Often when a company operates in a fast growing industry, and contrary views of its prospects abound, a strong indication of what may be really unfolding in its business can be garnered by following the money of those who should know. When looking at merits of Merge Healthcare as an investment, I believe this approach applies.
Merge Healthcare (MRGE) is a leading provider of enterprise imaging and interoperability solutions that facilitate the sharing of images to create a more effective and efficient electronic healthcare experience for patients and physicians. Recently, MRGE has been the object of short seller commentary (on this venue as a matter of fact). As a result, short interest has increased to 9.90% of the outstanding float and the number of days to cover all the short positions has increased to 10, as of December 31, 2011. Meanwhile, the shares which traded at a high of $7.23 on September 16, 2011, are now trading at about $5.00 after recovering from a recent low below $4.50.
In order to get a full appreciation of where MRGE has been, and hopefully where it is going next, it is useful to take a look at its distant corporate history:
- 12/2005 - MRGE stock price peaks at $30, as recent quarterly EPS hits $ .28. Only problem, that few knew at the time, the numbers weren't real.
- 11/2006 - MRGE announces restructuring plan as stock drops below $7.
- 10/2007 - News of an accounting scandal breaks and the "you KNOW what" hits the fan. MRGE delays its earnings release and announces that prior earnings will be restated downward. Wall Street analysts start dropping coverage. Stock price plummets to below $2.
- 06/2008 - On the verge of insolvency and with a stock price down to just pennies, private equity firm Merrick RIS, LLC steps up to the plate to rescue MRGE from imminent insolvency with a $20,000,000 investment. The turnaround commences.
Merrick RIS, LLC is the investment vehicle controlled by Michael Ferro Jr. and MRGE has been on an acquisition binge since Ferro took over. Ferro is following a similar game plan he successfully executed in growing and selling a company called Click Commerce. A timeline of his acquisition spree since gaining control of the company follows:
- July 2009 - Acquires E-Trials Worldwide
- September 2009 - Acquires Confirma
- April 2010 - Outbid a rival private equity firm to acquire Amicas
- August 2011 - Acquires of Ophthalmic Imaging System
Why the aggressive acquisitions binge? Well one of the main factors is very likely the $787 billion American Recovery and Reinvestment Act passed in 2009 that provides $20,000,000,000 (that's a lot of zeros), over the subsequent years, to encourage hospitals and physicians to automate electronic health records. As an added incentive the legislation also provides future penalties if they fail to do so. It's certainly beneficial to have the U.S government pushing and paying for some of your products.
I have always been of the belief that the end game for MRGE is an acquisition by a larger company and the recent short seller commentary has given me the opportunity to reacquire MRGE shares on the cheap. Through acquisitions and organic growth, MRGE has shown tremendous revenue growth in the last 3 years (2008 ->$56.8mm, 2009->$66.8mm, 2010->$140.3mm, 2011->$224MM ( Annualized Estimate). However, it's expensive capital structure, a legacy outcome of the need to save the company from bankruptcy and to finance its acquisitions, has precluded it from achieving positive GAAP EPS. It currently has $242 million in very expensive 11 ¾% corporate notes due in 5/1/2015 on its balance sheet.
FOLLOW THE MONEY: Aside from being in right industry at the right time with the right government incentives and the right management team, there are two additional compelling factors that give me the confidence that MRGE will be a solid performer in the coming year and continue to successfully execute their business plan. First and foremost is continued insider buying. Even though Mr. Ferro already controls the company, he recently stepped up his insider purchases as the shares declined off their highs. When the Chairman continues to purchase shares over $5 even though the bulk of his 31,523, 637 shares were purchased at much lower prices, it's a very good signal. The following table shows his purchases for the last 15 months:
Note that in just the last 2 months, Ferro has purchased 258,000 shares in the $5 range compared to 100,000 shares purchased in the prior 12 months in the $2.68 - $2.75 range. So he is investing much larger amounts at much higher prices. Do you think this is any indication of how MRGE is doing despite some of bearish views from short sellers? I say follow the money.
Another place to follow the money is by taking a look at the trading of MRGE's debt. In the last year, the outstanding notes have consistently traded at a health premium to their issuance price of 97.266 on 11/2/2010 (most recent trades of last week were at 106.75 with a yield to maturity of 8.42%). This is an indication that the bond market is getting very comfortable with the balance sheet and cash flows of the company and it's often stated that the bond market is smarter than the equity market. This premium pricing opens up the opportunity for the company to recapitalize its balance sheet at more favorable terms at some point in the future. A favorable recapitalization would have significant impact on future GAAP EPS and cash flow.
I have focused here primarily on the MRGE management team, their insider buying and the balance sheet, without spending much time on the nuts and bolts of the company's product line including Merge Honeycomb, a newly introduced cloud based health data warehouse. For those who want to get a better understanding of Merge Healthcare's business and products, the company's corporate fact sheet is a must read. However, with money going into this company from those who should know, it seems like MRGE is a company worth looking at.