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Shareholders in Patterson Companies (NASDAQ:PDCO) are cautiously optimistic about the company's move to further expand its veterinary business, by acquiring the veterinary business from UK-based Dechra Pharmaceuticals.

Patterson made an excellent deal, which is executed at really fair terms. The deal brings diversification to the overall business and is immediately accretive to earnings per share. Despite the excellent deal, which is executed at a discount to Patterson's own valuation, shares are fairly valued around 18 times annual earnings at this point in the economic cycle.

The Deal

Patterson Companies announced that it has agreed to acquire National Veterinary Services Limited, a subsidiary of Dechra Pharmaceuticals PLC (OTC:DPHAF). Patterson will pay 87.5 million Pounds for the activities, the equivalent of $135 million.

The company is the largest veterinary distributor in the UK providing a range of services and products, including reference laboratory offerings. With the acquisition, Patterson is focusing to build its value-added business model.

For the year ending on June of this year, the unit generated annual revenues of 315 million Pounds, the equivalent of $486 million in revenues. The deal will be accretive to earnings by $0.04-$0.05 per share, including one-time expenses related to the deal.

The deal values the activities at 0.3 times annual revenues. Given that Patterson sees four to five cents earnings per share accretion, after tax-earnings should increase by roughly $5 million. Attributing 5% financing costs to the deal, the unlevered Veterinary activities should be able to earn around $10 million after tax, valuing the deal around 13-14 times annual earnings. Note that this is a conservative estimate as it excludes any one-time costs related to the deal.

The board of directors of both companies have already approved the deal, but the transaction is still subject to shareholder approval by Dechra's shareholders. The deal is subject to normal closing conditions and is expected to close in August of this year.

Valuation

Patterson ended its fiscal 2013 with $505.3 million in cash and equivalents. The company operates with $725 million in total debt, for a net debt position of $220 million. Patterson has sufficient liquidity to finance the deal with current cash at hand.

The company generated full-year revenues of $3.64 billion for the year, up 2.9% on the year before. Net income fell by 1.2% to $210.3 million.

Trading around $39 per share, the market values Patterson at $4.15 billion. This values the business at 1.1 times annual revenues and 19-20 times annual earnings.

Patterson currently pays a quarterly dividend of $0.16 per share, for an annual dividend yield of 1.6%.

Some Historical Perspective

Patterson's share price peaked a long time ago. Back in 2005, shares hit all-time highs in their mid-fifties. From there onwards, it was downhill as shares hit lows of $15 during the financial crisis of 2009.

After the company initiated dividends in 2010, shares have recovered towards the $30-$40 range in the past two years. Shares are currently trading near the high end of this range, trading at levels last seen back in 2007.

Between its fiscal 2010 and 2013, Patterson has grown its annual revenues by a cumulative 12% to $3.64 billion. Net earnings fell by a percent towards $210 million. Still, earnings per share did increase as the company retired almost 13% of its shares outstanding over the past two years alone.

Investment Thesis

In line with the rest of the market, shares have advanced some 15% so far this year, and investors seem to like the latest deal.

The addition of the UK-based activities will boost pro-forma revenues from $3.6 billion towards $4.1 billion. The deal is valued at just 0.3 times annual revenues, which compares to Patterson's own valuation at 1.1 times revenues.

As mentioned before, the estimated unlevered earnings potential of $10 million is quite conservative. This values the assets at 13-14 times annual earnings, which compares to 19 times earnings for Patterson itself.

Yet the deal is no game changer at all. While revenues will increase a fair bit, total earnings will increase by just a bit. The potential for synergies appear to be limited as well, even as total veterinary revenues could increase by roughly two-thirds. The acquired activities are located in a new geographic area and few integration efforts will be made initially as Patterson is still integrating its IT-operations.

Besides growing operations by this deal, Patterson has boosted payouts to shareholders recently. Earlier this year, it hiked its quarterly dividend by 14% towards $0.16 per share. This already came on top of sizable share repurchases in recent times.

Overall, the deal seems quite appealing, while the overall valuation of the diversified conglomerate is fair. Trading around 1.0 times annual revenues on a pro-forma basis, and 18 times annual earnings, shares are fairly valued. Nothing more, nothing less.

Source: Patterson Companies - Fairly Valued Despite Excellent Addition In The Veterinary Business