Newsletter Value Investor Insight carried an interview April 30th with West Coast Asset Management's Atticus Lowe, whose fund has returned 13.7% after fees annually since the firm was founded in January 2001, versus 2.3% for the S&P 500, according to Value Investor Insight. Here's the excerpt from the interview in which he discusses Agiotech Pharmaceuticals (ANPI), which was trading at $5.66 at the time of the interview (current price here), and National Home Health Care (NHHC), which was trading at $11.66 at the time of the interview (current price here):
Your next healthcare idea, Angiotech Pharmaceuticals (ANPI), is surrounded by some controversy.
AL: Angiotech was originally a pure play on Boston Scientific’s paclitaxel-eluting Taxus coronary stent, on which it receives a net royalty of about 6% from licensing its coating technology. As a first step toward diversification, the company last year paid $785 million to buy American Medical Instruments, which sells more than 5,000 products, including things like biopsy needles, surgical knives and sutures. These tend to be high-margin niche products that don’t attract a lot of competition.
The company is currently surrounded by an extreme amount of negative sentiment relating to Taxus stents, which we think is ultimately not a big part of its business. A new coronary stent from Abbott Laboratories, which uses a different coating than Angiotech’s, is coming out soon and their studies to date have shown it to be more effective in certain applications than the Taxus stent. While the market responded as if that was the end of the story, there is still a huge body of data that supports the efficacy of the Taxus product.
Isn’t the efficacy of coronary stents in general under some question?
AL: Yes, but again we believe the market is overreacting to still inconclusive and conflicting evidence. People may use the Taxus stent less in the future, but our research indicates that the product is completely viable and will be in the market for a long time. We estimate the dis- counted net present value of stent royalties to Angiotech at $350 million, which we think is conservative given that the net after-tax royalty from Taxus sales in 2006 was over $100 million.
Why do you consider that “ultimately not a big part” of the business?
AL: Because of the growth prospects in the American Medical Instruments’ business and from a tremendously robust new-product pipeline.
The AMI business should generate EBITDA of $55 million this year and we think they have considerable potential to expand sales through product improvements using Angiotech’s technology. For example, they’re applying “echo coating” technology to biopsy needles, which allows the needles to be seen in ultrasound imaging. This is a clear improvement over competing products, which should result in significantly increased market share – at 90% gross margins – in a $200-million market.
Another exciting product AMI has is called the quill, which is a knotless suture. Each stitch has little microquills going in opposite directions which allow the stitch to go in smoothly, but not move in the opposite direction. It saves doctors valuable time and improves aesthetics, while resulting in a suture that holds more strongly than a staple. The suture market is a multi-billion-dollar one and they have real potential to take share with this product, given that they already have an inroad from an existing AMI business.
Overall, we see AMI’s EBITDA growing at least 10-15% per year, perhaps much more. At the multiple of EBITDA at which comparable businesses trade – around 14.5x – we value the AMI business at around $800 million.
Your values for the stent and AMI businesses exceed the company’s $850 million enterprise value by 35%. What upside do you see from the product pipeline?
AL: We actually believe Angiotech’s pipeline is by itself worth multiples of the company’s current equity value. They have more than 10 products in the pipeline with $1 billion-plus sales potential, each having a good chance of success. So at the current share price of around $5.70, there’s just a huge gap here between what we think the company is worth and its market value.
The closest-to-market product in the pipeline is called vascular wrap. For patients suffering from peripheral vascular disease and hemodialysis, a graft is used to bridge the arteries, resulting in a lot of scarring and patient discomfort. Angiotech’s wrap, coated with paclitaxel, is placed around the graft and has been shown to improve healing and dramatically reduce scarring. It’s gone through pivotal trials in Europe with great success and we think this is a shooin for approval, providing annual sales potential for the company of at least $500 million.
Another highly promising product would allow steroid injections directly into joints, with the same efficacy but using only one-tenth the amount of steroid used in traditional cortisone shots. If they can reduce the amount of drug and take away the side effects, usage of this product would be extremely high.
We don’t think it’s a stretch to imagine Angiotech as a major medical-device player in the next five years, in the league of a company like Boston Scientific.
...Your last idea, National Home Health Care (NHHC), is a quirky one.
AL: This is a small home healthcare provider in the northeastern U.S., serving Medicare, Medicaid and private-market patients. The company primarily provides nursing services, from monitoring to medication supervision to changing of surgical dressings. It also provides physical therapists or speech pathologists as part of a patient’s convalescence. In general, home healthcare is a fast-growing sector of the market, cheaper than providing the same services elsewhere and favored by patients over hospital care.
Unlike your other healthcare ideas, this doesn’t appear to have any intellectual property to speak of.
AL: It is in a competitive, service business, but the stock is so darn cheap that there’s a huge margin of safety. It’s a micro-cap, with a market value of about $65 million and net cash and receivables of $36 million. Revenues are over $100 million and we expect them to generate $8 million in EBITDA this year. If you include working capital, at the current share price of $11.70 it trades at an enterprise- value-to-EBITDA multiple of only 4x, versus the average peer multiple of 8.8x. So at peer levels, the stock should trade for closer to $20 per share.
What’s the problem?
AL: Management, unfortunately, is in our opinion not pursuing the best interests of shareholders. The company entered into a favorable-to-management merger agreement last November with a private-equity firm, allowing top management to back into a significant equity interest upon reaching certain milestones. They didn’t adequately pursue other options and put in place an absurd breakup fee. Management controls 51% of the company and the proposed merger does not require a “majority-of-theminority” vote from independent shareholders, which is obviously self serving. Another bidder, a nearby company, just offered $12 per share, which we assume the management group will try to beat.
Given the scenario you’ve described, why isn’t this hopeless for shareholders looking to get involved today?
AL: We definitely don’t think the story is over. The jury is still out on whether the board of directors – which in our opinion is either incompetent or unethical – will do the right thing. If the board properly shops the company, we believe it would fetch much more than the current bids. As shareholders, we intend to exercise appraisal rights and vote against any deal not at fair value. Many non-insider shareholders have publicly said the same thing.
This is a different type of investment for us, but we’re very well protected on the downside and still have significant upside. The downside protection comes from a very cheap valuation, having two bidders who are willing to pay the current share price, plenty of cash on the balance sheet and a dividend yield of 2.5%.
Are you seeing any dark clouds on the horizon for the market going forward?
AL: We’re certainly not alone in this, but we are worried about how an ongoing housing downturn will affect consumer spending. We also think people might be underestimating the impact on the U.S. middle class of the “flattening” of the world. Business owners are increasingly hard-pressed to keep operations in the U.S. when competitors can match their quality at better prices by producing overseas. While U.S. companies are wellequipped to adjust to that and take advantage of growth outside the U.S., we’re still at the very early stages of knowing the long-term extent to which globalization will affect the incomes of many U.S. workers.
More than anything, we’re focused on individual opportunities rather than reacting to bigger-picture trends. By focusing on stocks we know very well, with a high level of tangible downside protection, we’ve so far captured more than the market return in up markets and only 15% of the market’s loss in down markets. For value investors, that’s kind of what it’s all about.