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This analysis of MedQuist (MEDH) was provided to TradingIPOs subscribers in advance of its IPO. The company priced its IPO on February 3rd at $8 per share, below its expected range.

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[Update at bottom]

MedQuist plans on offering 9 million shares (assuming overs) at a range of $10-$12. Insiders will be selling 4.3 million shares in the deal. Lazard, Macquarie and RBC leading the deal, Loop Capital co-managing. Post-IPO MEDH will have 51.1 million shares outstanding for a market cap of $562.1 million on a pricing of $11. IPO proceeds will be used for working capital.

SAC PEI CB will own 32% of MEDH post-IPO.

A rather lame lock-up agreement here. Approximately 12-14 million shares will not be covered by any lock-up agreements post-IPO, meaning they can be sold at any time. Only 22.5 million shares of the 42 million non-floated will be beholden to the 180 day lock-up agreement.

From the prospectus: 'We are a leading provider of integrated clinical documentation solutions for the U.S. healthcare system.'

MEDH's systems convert physicians' dictation of patient ineractions into an electronic record.

Solutions are a combination of voice capture and transmission, automated speech recognition, or ASR, medical transcription and editing, workflow automation, and document management and distribution.

MEDH is the largest provider of clinical documentation solutions based on the physician narrative in the US. 3.4 billion lines of clinical documentation processed annually. MEDH is actually a combination of three separate companies, CBay, MedQuist and Spheris.

Not all of MEDH's transcription is done automated. Approximately 42% is transcribe offshore by 14,000 individuals. 67% is from automated speech recognition software. So we have a 2/3 tech company here and a 1/3 outsourcing transcription operation. MEDH has done a nice job of increasing the technology/automated percentage annually.

Customers include 2,400 hospitals clinics and physician practices throughout the US, including 40% of hospitals with more than 500 beds. Average tenure of top 50 customers is 5 years with 98% of all revenues being recurring.

Sector - Accurate and timely clinical documentation has become a critical requirement of the growing U.S. healthcare system. Medicare, Medicaid, and insurance companies demand extensive patient care documentation. The 2009 Health Information Technology for Economic and Clinical Health Act includes numerous incentives to promote the adoption and meaningful use of electronic health records, or EHRs, across the healthcare industry. MEDH believes these drivers will fuel growth going forward. MEDH believes the medical transcription sector will grow 8% annually over the next 4 years. MEDH believes outsourcing of medical transcription is just 33% of the overall market.

Total current outsourced transcription end market is $1.7 billion annually. MEDH is the largest provider; based on 2010 revenues they appear to have an approximately 25% market share. Pretty impressive.

Financials

Debt is the issue here. Debt post-IPO will be $295 million. Note that MEDH will have $64 million of cash on the balance sheet. They seem intent on using this cash to acquire, however, so expect

  1. an acquisition over the next 1-2 years and
  2. that debt to remain on the books.

Gross margins improvement as MEDH shifts a higher percentage of transcriptions to all electronic.

2010 - $461 million in revenues, a pro forma drop of 10%. Revenue decrease is 100% due to the drop in Spheris, whose assets MEDH purchased in 2010. Actual revenues increased, however Spheris revenues declined significantly in 2010. Gross margins of 37%, operating margins of 9%. The kicker here is the debt. Sort of a chicken and egg issue here as without the two large acquisitions, MEDH's revenues stream would be relatively small. With the acquisitions, you've a sector leader with $461 million in annual revenues saddled with debt.

Debt servicing looks to eat up 75% of operating profits. Too much, too much, too much. MEDH has extensive tax loss carryforwards, so a nil tax rate in 2010. Net margins of 2 1/4%. EPS (pro forma) of $0.20.

2011 - Look for margins to continue to improve. MEDH expects to have approximately $20 million in debt maturing as well as continued tax loss carryforwards. Revenues should increase as MEDH digests the Spheris acquisition. 10% puts MEDH at $500 million, right where the combined entities were in 2009. Gross margins of 39%, operating margins of 11%. Debt servicing still looks to eat up 55% of operating profits in 2011. Net margins of 4.5%, EPS of $0.44. On a pricing of $11, MEDH would trade 25 X's 2011 estimates.

Conclusion - Different medical services niche, but this deal reminds me quite a bit of Emdeon (EM). Dominant sector leaders with quite a bit of debt. If you look at the financials, these two match up quite well on growth, sector leadership and even debt servicing ratio. EM trades about 15 X's 2011 estimates and has really been lackluster since IPO. MEDH does have potential for better bottom line growth, as they continue to shift from outsourcing transcriptions to automation. However, the debt should cap the upside here for quite awhile. Neutral on the deal, sector leader coming public valued about right.

Update: Note that MEDH priced 4.5 million shares at $8. Insiders opted not to sell and the deal came at a 27% discount to the middle of the initial range. That combination allowed the deal to work short term and gives it a much better chance to work mid-term as well. Still some issues here, but an attractive pricing.

Disclosure: Tradingipos.com does own shares from $8.50 with a stop-out set on a new low $8.29.

Source: MedQuist's IPO Has Improved Chance to Work Both Short- and Mid-Term