By: Jared Sleeper
Seracare Life Sciences (SRLS) is a bio-pharmaceutical company that produces raw materials and diagnostic tests for various parts of the medical industry, including clinics and biotech firms. It also provides bioservices to the federal government at a major facility near Washington D.C. It has a history of shoddy management (fraud-driven bankruptcy in 2007) and a recent takeover bid threw the company into turmoil, leading it consider strategic alternatives (with Lazard) at a substantial cost. As a result, Seracare's expenses have soared even as revenue fell this year due to a loss of federal stimulus funding for its bio-services division, leading to a pronounced negative trend on its income statement as the market awaits the results of its review. With a strong core business, high barriers to entry due to government regulation and reputational issues and an extremely solid balance sheet, there is little downside for Seracare, which we believe trades at a discount to its true value. There are two possible routes to realizing this value: a strategic alternative, including a buyout of the company, or the cessation of the strategic review, which will improve the company's income and cash flow statements significantly going forward as the company focuses its substantial recurring free cash flows on developing new product lines that synergize well with its existing revenue stream and customer base.
Seracare's primary businesses are high quality and likely to enjoy steady growth
Seracare produces raw materials and diagnostic tests for the pharmaceutical industry, essentially helping companies and clinics monitor the efficacy of the tests they use to diagnose diseases by providing samples that have the disease and samples that don't, or alternatively providing raw materials for companies to make their own tests. This is a stable, recurring business as the tests are heavily regulated and there is a significant cost for many of Seracare's smaller customers to create their own tests or switch suppliers due to Federal regulations. The bioservices division, which manages one of the few commercial business in the U.S., is also stable, though it is government dependent. Growth in this division is limited and margins are lower than in biopharmaceuticals, one of the reasons the company his discussed divesting this asset in the past and may do so as part of the strategic alternatives process that is currently under way.
Seracare's value has been depressed by temporary factors
This summer, a wealth management firm made an unsolicited offer to purchase the company for $4.25. Details are scant, but the legitimacy of the offer was questioned and it was not approved. Nonetheless, it caused company to initiate a review of strategic alternatives, bringing Lazard (renowned for its Life Sciences M&A division) in as an adviser at considerable cost. This process has added turmoil to the company, taking away vital management attention and in our view causing the company to under-execute this past year, in addition to the massive up front costs of hiring and providing assistance to Lazard. The result has been a disastrous trend in quarterly net income, bottoming out with a net loss in the fourth quarter of last year and continuing with only weak profitability in the recently released first quarter. This weakness is likely to continue until the end of the strategic review process. Nonetheless, these factors are temporary and unrelated to the core businesses of Seracare, as evidenced by stable gross margins (roughly 40%) and revenue for the past four quarters (a slight decline has been caused by the loss of federal stimulus spending on the low margin bioservices division and offset by an increase in the high-margin biopharmaceutical product lines), and we believe that they are masking the true value of this company.
Seracare is cheap when its true operating potential is considered:
- Rejected buyout offer of $4.25 per share this summer
- Conservative DCF estimate (using projected figures without the temporary costs) of $4.60
- With a 14X FCF model and our projected FCF for 2012, a valuation of $4.40
The company also has .90/share in cash and another .90/share of current assets, lending strength to our already conservative valuations.
All factors considered, we estimate a (very conservative) true value for SRLS of $4.50, with minimal downside risk from current prices.
Due to its small size but strong recurring revenue and relationships in the pharmaceutical sector, Seracare has been mentioned as a potential acquisition target by larger companies in the space, including BioRad Laboratories (BIO), Life Technologies Corp. (LIFE) and Millipore, and management seems to be strongly pursuing that sort of action by employing Lazard in a process that has lasted for roughly six months with no sign of stopping. This notion is bolstered by the fact that Seracare's interim CEO, Greg Gould, has experience leading mergers in the past. The lack of a permanent CEO appointment also points to the fact that Seracare may be waiting for the end of the strategic review process to do so, another sign it is serious about selling the firm to realize the company's value.
For those reasons, we recommend buying Seracare with a $4.50 price target, roughly 25% above the current price. With promising earnings released last Friday, strong potential for acquisition and a business model that provides recurring, high margin revenue, Seracare is poised for growth and a return to strong profitability as costs related to its strategic alternatives search decrease and disappear. Though the market has begun recognizing the value in the company we believe this process is set to continue, and look for the company to outperform the market until its true value is realized, or it is purchased at a significant premium to today's price level.
Author note: This article was written and submitted before the recent buyout news.
Disclosure: I am long SRLS.