IMS Health (NYSE:IMS) has managed to attract significant investor interest after announcing the merger with Quintiles (NYSE:Q) to create a major data and research platform for the healthcare industry, which will be known as Quintiles IMS Holdings. Even though the new name does not reflect any creativity, finding ways that can create value for the shareholder certainly needs imagination, given the opportunity for investors is still not clear.
No doubt, over the next few months, the merger with Quintiles may continue to help the sentiment around the stock, with the market focused on mostly long-term strategic benefits from the merger, be it the combined information pool that can help pharmaceutical companies cut costs and improve efficiency of their research or the relative scale in the industry, rather than questions about the existing business, which is offering limited opportunities beyond those offered by RWE (Real World Evidence) and CRM solutions.
Even if one ignores the challenges faced by the CRO market itself, with consolidation in the customer base that seems to be making the merger more of a compulsion, or the usual integration risks that come along with any merger of equals, there are concerns worth digging deeper. The business continues to suffer from a low organic growth rate and weak gross margins, while the balance sheet is hardly in shape to support acquisitions and cash flows remain unimpressive, especially if de-leveraging becomes a priority.
In the meantime, with the stock trading at more than 5 times book and 14-15 times EV/expected adjusted EBITDA for the current year, the market seems to be ignoring the uncertainty and lack of synergies beyond what management of the two companies highlighted, i.e. opportunity to optimize tax assets, annual cost savings of $100m by the end of the third year of the merger, etc.
Issues raised in the previous note and the merger
As covered in detail in my previous note, other than pockets of growth here or there, the support for the company to deliver on the targeted mid-to-high single-digit type of top line growth with margin stability or improvement looks weak. Competitively, newcomers like Veeva Systems (NYSE:VEEV), are going for the meatier opportunities like SaaS-based CRM in the space and have been successful at monetizing it too, while IMS is fighting to offset the declining revenue from the legacy business inherited from the Cegedim acquisition.
Even though theoretically the argument for the merger with Quintiles seems valid, i.e. combining IMS's ability to track and offer data related to prescriptions, medical claims, electronic records, etc., with Quintiles' CRO (contract research organization) services that can position the company well for outcome-based analyses using RWE, the practical implications and regulatory uncertainties remain. The upcoming listing of Medpace (NASDAQ:MEDP) and progress on the rumored combination like INC Research (NASDAQ:INCR) and Laboratory Corp. (NYSE:LH) or listing of inVentiv will undoubtedly blunt the edge as well as increase the relative scrutiny of the combined company in the CRO space.
Trends at balance sheet and margins remain worrisome
The balance sheet continues to remain weak and since acquisitions and global scale are a big part of the firm's strategic goals, the limitation of the balance sheet can hardly be shrugged off as a temporary or short term in nature. Even though the merger will help, the leverage ratio of the combined company is expected around 4 times debt/adjusted EBITDA, high by any standards. The gross margins have been weak, especially for the all-important tech services business, highlighting the problem of acquiring low margin businesses and relatively weak profitability of the new tech implementations.
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