Australia | Dec 13 2018
Sonic Healthcare will acquire Aurora Diagnostics, which is expected to transform its US business and provide substantial revenue synergies.
-Strategically strong acquisition, providing expanded scale in the US
-Sonic Healthcare to cross-sell its clinical pathology services where Aurora operates
-Question of whether raising equity at current point in time is appropriate
By Eva Brocklehurst
Sonic Healthcare ((SHL)) is expanding its scale and operations in the US, reducing reliance on the volatile Australian health sector and creating a significant global pathology practice. Brokers find several reasons why this is a strategically compelling transaction which will transform the US business.
The company will acquire Aurora Diagnostics for US$540m, a US anatomical pathology business with pro forma revenue of US$310m and operating earnings (EBITDA) of US$59m. Brokers consider the acquisition strategically sound, providing near-term earnings accretion and potential for growth over the longer term.
Reimbursement pressure for Sonic Healthcare in both the US and Germany, in Macquarie's view, is balanced by scope for further acquisitions and the potential for lower Australian collection centre rental costs.
While Deutsche Bank envisages financial merits and revenue synergies from the transaction, the challenging US market conditions and questions over the sustainability of margins makes it wary.
Despite the acquisition being a potential driver of growth, Credit Suisse is cautious as well about the muted level of organic growth across the group, as Australian pathology volume growth slows with Germany being volatile after regulation changes.
Credit Suisse finds few cost synergies in the acquisition but potential for revenue synergies, as the company leverages scale across the hospital market and cross-sells into the base clinical pathology platform. The broker continues to believe Sonic Healthcare will explore acquisitions in the US and includes US$150m in expenditure for acquisitions, debt funded, in its modelling.
Sonic Healthcare is funding the acquisition with $600m in an institutional placement at $19.50 a share and up to $100m via a share purchase plan, as well as a bridging facility. The acquisition is forecast to be accretive to FY19 earnings by 3% and close early in 2019.
The multiple paid is at the higher end of the historical range, Morgans observes, although synergies that are expected from revenue expansion and cross-selling opportunities between anatomical and clinical pathology make the purchase price appear more reasonable. Morgans also believes geographic diversification and scale should dampen any short-term volatility.
Citi considers this a good strategic acquisition, as Aurora Diagnostics is a leader in anatomical pathology. Nevertheless, the broker questions whether raising equity when the stock is at a 52-week low is appropriate, given there is a balance sheet capacity to fully fund the deal with debt.
Moreover, despite financials being publicly available, there is limited visibility on the business given it was acquired from private equity and Citi wants more time to assess its market position. The broker upgrades to Buy from Neutral as the acquisition increases forecasts for FY20 revenue by 8% and net profit by 12%. Moreover, the share price has fallen -19% since Sonic Healthcare reported in August.
The deal increases the company's US business by around 38%, Morgan Stanley notes, while diluting the US funding risk. The broker, in examining the latest financial report filed by Aurora Diagnostics, calculates top-line growth of 7.7%, of which only 0.6% was organic. Aurora Diagnostics completed five acquisitions during 2017.
The US anatomical pathology market is highly fragmented and growing strongly. Growth is being driven by the increased prevalence of chronic disease, an ageing population and increased expenditure on healthcare. Growth is skewed towards outpatient practices.
Brokers also note funding for anatomical pathology is more stable versus clinical pathology, with only 2% of the company's revenue stream affected by cuts to funding. US Medicare funding for anatomical services falls under the physician fee schedule (PFS).
The company operates 32 pathology practices across 19 US states with more than 100 hospital contracts. Anatomical pathology, which involves such areas as dermatopathology, gastrointestinal, haematopathology, and women's health, accounts for 90% of revenue, with allied services such as molecular and next-generation testing comprising the remainder.
Morgan Stanley highlights these allied services potentially have high-growth and partnering opportunities with biopharma and diagnostic companies, which is not encapsulated in current accretion estimates.
FNArena's database shows four Buy ratings and four Hold. The consensus target is $26.02, suggesting 19.2% upside to the last share price. Targets range from $23.20 (UBS) to $29.56 (Deutsche Bank).
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