Hill-Rom Holdings (NYSE:HRC) announced the acquisition of the medical business of German-based TRUMPF group. Investors are cautiously optimistic about the deal which appears to have been executed at attractive valuation multiples.
Despite the deal, I remain very cautious to invest in Hill-Rom. The company already trades at 18 times adjusted earnings while the company's track record in terms of its operations and share price performance is disappointing to say the least.
Highlights Of The Deal
Hill-Rom announced that it has reached an agreement to acquire TRUMPF Medical, the medical unit of the German-based TRUMPF Group.
Under terms of the deal, Hill-Rom will pay $250 million in cash in a deal which will be immediately accretive to adjusted earnings per share.
The deal is expected to close in the fourth quarter of Hill-Rom's fiscal year.
TRUMPF Medical provides operating room infrastructure products like surgical tables, surgical lighting and supply units.
These products will be added to the company's own portfolio for surgical safety including the Bard-Parker scalpels, the Allen Advance Spine Table and other related systems and accessories.
With the acquisition, the company will double the surgical portfolio and capitalize on new customer partnerships, while strengthening the footprint in growth markets around the world. Besides bringing more diversification in terms of product offerings, geographical areas, the deal also brings improved prospects for growth. Recently reported growth rates of TRUMPF have outpaced growth of Hill-Rom by a comfortable margin.
Note that Hill-Rom manufactures and provides medical technology and services for the health care industry. The company has three main segments being North America, International and Respiratory Care.
The $250 million deal values the company at exactly 1.0 times trailing revenues over the past twelve months. Revenues of the business have grown at a 6% growth rate per annum between 2010 and 2013. The business generates the vast majority of its revenues in Asia-Pacific, EMEA and Latin America. The revenue multiple looks rather favorable compared to Hill-Rom's own valuation as discussed later.
The acquisition will add roughly $0.12 to $0.15 per share in adjusted earnings for the fiscal year of 2015. This implies that adjusted earnings are seen up by $7-$9 million after financing costs.
The company has not reported anything on expected cost or revenue synergies which undoubtedly can be achieved. Typically deals which involve the usage of expensive sales representatives can result in sizable revenue and cost synergies.
Valuation Of Hill-Rom
Hill-Rom anticipates to finance the deal with both cash at hand and borrowings under the existing credit facility.
The company ended its second quarter with $120.3 million in cash and equivalents. Total debt stood at $343.3 million which results in a net debt position of $223 million. The company's net debt position is set to double following closure of the deal.
Trading around $40 per share, Hill-Rom's equity is valued at $2.3 billion. The company anticipates annual revenues to fall by 4-5% this year towards $1.64 billion. Adjusted earnings, which exclude $0.31 in amortization charges, are seen at $2.18 to $2.28 per share.
At current levels, equity is valued at 1.4 times annual revenues and 18 times adjusted earnings.
Hill-Rom currently pays a quarterly dividend of $0.1525 which provides investors with a 1.5% dividend yield.
Investors React Cautiously Optimistic
Shareholders in Hill-Rom reacted cautiously optimistic to the announced deal, sending shares about 1.5% higher. The comments about earnings per share accretion following the deal and the relatively appealing revenue multiple of the deal might have contributed to that. The fact that TRUMPF is showing solid growth is comforting as well with the core business of Hill-Rom seeing short-term pressure on its revenues.
In the longer run, investors have seen very disappointing returns even after accounting for the spin-off from Hillenbrand (NYSE:HI), the industrial activities of the former group. The combined share price of both Hill-Rom and Hillenbrand fell from $70 in 2007 before the split to lows of around $25 in 2009. The value of the combination recovered to about $40-$60 following the recession and currently stands at $70 again.
The stagnation in the valuation and share price performance comes on the back of disappointing operating performance as revenues have actually been down slightly over the past decade. This was only partially offset by a very modest pace of share repurchases.
Hillenbrand posted revenues of $678 million in 2008 on which it turned a $93 million profit. Adjusting for the spin-off, Hill-Rom has seen modest annual revenue growth over the past decade which would have been accompanied by solid earnings growth.
Yet this is the past, and Hill-Rom's own operations have seen some real stagnation, especially in terms of earnings in recent years. While the deal appears nice, it will add "only" 15% in annual revenues and therefore cannot entirely move the needle in the right direction, given the still very modest performance of the core business. The increase in leverage and already "fair" valuation create few opportunities here.
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