher rank on the NZX50 index and so obliging index tracking funds to buy up.

The sale will also, presumably, have given Healthcare a greater spread of shareholders from Australia and further afield, although who exactly bought the shares hasn't yet been revealed.

These changes are likely to focus investor attention on the valuation gap between Healthcare and its peers.

Then there are the announcements from the US battlefront two in just over a month and another one coming.

The January 18 signing of a "shared primary purchasing agreement" with Apria Healthcare can only reinforce Healthcare's position as a serious player in the US market.

Apria is the US' biggest home healthcare services provider and has a 15% or $US90 million share of the obstructive sleep apnoea market.

Analysts reckon the benefits to Healthcare will be phased but will build up over time into a significant earnings contribution.

Last Friday Healthcare announced changes in its supply agreement with Premier, one of the US' largest hospital and healthcare group alliances.

Cardinal Health, Healthcare's US distributor for respiratory humidification units, signed a shared primary purchasing agreement with Premier.

In short, Healthcare will now have to share with another company, Hudson, the supply of the heating bases such units use. But for the first time it will also be able to supply lucrative breathing circuits.

The company reckons the loss of sole supplier status for heaters will be more than made up for by the opportunity to sell more circuits.

The deal also has possible implications for another big contract coming up, from Novation, another hospital and healthcare alliance of similar size to Premier.

The key thing with these sorts of deals is that F&P is steadily increasing its installed base of controller units and is pushing an expanding array of consumables across it.

In this case Hudson is now the sole supplier but Healthcare has the opportunity to persuade Novation to move to a shared arrangement.

A curious aspect of the Appliances selldown is the timing.

Appliances doesn't need the money and is in fact giving most of the $232 million raised back to shareholders via a special dividend and a share buyback. It will still pocket enough $92 million to more than wipe out its debt.

Managing director Jon Bongard said the sale provided Appliances with "further financial flexibility" for the range of "exciting growth opportunities" the company is "actively pursuing."

Analysts are scratching their heads over what these might be.

A Kiwi corporate with money in its pocket and expansive ambitions usually has battle-hardened shareholders heading for the exit.

But Appliances' credit with investors is good, so shareholders will probably stand by to be excited.

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