A Bullish Diagnosis on Rochester Medical

Rochester Medical Corporation (ROCM) develops and manufactures a line of urinary continence and urine drainage care products, which are marketed to hospitals and extended-care facilities. The Company's extended care products include a line of male external catheters for managing male urinary incontinence and a line of intermittent catheters for managing male and female urinary retention. Its acute care products include a line of standard Foley catheters and its innovative RELEASE-NF Catheter, an antibacterial Foley catheter that reduces the incidence of hospital acquired urinary tract infections. Most of the company's products are made of silicone rather than latex to reduce the risk of allergic reactions.

The Company recently reported record FY07 revenues of $32.7 million (up 51% from FY06 revenues of $21.7M) and net income (less $31M in net gains from legal settlements) of $3M (up over 50% from $1.96M during FY06). The Company's antibacterial Foley catheter is poised for market share gains based on legal victories and a focus on preventing hospital-acquired infections that is currently underway. In addition, ongoing litigation against Tyco (TYC), which is set to resume in February 2008, may result in a cash windfall of between $20M - $30M and injunctive relief from alleged anti-competitive conduct by Tyco (Covidien: COV is the independent company that was spun off from Tyco Healthcare) based on previous settlements with other defendants named in the same lawsuit.

I have modeled for an expected cash/equivalents position at the end of FY08 of between $58M - $68M based on cash flow from operations and a successful resolution to the ongoing Tyco lawsuit, yielding an enterprise value (EV) of just $99M. The larger and slower-growing CR Bard (BCR) trades at a ratio of 3.8X EV/Revenue (ttm). Applying this multiple to Rochester Medical results in an expected EV of $152M for FY08 and $179M for FY09 on conservative sales estimates of $40M and $47M, respectively. The equivalent market cap is $207M for FY08 and $234M for FY09, which yields a fully diluted 2008 – 2009 price range of $16.43 to $18.57. However, I believe that ROCM warrants a 50% premium to this EV/revenue valuation model, resulting in a 2008 – 2009 price range of between $25 - $28 per share. This premium is justified because of the Company's better growth prospects which are starting at a smaller base level of sales, smaller market cap, continued medical device industry M&A activity, and continued product innovations to meet emerging medical needs (such as the current opportunity for its antibacterial Foley catheter in hospitals).

New rules adopted by the Centers for Medicare and Medicaid Services call for payments to be withheld from hospitals for care associated with treating certain hospital-acquired infections, such as catheter-associated urinary tract infections. These new rules will go into effect in October 2008 and build upon legislative efforts which are ongoing in many states for the public reporting of hospital-acquired infections. Both of these factors provide incentive for hospitals to increase resources for infection control and prevention; and since catheter-associated infections are the most common form of hospital-acquired infection, the Company's antibacterial catheter is poised to gain market share. CDC data reveals that catheter-associated urinary tract infections are the most common (40%) infection developed by patients in hospitals, with an annual cost to hospitals of $451 million, affecting 600,000 patients per year among an estimated 4 million patients who undergo urinary catheterizations each year.

Disclosure: none

Comments

[aaron2006:]

rocm will ignite like a volcano one of these days. Great news is on the way. The worst is over & the best is about to rise on us. Michael Murphy is very bullish on this great stock.

2007 Nov 26 05:49 PM