Pathology provider Sonic Healthcare (SHL) has expanded its presence in Germany with the acquisition of five regional laboratories. Brokers were not surprised, as management had flagged an intention to pursue more acquisitions at the FY13 results briefing in order to exploit such opportunities.
Deutsche Bank expects this expansion should boost earnings and returns, with Sonic also benefitting from improving operations in the rest of Europe and Australia as well as from cost cutting in the US. A weaker Australian dollar adds a fillip too. The purchase price is EUR76m, equating to around $110m. The operations are in the west/south-west of Germany, where Sonic is lightly represented, and are being purchased from France-based Labco’s private equity owners. The business has faced operating challenges in recent years but it generates revenue of EUR53m. Deutsche Bank does not expect Sonic will have a problem with competition regulators because there’s only a small geographic overlap with the company’s existing business. Sonic has a strong history of integrating laboratory businesses and this should be relatively straight forward, in Deutsche Bank’s view.
The FNArena database also presents a solid picture. There are three Buy and five Hold ratings. The consensus price target is $16.50, signalling 1.8% upside to the last share price. The range is $15.23 to $18.00. The consensus target has moved from $16.18 ahead of the announcement. There is a 4.3% dividend yield on FY14 earnings forecasts and 4.7% on FY15.
Deutsche Bank estimates the acquisition will lift Sonic’s German revenues by around 12% and boost earnings by 3% in FY15. The broker sees little risk to these forecasts given Sonic’s good track record in Germany and its extensive experience with integrating acquisitions. JP Morgan thinks the company’s track record on delivering returns from acquisitions has not been speedy, particularly when it comes to the US. Nevertheless, in terms of margin improvement, in Germany the record has been impressive. JP Morgan has stated a preference for the acquisitive behaviour to stop, because of the dilution to the returns on invested capital, but in this particular case there is merit in the extra scale, which could provide a buffer to any future funding pressures in Germany.
This pathology funding environment presents the most risk to brokers’ evaluation of Sonic. There is considerable uncertainty in Germany and it’s not clear if further adjustments will occur beyond the first half of FY14. The market is ripe for further consolidation. Ongoing funding pressures are likely to put smaller operators under significant financial pressure. In Citi’s view this should benefit Sonic. Nevertheless, the risk to reimbursement and lack of clarity on funding means accurately pricing such acquisitions can be more difficult. Germany has advantages in its infrastructure and the potential synergies are high so this should be a source of earnings upside and potential share price improvement for Sonic, according to Citi.
A strategically sound purchase, was how Credit Suisse described it. There are obvious synergies and, while the market share issue may be of concern in one of the regions, it should not be enough to hamper the deal. Financial details were not disclosed but the broker estimates that, assuming Labco generates a 15% earnings margin, pre-synergies, the implied multiple is around 9.5 times. Credit Suisse would expect Sonic to double the current margin because of physical asset rationalisation and the procurement benefits that come with a bigger grouping. Credit Suisse deems the earnings accretion, at around 5% in FY14 and 3-3.5% beyond, as modest, but helpful.
CIMB also liked the deal and think this is a well-positioned acquisition with multiple earnings drivers. Moreover, it does not stretch trading levels. The acquisition would take Sonic to around 13% of the EUR3.5bn market in Germany and, hence, it is unlikely to raise the ire of regulators. UBS describes the acquisition as compelling. Labco appears to have had some losses to market share in recent years but Sonic has assured the broker that this has stabilised. UBS’ channel checks have suggested there is likely to be a further 8-10% reduction in the rates paid under the German EBM into 2014 but this largely represents a flat year-on-year fee and the underlying volume growth should contribute to Sonic’s operations.