By Stephen D. Simpson
Normally I'm thrilled to see one of my portfolio companies get bought, particularly when that was at least part of the initial purchase thesis. And yet, I cannot whole-heartedly celebrate Monday morning's news that Accuray (ARAY) is acquiring TomoTherapy (TOMO) for $4.80 in cash and stock.
Oh true, I am going to show a profit on this deal. Assuming that the $4.80 price holds up (part of the deal includes Accuray stock), that will be a 32% return for me in just 10 days of TOMO ownership. That is certainly nothing to complain about, but I am going to complain anyway.
The Terms of the Deal
Accuray announced that it will be acquiring TomoTherapy for $3.15 per share in cash and just under 0.165 shares of Accuray stock. That translates into $4.80 per share for TomoTherapy, a 31% premium to Friday's close and a deal value of $277 million. In terms of ratios, that is just 1.3 times trailing sales, an exceptionally low premium by the standards of past emerging med-tech deals but perhaps not so ridiculous for a company that sells into a fiercely competitive capital equipment market and does not have near term profit prospects.
What TOMO and Accuray Do
Both TomoTherapy and Accuray are in the business of developing and selling advanced radiation therapy systems for the treatment of cancer. TomoTherapy sells the Hi-Art system which features an imaging system integrated with the radiation delivery, and the 3D imaging capability allows doctors to more accurately treat cancer. The Hi-Art also features a unique helical delivery pattern that helps deliver more energy to the target tissue with less exposure to healthy tissue around the cancer.
TOMO has also recently launched the TomoHD system, another integrated system, but one that was designed to be more flexible and treat a wider range of cancers.
As investors might imagine, these are very expensive systems and the hospital capital budget issues of 2008-2010 were clearly a challenge for TomoTherapy. Even more troublesome has been the issue of competition. Varian (VAR) is the 800lb gorilla in radiation therapy with roughly 70% share in the U.S. and 50% worldwide, while Sweden's Elekta is a major player in Europe, and Siemens (SI) is still a factor in the market as well.
Accuray also sells into the radiation therapy market, but with a meaningfully different product. Accuray sells the CyberKnife Robotic Radiosurgery System. The CyberKnife is an intelligent robotic system that has a unique ability to treat solid tumors everywhere in the body, allowing doctors to directly attack tumors that would otherwise by inoperable or untreatable. With solid data in hand in areas like spine and head and neck cancer and very encouraging data in prostate cancer, it does not seem unreasonable to say that Accuray has some of the best technology in stereotactic radiosurgery.
The Combined Company – Tech-Forward, but Sales-Light
Adding TomoTherapy's products and technology definitely broadens Accuray's portfolio and that will certainly help the company's efforts to market against Varian and Elekta. Unfortunately, success in medical technology is not always about technology; marketing and after-market support matter as well. That is especially true in a business where customers frequently have to build or significantly remodel entire buildings to house these systems. So while this deal will double Accuray's sales, the combined company is still tiny compared to Varian.
Should Investors Demand Better?
As a new TomoTherapy shareholder, I think management is selling this company too cheaply. True, the company has struggled, but recent improved performance and the launch of TomoHD suggested a brighter future. What's more, Accuray's stock has been very strong of late and is not a great bargain itself. So not only does TOMO management seem to be demanding too little, a significant part of that compensation may itself be slightly overvalued.
Now it's true that TOMO may have not been bargaining from a position strength. TomoTherapy has good technology, but this would not be the first company to have highly competitive technology but still fail.
It would not be unthinkable that a rival bidder could step in and attempt to break up this deal. Philips (PHG), Hitachi (HIT), and General Electric (GE) all have "big iron" medical businesses that could leverage TomoTherapy's technology to good effect. Likewise, Siemens has talked previously about trying to break out of its status as a distant third place player in radiation, and a deal for a company like TomoTherapy could help (though the company does have a relationship with Accuray already). Of course, with only about $450 million in projected sales for 2011, the combined TomoTherapy-Accuray could arguably be even more attractive to a large buyer.
The Bottom Line
This deal may raise an eyebrow or two at Varian and Elekta, but neither company is likely to sweat too much until the combined company shows that "one plus one" equals something more than two. In the meantime, Accuray shareholders ought to be pleased that their company is adding excellent technology and broadening out its product suite at a very appealing price. TomoTherapy shareholders, though, should sit tight – the price we are getting does not seem like fair value, but there is always the possibility of a better bid and the chance that the combined company can deliver value that TomoTherapy could not on its own.