Kinetic Concepts Shows Why It's the Perfect Buyout Target

| About: Kinetic Concepts, (KCI)

By Boyd Erman

Kinetic Concepts Inc. (NYSE:KCI), the medical devices company being bought by two big Canadian pension funds, has exactly what private-equity buyers want: It's cheap, can be levered up and it spins off lots of cash.

Canada Pension Plan Investment Board and PSP Investments, which runs pension money for federal government employees, are teaming up with private-equity firm Apax Partners to buy Kinetic for about $5 billion in cash, with the price rising to about $6.3 billion including assumed debt.

What they are getting is a company, even after a rise in its stock, that's trading cheaper relative to its estimated earnings before interest, taxes, depreciation and amortization than many other makers of medical products. According to Bloomberg News, which took a smart look at why Kinetic is a good buyout candidate, Kinetic is the cheapest of 20 U.S. and British medical products makers with market values in the $1-10 range, and trades at a price-earnings ratio that's almost half the industry average.

There's also room to lever up the balance sheet with additional debt to juice returns for the equity owners. Bloomberg cites a Standard & Poor's analyst saying that Kinetic could handle another $650 million of debt without losing its current credit rating.

The company produces about $300 million a year of free cash flow that could be used to cover interest costs and debt paydown, according to a recent company presentation.

Of course, it's worth asking why Kinetic is so cheap relative to competitors. One reason may be that its main revenue-producing division is barely growing. That's not something public market investors tend to like, but it may be less of an issue for private equity firms that just want the company's cash flow to pay down debt. In the meantime, the new owners can try to revitalize the business.