Owens & Minor (NYSE:OMI) saw modest shareholder support for the company's intentions to acquire Medical Actions Industries (MDCI). This support comes despite a very high premium which the company is willing to pay to acquire the business.
Investors are cautiously optimistic about the deal given the sizable synergy estimates. I like the deal as well being complementary to the company's strategy to vertically integrate its business and boost margins.
While the dividend yield is appealing, the company has shown modest historical growth in recent years. As such I believe the current valuation is largely fair.
The Deal Highlights
Owens & Minor announced that it has signed a definitive agreement with Medical Actions Industries to acquire its operations in a deal valuing shares of Medical Actions at $13.80 per share.
The offer represents a big 95% premium for shares of Medical Actions Industries. Investors in Owens & Minor are still cautiously positive on the deal despite the steep premium on the back of sizable anticipated synergies.
The all-cash deal values Medical Actions at roughly $208 million and is expected to close in the fourth quarter of this year.
Strategic And Financial Rationale
Medical Actions provides custom procedure trays and minor procedure kits. The company is no stranger to Owens & Minor as the company generates 45% of its sales being a supplier to Owens. For the year of 2013, Medical Actions posted revenues of $287.8 million.
The deal fits within Owens & Minor's strategy to ¨connect the world of medical products to the point of care¨; thereby expanding the reach to patients. The tray products being added will complement Owens & Minor's ability to provide more unitized services. This should drive topline revenue growth on the back of greater opportunities for the company's sales force. Of course, cost reductions are anticipated as well.
Essentially Owens & Minor is looking to integrate the supply chain in a vertical way, combining the functions of producer, logistical provider and sales. This should boost margins which are very slim for the company at the moment, while creating more value and cost effective solutions for its end-clients.
Despite the huge premium, the company anticipates that the deal is accretive to non-GAAP earnings per share in 2015 and thereafter. Note that Medical Actions reported earnings of just $4.1 million over the past year. To be accretive, the deal should result in sizable anticipated synergies, which is exactly the case.
The company anticipates achieving $10-$12 million in pre-tax cost synergies by the end of the calendar year of 2016. This excludes the potential for revenue synergies resulting from the deal. These estimates are actually quite sizable in relation to the price tag of the deal and could very easily justify the big premium being paid.
Total cost synergies could boost the bottom line by roughly $7 million after statutory tax rates. Based on that contribution alone, the deal values Medical Actions at roughly 30 times earnings. While this seems a high price, it excludes the modest profit contribution from Medical Actions itself, as well as anticipated but not specified revenue synergies.
Valuing Owens & Minor
Back in April, Owens & Minor released its first quarter results. The company operates with $182 million in cash and equivalents. Total debt of nearly $215 million results in a very modest net debt position of about $33 million. The deal will be financed with existing cash holdings and unused capacity from the company's existing borrowing facilities.
The company posts huge revenues but operates in a very low margin business. On a trailing basis the company posted revenues of $9.05 billion on which it net earned just $110 million, for a net after tax profit margin of merely 1.2%.
Trading around $35 per share, Owens & Minor's equity is valued at $2.2 billion. This values the company at merely 0.25 times annual sales and 20 times GAAP earnings.
The company pays a quarterly dividend of $0.25 per share, providing investors with a decent 2.8% dividend yield.
Background
Over the past decade Owens & Minor has roughly doubled its annual revenues from $4.5 billion to about $9 billion at the moment. It should be noted that revenue growth has been much more modest in the second half of this time frame.
The company operates with very slim operating margins of around 2.0 to 2.5% in recent years. While this is very thin, the huge turnover and relatively stable nature of these margins do provide comfort.
Gross margins have improved in recent years to about 12% and the addition of Medical Actions will be very accretive to gross margins, although its own margins of 19% are not very high as well. Note that the overall deal will add just about 3% in annual revenues, but is really more significant than that. Anticipated cost synergies of $10-$12 million are sizable in relation to anticipated earnings of roughly $2.00 per share, or about $125 million per annum.
The strategic nature to focus on vertical integration could have more prospects for long term margin expansion as the company will focus on more value-accretive tasks in the value chain. Deals like these offer both the appeal of potential costs as well as revenue synergies, and are very nice in my opinion.
That being said, shares are fairly valued at this point in the cycle given the fair valuation but modest overall growth. The company's dividend, currently yielding 2.8% is one of the key attraction points in what is a decent long term investment. Yet I am not hurrying to pick up shares at today's levels.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
