Sunday, February 27, 2011

High Growth Plays in Wireless Infrastructure

American Tower $AMT is a great way to buy into the wireless infrastructure market. It competes well with the likes of other cell phone tower companies like SBA Communications $SBAC and Crown Castle International $CCI. However, as with any company, the question arises of evaluation and future prospects.

Wireless Infrastructure Growth

Long term growth looks assured for this industry. The move from 3G to 4G will stimulate a massive pick up in bandwidth demand as will the increasing penetration of smart phones and internet purposed mobile phones. In addition, the roll out of telecommunications and bandwidth to the emerging markets continues apace. All of this is great news for the cell tower providers.

The business model of AMT, SBAC and CCI is to undergo large amount of capital expenditures initially, in order to roll out a network of towers. This usually involves having longer term contracts with the network providers (in order to guarantee cash flows) and then selling initial 'stack' on the tower to new entrants or as an expansion to the existing clients. The marginal cost of adding a new customer is low, so the key to future growth is to add scale while you can.

Cash Flow is the Key

American Tower is the leader player in this space and generated the best margins, however margins are one thing and capital expenditures are another. Essentially, the cell tower companies can expand the network of towers by either acquiring existing towers or buying land and, constructing towers via capital expenditures.

Naturally, an investor would want a company to aggressively roll out expenditures early on, but also see that the reported growth is covering expenditures. In addition, margins and growth should indicate that the company is on the right track to delivering long term sustainable cash flows. American Tower is delivering on most of these objectives but what about the evaluation?

American Tower Evaluation

At the current price of $53.76 American Tower has a market cap of $21.4bn and an Enterprise Value of $26.09bn. Gross Margins are very high at above 76% and the company is already generating operating margins of nearly 40%  Revenues grew at 15% in 2010 and are set for 15% and 10% growth in 2011 and 12 respectively. So, all looks fine from the top line perspective.

However, as discussed above, the key is cashflow and whether American Tower is on a good evaluation or not. Turning to the 2010 results, AMT managed to generate $1.02bn in operating cash flows and spent $346m on capital expenditures. This implies free cash flow generation of $647m but this needs to be put into the context of a growing business. For example, of the capital expenditures $277m was spent on expansionary capex whilst nearly $70m was for maintenance capex. It would be easy to assume that the maintenance capex is giving a better long term picture but there are some caveats here.

Firstly, the capex figures only include expenditures for land and new construction. As a matter of fact, American Tower also spent a further $899m in acquiring communication sites with $570m of that spent on international sites. So clearly, capex is only one part of the equation. The key to getting a 'snapshot' look is to consider that American Tower depreciates its property, equipment and construction in 15-20 years, so the mid point of the useful life estimation  is 17.5 years. Looking at American Tower's balance sheet shows $3.62bn, which if depreciated (straight line) will give maintenance capex of $206m. Assuming this is the 'normalised' capex would give 2010 normalised free cash flow of $815m and a FCF/EV of 3.1%

This is ok for a business growing operating income and Ebitda in the low teens. However, it is not cheap for a relatively early stage business that is competitive and needs to demonstrate that it can expand margins.

I took a pass.

Tuesday, February 22, 2011

Sonosite is a High Grow Healthcare Play

Sonosite $SONO is a leading player within a high growth niche area of healthcare. The company specialises in hand carried ultrasound systems and, is the leading player in the US in this area. SONO is competing with some very big companies like GE , Philips and Siemens but it has demonstrated the capability to lead this market. As such, this stock is a genuine takeover candidate for these companies or a larger company like Mindray.

Sonosite are involved in miniaturising and simplifying ultrasound for Point of Care (PoC) medicine. The company was spun out of a larger US company in 1998 and until now has established over sixty thousands installed users. The company's solutions are sometimes described as 'portable ultrasound' but this description does not allude to some of the growth drivers for Sonosite. Before going into them, it is useful to see how Sonosite is performing right now.

Sonosite SONO Q4 Results

Turning to the recent Q4 results
  • Q4 Revenues of $89.3m vs. $83.7m estimates
  • Including Non-Recurring Charges EPS was 41c vs. 36c estimates
  • Full Year Revenues of $310-325m vs. $312m estimates
  • Full Year gross margins stable at around 71%
  • Operational expenses of $184-186m
  • Tax rate of 34%
  • Analyst are forecasting EPS of $1.20 for 2011
Listening to the conference call the management are seeing a 50/50 split between international and US sales in 2011. International growth is seen as stable but low growth in Western Europe, however the emerging market and BRIC economies are seen as faster growing. A combination of organic revenue growth, new product launches in the second half and growing contribution from the Visual Sonics acquisition will increase the top line by 13-18% according to Sonosite.

One interesting aspect of this growth is that it will be more back end loaded, so investors can expect a 40/60 split of revenues in the two halves, with revenues in Q2 and Q3 being higher than in previous years. Margins are likely to stay stable because Sonosite is in-what the company sees as- the first of a three year sales cycle. Typically this means that sales costs, R & D and promotional activity are higher in the first year. After which, operating margins will expand in the next couple of years.

Sonosite estimates that it either held or gained market share in its major markets and the management do not appear to be planning any acquisitions for 2011.

Sonosite Growth Prospects

The growing usage of portable ultrasound for emergency procedures (where portability is an issue) is one area of growth as is increasing usage for certain medical procedures. In particular, advances in portable ultrasound technology are seen as creating a market for the machines to be used in procedures that would otherwise be covered by computed tomography (CT) or magnetic resonance imaging (MRI).

For example, patients who need on going antibiotics or chemotherapy will have a Peripherally Inserted Central Catheter (PICC) placed in them and, portable ultrasound is ideal for helping the nurse visually see how the instrument should be placed. Similarly, nurses use the machines to guide them in injecting anesthetics near peripheral nerves prior to surgery. For this type of hospital usage, Sonosite claims to be the clear leader with GE its main competitor.

Another growing usage is for detection of breast cancer, as ultrasound gives very high

Sonosite also cites Mindray as being a competitor in some of its markets and, they could be potentially an acquirer because Sonosite and GE have already settled a law suit. Furthermore, Sonosite should be attractive to the likes of Philips or Siemens who could immediately gain scale in the US by buying SONO.

Sonosite Evaluation

The stock trades at a share price of $36.94 which gives it a market cap of $498m and an Enterprise Value of $497m which makes it a small cap growth play. Analyst estimates are for EPS of $1.20 and $1.64 for 2011 and 2012 respectively. This hardly makes the stock cheap on a PE basis.  However, net income is only one side of the story, because SONO have been booking losses via buying back convertible debt. Furthermore, Sonosite is a highly cash generative business.

Given the numbers in the guidance above, it is entirely feasible that, for 2011, Sonosite will record $225m in gross margin and 40.4m in operating income. Assuming losses on debt repurchases similar to 2010 would give pre-tax profits of $29m and $19.1m in net income. Given traditional operating cash flow conversion, Sonosite could generate $33.5m in operating cash flow and around $31m in free cash flow (FCF).  This equates to a foward FCF/EV yield of  6.2% based on a current price of $36.94

This looks too cheap, so I bought some with a $45 price target.


iData Report, "U.S. Market for Ultrasound Equipment 2010"

Saturday, February 19, 2011

Campbell Soup Confirms Weakness

Campbell Soup $CPB gave results recently and confirmed the difficulties within the sector. From a macro-economic perspective Campbell Soup is faced with many challenges, many of which were outlined in a previous article

The major problem for Campbell Soup is that the US economy is increasingly seeing an uneven distribution of incomes which has been exacerbated by the recession. This means that they have little pricing power due to a lack of purchasing power by the overall US consumer. Campbell Soup does not have the ability of a Coach or a Nordstrom in being exposed to higher income demographics.

The lack of pricing power is causing margins to fall as food input and energy prices are rising. What makes it worse is that it is the emerging markets (where the jobs just got exported to) that are driving these prices higher. This leaves the lower income US citizen with little wage bargaining power and his discretionary spending power is crimped due to spending more of his income on food/energy. None of which, is good news for Campbell Soup.

It is no surprise to see Campbell struggling in the current environment and there is little attraction in buying the stock. Food inflation is around and Campbell Soup can't pass on the cost rises. I'm taking a pass here.

Blue Coat Q3 Earnings Write Up

Blue Coat $BCSI gave disappointing results which contrast unfavourably with Riverbed $RVBD, but might there be value in the share price? Blue Coat was originally written up in an in-depth article on this blog. The linked article should serve as providing the background to this update following results. In summary Blue Coat is a 'turnaround' story but as still to demonstrate that the company is on track.

The orientation of this blog is towards Growth at Reasonable Price (GARP) investing and so BCSI does not, as yet, seem to be a stock worth buying. However, for investors who favour special situations or value type investing than Blue Coat offers a more compelling proposition. Hopefully, some of the information here will be of use.

Blue Coat Q3 Results

The results were disappointing
  • Q3 Revenues of $123.8m vs. $125.1m estimates
  • Adj EPS of 34c vs. 36c estimates
As was the outlook
  • Q4 Revenues of $121-128m vs. $129.8m estimates
  • Q4 EPS of 32-38c vs. 38c estimates

Clearly, these are disappointing numbers and the stock sold off aggressively afterwards. Aside from the miss, what is peculiar about the results is that the analysts focussed on the performance of the Americas and Europe but completely ignored the Asian region in their questions during the conference call. This is bemusing, because the Americas looked ok (close to usual sequential decline) and Europe did ok. Asia was rather disappointing. The management said that the results were in line with expectations bar the Americas being slightly weaker than expected.

Regional Breakdown for Blue Coat Revenues

Before looking at the results in detail, it is worth nothing some of the points to look for in the results
  1. Blue Coat is restructuring the European Sales operation having previously over relied upon Tier 2 distributors
  2. Secure Web Gateway (core business) is a low growth business now as Blue Coat already has strong market share
  3. Blue Coat's WAN optimization solution is generally seen as weaker than Riverbed's (who reported v strong growth) but has the facility to offer security as well. When customers want both than Blue Coat is advantaged
Turning to the regional revenue numbers (the numbers in red represent sequential declines)

Q2 09
Q3 09
Q4 09
Q1 10
Q2 10
Q3 10
Q4 10
Q1 11
Q2 11
Q3 11

Source: Blue Coat

The Q3 Americas numbers look weak but actually there are in line with last years sequential decline (-3.3% vs. -3.1%)  and the European numbers recorded a sequential increase which might suggest that Blue Coat is over the worst of the company's troubles in Europe. However, Q3 is normally a very strong quarter in Europe for Blue Coat. As noted above APAC sales were rather disappointing and Q3 was only 4.5% above 2009. This is not particularly good given that this region is leading the global recovery.

Interpolating the historical numbers and making the following assumptions could give the following revenues for Q4
  • Americas follows 2009 sequential increase, giving $60m
  • Europe Q4 tracks same relative performance (against 2009) as Q3 did, giving $39.1m
  • APAC YoY tracks Q3, giving $27.5m
This totals as a-conservatively put together-revenue forecast of $126.6m for Q4. The analyst estimates are for $129.8m but Blue Coat are guiding towards $121-128m. Either, Blue Coat is trying to under promise/over deliver or there is a fundamental weakness here.

Blue Coats Strategy

Essentially, the new CEO is trying to restructure the European sales operation and reduce its dependence upon Tier 2 distribution. As a consequence, Blue Coat held back from major lead generation attempts. However, the company looks set to accelerate customer acquisition activity following the hiring of a new CMO and expansion of a number of sales partner alliances with the likes of HP, Microsoft, Oracle and IBM. Whilst this process can be expected to take time -management are asking for 6-9 months- Blue Coat is selling into very favourable end markets.

The core web gateway security market may be slowing but WAN optimisation sales for competitors such as Cisco and Riverbed are soaring. It may well be that Blue Coat's WAN offering is not as competitive as it once was. For example Riverbed are claiming 43% share of the Advanced Platform WAN Optimisation market and are releasing new products (Virtual Steelhead and Cloud Steelhead) which enable the transition towards cloud computing. Similarly, Riverbed has just released 'Whitewater' which is a cloud storage accelerator that enables cost effective moving of storage to the cloud.

In conclusion, whilst Blue Coat is generating large sums of cash -see previous research- recent revenue growth has been weak and, the company is challenged to generate growth in its core market of secure web gateway. Nevertheless, it has the elements of a turnaround story and is favoured by strong end markets. For the value investor this may prove compelling.

For a GARP investor, it may make more sense to wait for confirmation that the Blue Coat product offering is not being fundamentally challenged. In the opinion of this blog, anything less than $126.6m in the Q4 revenue numbers will be a disappointment.

Thursday, February 17, 2011

Nice Systems Benefits from Increased Regulatory and Compliance Requirements

Nice Systems $NICE is a, err, NICE way to play the growing trends towards regulation and security management within financial services. Nice gave results recently and announced an acquisition which was well received by the market. With the implementation of Dodd-Frank and the increasing needs for firms to manage security and work flow optimisation, Nice looks set to grow strongly.

Nice Systems helps companies to extract insight from interactions, transactions and surveillance. The information is gathered from a wide range of different sources, from emails and phone calls to video surveillance. Nice should see good growth as financial firms start to spend again to support expansion and deal with mounting compliance and regulatory issues. For example, the Dodd-Frank legislation is expected to lead to many more firms being regulated.

Furthermore, financial firms and Governments are under increasing pressure to protect themselves and the company from internal and external security threats as well as ensure that work flow is being properly managed. These words sound abstract, but consider Nick Leeson and Jerome Kerviel, both of whom benefitted from lax monitoring and compliance controls.

Nice Systems Results

Turning to the recent results
  • Q4 Revenues of $187m vs. $180m estimates
  • EPS of 51c vs. 49c estimates
  • Q1 Revenues of $179-$183m vs. $179.3m
  • Q1 EPS of 43-27c vs. 45c estimates
  • Full year Revenues of $775-800m vs. $768.5m
  • Full Year EPS of $1.96-2.06 vs. $2.02 estimates
It should be added that the guidance includes the impact of the CyberTech acquisition ($25m to full year revenues) which is expected to complete at the end of March. Nevertheless, the guidance for Q1 is an upgrade and Nice beat Q4 estimates handsomely.

CyberTech Acquisition and Nice Systems Position

 Essentially, Nice Systems is positioned at the high end of the Work Flow Optimisation market. As such, Nice tends to offer relatively expensive large scale solutions to the enterprise market. Whilst this leaves them exposed to cheaper competitors chasing Nice's installed base when they come to upgrade or renew, it also ensures that Nice offers a comprehensive best in class solution.

The CyberTech acquisition is intended to give Nice some complimentary solutions and also allow Nice to offer sales with a lower Total Cost of Ownership (TCO). In particular, CyberTech offers compliance recording solutions and has a good position within European financial services firms. CyberTech is not only a good technology fit but also a good geographic one too, as Nice's current strength is in the US and Asia. Buying CyberTech will also allow Nice to make inroads into the previously uncharted SMB territory.

One area of possible concern is public sector end demand, but it is probable that this is an area whereby Governments will be highly reticent to cut. Work Flow Optimisation gives a tangible return on investment and much of Nice end demand is regulatory and compliance led. Another cause of worry could be an increase in the demand from organisations for their WFO solutions to be sold by their contact center infrastructure provider. Although, Nice is focused on the high end so this trend is unlikely to have a great affect.

Nice on a Nice Stock Evaluation?

With a stock price of $35.36 Nice has a market cap of $2.22bn and an Enterprise Value of $1.92bn with a highly cash generative business model. The current PE ratio is 35.36/1.85=20.2x and Nice trades on 17.5x forward earnings. Turning to free cash flow Nice just generated $133.3m which puts the company on a FCF/EV= 6.9% which is very good. With some back of envelope calculations it is not unreasonable to expect Nice to translate the forecast $129.5m in net income into around $145m in free cash flow which would put the company on a forward FCF/EV of 145/1920=7.5% but it should be noted that the forecast tax rate for 2011 is only 17-18%

If you-very conservatively-adjust the numbers for a 30% tax rate the reduction could come to around $19m which would give an adjusted FCF/EV of  126/1920=6.6% approximately. If investors want to buy a stock on a forward ratio of 5.5% then this would give a of around $42.2

I bought some with this target in mind.

Actelion Preparing to Counter Gilead in PAH

Gilead Sciences' $GILD rival Actelion $ATLN gave full year results today and they were positively received.  As ever with biotech and pharmaceutical companies, investors will always want to focus on the pipeline in order to decide whether the stock is worth buying. Going forward the key event driver for Actelion will be Macitentan. Gilead was featured extensively in an in depth article on earnings view. Before going into more detail, it might be worthwhile to understand the background.

Tracleer vs. Letairis in Pulmonary Arterial Hypertension

Actelion is a rival to Gilead because they compete in Pulmonary Arterial Hypertension (PAH). Gilead's Letairis seems to be gaining market share on Actelion's blockbuster drug Tracleer. Interestingly, in an attempt to broaden their indications, both drugs were put into phase III trials for Idiopathic Pulmonary Fibrosis (IPF) and both failed last year!

The advantage of Letairis is that it is taken on a once a day regimen (as opposed to twice for Tracleer) and has a more flexible dosing regime. In addition, it has demonstrated a superior liver toxicity profile to Tracleer.

According to Trista Morrison in Bioworld, Letairis has demonstrated superior efficacy to Tracleer:
“ the 5mg dose of Letairis... ...increased the distance covered during a six-minute walk by a mean of 31m in one trial and 59m in the other." and "10mg dose... ... increase was 51m. In the Tracleer Phase III, the 125mg dose increased distance by a mean of 35m in one trial and 76 meters in the other. “
As noted in a previous article on Gilead, Letairis has been expanding sales strongly. Although Letairis does have some potential side effects. On the downside, Letairis (ambrisentan) has been linked to an increased risk of peripheral edema (or oedema) and the FDA approved safety labelling revisions according to Yael Waknine:
“Peripheral edema is a known class effect of endothelin receptor antagonists and is also a clinical consequence of (PAH) and worsening PAH. However, clinical study data have revealed an increased incidence of peripheral edema in patients receiving 5 or 10 mg/day of ambrisentan vs. placebo (17% vs. 11%)."
The article goes on to point out that the majority of the cases were mild /moderate in severity, and they occurred with greater frequency and severity in old patients.

So what is PAH and how do these drugs differ?

Pulmonary Arterial Hypertension

One of the problems with pulmonary arterial hypertension is that it is difficult to detect early on. Symptoms include things like chest pain, shortness of breath, palpitations, excessive fatigue and fainting. These symptoms are often mistaken for other conditions, particularly as PAH is not a widely held condition. The cause of PAH is unknown and, ultimately, the condition will cause death. Therefore, treatments are focused on improving survival rates via blocking either ETA receptors or ETA and ETB receptors.


Endothelin ETA and ETB Receptors

Endothelin is a powerful vasoconstrictor which has diverse actions that effect homeostatic actions in the body. According to Schneider et al the two receptor subtypes, ETA and ETB

"mediate the actions of endothelin. ETA receptors.. ..promote vasoconstriction, growth, and inflammation, whereas ETB receptors produce vasodilation, inhibit growth and inflammation. Potent and selective receptors... ...have shown promising results in the treatment of.. ..pulmonary arterial hypertension, acute and chronic heart failure, hypertension, renal failure, and atherosclerosis.”
ETA and ETB receptors have opposing actions and it is this contradiction which defines the competition between Actelion’s Tracleer (blocks ETA and ETB receptors) and Gilead’s Letairis (blocks ETA receptors only).

Actelion's Plans for Macitentan in PAH and IPF

Similarly, Actelion's Macitentan blocks ETA and ETB receptors. More light on Macitentan was shed by Iglarz et al:

“optimized for its potency and dual blockade of ETA and ETB receptors since both receptors mediate the deleterious effects of ET-1 in pathology” and “dual antagonism was superior to ETA-selective antagonism in terms of maximal efficacy. This ranking of efficacy between selective and dual antagonism in pathology is inverse in physiology, where in healthy subjects, ETA-selective antagonists induced greater vasodilation than dual"
Actelion has Macitentan in Phase III and it appears that this will be the focus of their efforts in order to retain leadership in PAH after Tracleer’s patent expiry in 2015. In common with Tracleer, It is a dual endothelin receptor antagonist. However, unlike Tracleer, it has shown good efficacy in idiopathic pulmonary fibrosis.

Macitentan Advantages and Timeline

Macitentan is well tolerated and seems to be free of many of the potential liver toxicity issues that are associated with Tracleer and Gilead’s Letairis. According to Martine Clozel,
"Macitentan is expected to protect tissues from the deleterious effect of elevated ET, via a comprehensive blockade of ET receptors in the tissue compartment.”
Unlike Tracleer (but in common with Letairis) it is a taken once a day and has demonstrated greater efficacy than both in pulmonary arterial hypertension. After the intended Phase III and FDA approval Actelion would hope for Macitentan to replace Tracleer and also to open up the IPF market for them.

Phase III results for Macitentan in PAH are expected in late 2011 or early 2012, whilst Phase II results for Macitentan in IPF are expected in the second half of 2011. There are exciting days ahead for Actelion!



Clozel, Martine “Better by Design- Potential of Tissue Targeting”  Abstract from7th International Pulmonary Hypertension Forum, 2008
Iglarz M. et al. “Pharmacology of Macitentan, an orally active tissue targeting dual endothelin receptor antagonist.” J Pharmacol Exp Ther. 2008 Sep 9
Morrison, Trista “Gilead Gets Letairis Approval, Potential Best In Class For PAH”  Bioworld Today, 2007
Schneider, Markus P., Erika I. Boesen and David M. Pollock “Contrasting Actions of Endothelin ETA and ETB Receptors in Cardiovascular Disease Pharmacology and Toxicology, Volume 47, 2007
Waknine,Yael “FDA Safety Changes: Serevent Diskus, Letairis, Antibiotics”  Medscape News,2008

Wednesday, February 16, 2011

Treatt Confirms Raw Material Price Pressures

Treatt is a UK stock and, a relatively small player in the flavours and fragrances industry but the company's latest interim management statement is confirming the general trend in the industry. Givaudan gave notice of the threat of rising raw material prices earlier this month and Treatt are saying the same thing.

From the recent Treatt statement ...
However, as prices have continued to rise, there has been an increase in working capital and margins have narrowed as not all price increases can be passed on to customers.  The Group is seeking to manage the potential downside risk if, and when, prices begin to fall.

In other words, not only is it not possible to pass on rising costs but when prices do fall, there will be a short/mid term period whereby Treatt will be saddled with having paid high prices for Treatt's raw material costs. This matches what Givaudan said about the uncertainty over margins this year. I would expect $IFF International Flavors and Fragrances and Symrise to be exposed to similar pressures.

All of which is frustrating for these companies because the secular outlook for these companies -in particular Symrise- is positive, but I don't think it is time to buy them just yet.

Monday, February 14, 2011

Western Union and MoneyGram Value Traps?

Cash in Western Union Stock?

Western Union $WU has all the makings of a value trap investment. This research article will focus on Western Union but much of it is equally applicable to $MGI MoneyGram. Western Union stock is, on a superficial basis, very attractive for a portfolio, yet it contains danger. Any analyst research report should discuss these issues. On balance, I decided that this stock was not worth buying. Having said that, it is worthwhile to articulate the risk and reward profile of this stock in order to monitor.

Western Union Profit Drivers

The stock actually has a number of things going for it. I will outline these points in the context of the results. Western Union has...
  • Good exposure to the expected rise in employment this year
  • Very favourable demographic trends of globalisation and migrant workers
  • Increasing utilisation of technology to capitalise on the potential of things like pre-paid cards and mobile money transfer
  • An expanding network of 80,000 agents and 16,000 corridors and a global leading position in money transfers
  • Highly cash generative business model
It's not hard to see why many would conclude that Western Union is a great stock to buy. As employment picks up in the developed economies, the kind of low level service personal that uses Western Union services will see an increase in income. Furthermore, increasing growth encourages more migration and this helps Western Union in its remittance business. For example, around 9% of Western Union's business involves remittances from USA to Mexico and, 85% of revenues are c2c. Putting all of these things together and, it is likely that Western Union will see a lot of potential upside this year.

Western Union Growth Strategy

Essentially, Western Union flourishes in environments whereby its customers do not have access to existing banking facilities. This is why international remittances of lowly paid workers are the core business for the company. Whilst this end market is guided by macro economic considerations (as discussed above) it is also being affected by technological changes. Western Union are seeking to stay ahead of the technology curve by expanding sales of pre-paid cards and establishing a long term position in mobile money transfer.

This is laudable but, I think, will prove challenging for Western Union. The world is full of companies of who, in recent history, suffered as their business models became obsolete as a consequence of technological changes. What is surprising, is how quickly these companies succumb to these pressures. Similarly, Western Union and its main competitor MoneyGram are facing significant challenges.

The Future of Money Transfers?

Here are five main challenges to companies like Western Union and MoneyGram. Most of which are coming from technological developments that threaten the core business of these companies
  1. Increasing banking penetration in emerging markets, for example, Latin American banks servicing workers with branches in US
  2. Email transfer banking and internet based transfers
  3. Micro Finance companies (many which are non-profit) expanding activities/lending in emerging markets
  4. Mobile phone based transfer payments
  5. The Federal Reserve may force them to fully disclose fees and exchange rate charges, in line with the Dodd-Frank laws
Every one of these factors is a long term threat to Western Union. Whilst the results and conference call contained many positives, the 2-4% drop in pricing is a cause for concern. Western Union's management are arguing that this is part of a strategy to win market share via promotions.

However, I have my doubts. I think the company is trying to stem back the advance of inevitable technological change. History does not look too kindly on companies that have tried to do this.

Western Union Evaluation

Listening to the latest conference call, it is clear that Western Union expects to generate between $1-1.2bn in free cash flow for 2011. Analyst consensus is for EPS of $1.51 and operating margins are expected to expand by 100 basis points to 27%  The forecast EPS growth of 6.3% is not great but should be put in the context if a higher tax rate (impact forecast at negative 6-8c for EPS) plus $50m or 6c negative impact from restructuring charges. Adding these effects back in would give EPS growth of 15%

With an EV of $15bn and a stock price of $21.4 this would put Western Union on a forward FCF/EV of 7.3% and a PE ratio of 14.2x which is attractive. Furthermore, Western Union is set for positive upside from employment gains and a growing economy. The management is doing all the right things in engaging in share buy backs and looking to return cash to shareholders.

All of this is fine and, short term I would expect the stock price to go higher. However, longer term there are structural challenges here and I don't like trying to time when they are going to hit.

I'll take a pass on Western Union.


Bloomberg Website "Western Union, MoneyGram May Lose as Fed Sets Remittance Rules"  (Accessed 14 Feb 2011)

Friday, February 11, 2011

Sirona is an Attractive Healthcare Growth Stock

Sirona CAD/CAM Systems Give Single Visit Restorations

Sirona Dental Systems $SIRO is a dental healthcare stock which is exposed to favourable demographic tailwinds and the expansion of the rollout of its global leading technology. Sirona gave results recently and they were very well received by the market. However, the evaluation and prospects look compelling and, it looks like there is more to run. Analysts will be keen to upgrade estimates in their equity research reports

Growth Drivers for Sirona

Sirona looks set to benefit from an ageing demographic, because as people get older they require more teeth maintenance. Furthermore, the trend is towards people having more teeth as they are older, which means more restoration work and ultimately more demand for Sirona's products.

Whilst the demographic argument is well worn in healthcare plays, it should carry more weight with Sirona because of a relative lack of insurance reimbursement issues with dentistry products and solutions. Indeed, the industry is shifting towards private from public pay and much of what Sirona does is aimed at the high end market.

The company is very well run and a global technology leader. Sirona spends around six to seven percent on research and development every year and is investing $15m in setting up a major new innovation centre in Bensheim, Germany. The balance sheet is solid, having seen the company engage in deleveraging the business over the last few years. Sirona is now in a position to make some acquisitions and I would expect some activity on this front.

Sirona Business Divisions CAD/CAM

A graphical breakdown of Sirona's business divisions for Q1

Q1 2011Revenue% total RevGP% total GPGP Margin
Treatment Centres49.821.1%2215.7%44.2%
Source: Company Accounts, Earnings View

...and then looking at how margins and revenues have moved...

% constant currencyRev GrowthGP growthGP Margin growth (bp)
Treatment Centres2320.1290
Source: Company Accounts, Earnings View

Sirona is best known for its CAD/CAM system Cerec, which allows dentists to make a tooth restoration in a single client visit in 95% of cases. This is advantageous for the patient because he gets an immediate treatment as opposed to a seven to ten day wait, which involves the restoration being created and then fitted in a second visit. Among Sirona's distributers are companies like Patterson and Henry Schein, who have helped establish the Cerec system into low double digit penetration in developed markets. Although impressive, it does suggest that there is plenty of room for growth. It is a proprietary system which is backed up by patents and Sirona's research leadership.

Clearly, many dentists will baulk at paying the sticker price of $100-120k for the system but it actually delivers an impressive return on investment. Sirona estimates that with 25 restorations a month, the cost savings of using the Cerec system should pay for itself within one year. Nevertheless, it is not hard to see that penetration has begun with the high end practices. For less active practices, Sirona has Cerec connect which gives dentists in option to tap into the Cerec technology but at a lower initial cost.

Looking at the results for CAD/CAM it is noticeable that International sales (up 23.3% in constant currency) far outpaced US sales (up .9%) and this is seen as being a result of a tougher US comparison. Sirona had record US sales growth in the comparable quarter last year. Margin expansion was good and came as a result of natural leveraging and a favorable shift in the sales mix.

Sirona Imaging Systems

Sirona are also a leader in Imaging Systems and, this division saw strong growth. However, there was some margin compression due to pricing pressure. This will be somewhat alleviated in the second half of the year when/if Sirona gets FDA approval to sell the new Ortho Plus XG 3D product. It may well be that dentists are holding off buying some of Sirona's other products while they wait for this to be approved.

Thinking longer term, Sirona has 40-45% penetration in this market place. Although, this sounds prohibitive to future growth, the 'penetration' refers to at least one sensor in the practice. Therefore, Sirona should have the opportunity to be able to sell more of them into this established base. Sirona intends to sell a few sensors into a given practice after establishing a presence.

Treatment Centres

Sirona saw very impressive growth in constant currency and margins. Sirona's treatment centres are focussed on the high end and have seen a resumption to growth as the economy recovers. Demand growth was stronger in Asia and Europe (Sirona has very strong in Germany) and I would expect this to continue as teeth surgery for cosmetic reasons is something that the wealthy can afford.

Sirona Stock Evaluation

Tabulating previous results for Sirona and some estimates assuming the current share price of $49.86 and a market cap of $2.76bn with an Enterprise Value of 2.86bn....

(m)200820092010Trail to Q12011E
Gross Profit346346399417470
Op Income6485128141158
Net Income295390101124
Change WC-42-271-26-25
Op Cash Flow95120176158200
Free Cash Flow5999152130150
% revenue7.7%13.9%19.7%16.4%17.6%
Source: Company Accounts, Earnings View

...demonstrates that Sirona does a very good job of converting income into cash flow and debt has fallen dramatically over the years. However, it is noticeable that working capital requirements (accounts receivables in particular) have risen to accommodate the growth in the quarter.

The full year results to Sep 2011 are expected to be front end loaded, but Sirona raised full year guidance to revenue growth of 9-10% (previously 7-9%) and operating income (excluding amortisation of $54m) of $208-216m which represents over 23% growth in operating income.

Current consensus EPS figures are for $2.88 to Sep 2011 but I think Sirona will report closer to $3.05 and I also think that the estimated free cash flow figure (above) is a bit light because they are spending $15m on a new innovation centre. The usual capex run rate is 3-4% so assuming 4% (34m) gives adj FCF=$166m. Assuming a 'fair' evaluation is a forward FCF/EV, of around 5% I think Sirona is better priced at closer to $58.

I bought some.