2023-08-21 05:36:22 ET
Summary
- ICU Medical's deal with Smiths Medical is underperforming, following a previous troubled deal with Hospira Infusion Systems.
- Shares have fallen by 50% over the past two years, as the company's outlook is uncertain.
- The business is facing quality issues and higher interest costs, and its leverage is still high.
Two years ago I concluded that ICU Medical ( ICUI ) got involved with decisive M&A, again. This came after the business was struggling for years after the Hospira deal in 2017. With the company having made a better prepared deal for the Smiths Medical business at the time, the deal looked better on paper.
That said, a 35% move higher in response to the deal announcement, felt like an overreaction, at least in the near term. Ever since, shares have fallen about 50% over the past two years, as the deal again is not delivering on its promises, creating a wobbly outlook, and few reasons to get involved just yet.
A Recap
ICU Medical announced a $1 billion deal for Hospira Infusion Systems in 2016, as the purchase price was cut to $900 million upon closing a year later as the acquired activities performed poorly before it had even closed.
Despite the shortfall in the results, shares rallied from the $100 mark in 2016 to a high around the $300 mark in 2018 as the deal was decisive with the own business posting much lower sales at the time.
This was seen in the numbers for 2017, a year in which sales grew from $379 million to $1.3 billion, as adjusted earnings rose from $4.88 per share to $6.45 per share, as the acquired activities were carrying lower margins and debt was assumed as well (with associated interest costs, even if they were cheap). Results largely came in around the same numbers in 2018 and 2019, but fell of course for obvious reasons in 2020.
With nearly 22 million shares trading around the $200 mark, equity of ICU was valued at $4.3 billion in September 2021, or just below $4 billion if we factor in a net cash position, all while the earnings power trended around $7 per share. Given this backdrop, ICU announced a huge deal, as it paid $2.35 billion to acquire the Smiths Medical business, a deal which involved 2 million shares to be issued, as well as a $1.85 billion cash component, and a potential $100 million earn-out.
The deal would add $1.2 billion in sales from infusion systems, vascular access and vital care, in an effort to create a more complementary product portfolio of IV therapies. With $190 million in anticipated EBITDA, the business is slightly more profitable than ICU, and at a 13 times multiple was less than the multiple at which ICU traded. Net debt was set to jump to $1.4 billion, for a 3.1 times leverage ratio.
After factoring in $50 million synergies in year 3, the company believes that earnings might rise from around $7 per share to $13 per share, which once delivered upon would be a huge achievement. The problem was the reaction, as shares rose from $200 to $270 upon the deal announcement. That was a bit too optimistic in my eyes, as execution was required and leverage would temporarily shoot up.
Enthusiasm Is Short Lived
After shares traded at $270 in September 2021, they quickly fell to the $200 mark early in 2022. Shares fell later in 2022 and have traded in a $130-$200 range ever since, as shares fell overnight from $170 in August to just $131 per share.
In the end, ICU closed the deal with Smiths in January 2022, and in February the company reported the 2021 results. Full year sales rose by just over 3% to $1.32 billion, as the company guided for 2022 adjusted earnings between $9.00 and $10.50 per share, based on $450-$500 million in EBITDA in the first year in which the Smiths deal contributes (except for the first days in January).
In February of this year, the company reported 2022 results which were weaker than expected of course. Full year sales rose from $1.32 billion to $2.28 billion as the own business was posting flattish results, which means that Smiths added less than a billion in sales, falling short of the $1.2 billion anticipated sales contribution. Net debt was reported at $1.44 billion, worrying as the business was performing far softer than expected, with a GAAP loss of $3.11 per share reported, or $74 million in dollar terms.
It was clear that the company expected softness to continue with 2023 EBITDA seen between $375 and $425 million, despite the realization of synergies. This and higher interest costs means that adjusted earnings are only seen at $5.75 and $7.25 per share.
In May, the company posted a 5% increase in first quarter sales to $568 million, with EBITDA improving to $102 million. The company squeezed out GAAP operating profit of $9 million, as restructuring costs came down, but amidst higher interest costs GAAP losses were reported at $10 million. The GAAP loss of $0.41 per share compares to an adjusted profit number of $1.74 per share, largely due to amortization charges, restructuring charges and quality systems and product related remediation charges.
Second quarter sales, as posted in August, were disappointing. In an inflationary environment and amidst a broader portfolio, the company posted a 2% fall in sales to $549 million. GAAP operating profits came in at just $2 million and change and amidst higher interest rates, GAAP losses were reported at nearly $10 million. This was equal to $0.41 per share as losses would come in at even higher if not for a lower tax rate, with adjusted earnings were reported at $1.88 per share.
On the back of the softer second quarter, the company trimmed the high end of the EBITDA guidance, now down from $425 million to $405 million, with adjusted earnings now seen in a $6.00-$6.85 per share range. With the midpoint of the EBITDA guidance now trimmed to $390 million, net debt is flattish at $1.44 billion, for a 3.7 times leverage. Lack of deleveraging is the result in partial because of many charges to earnings and an inventory build-up.
The 24 million shares of the company now represent a $3.1 billion equity valuation at $130, as the net debt load makes for a $4.5 billion enterprise valuation, close to the same valuation pre to the Smiths deal.
And Now?
The reality is that the deal with Smiths Medical is performing far worse than originally projected, which is the second troubled deal in a row. This comes as the business was (again) in worse shape than thought at the time of the deal announcement, including numerous quality issues which hurt the business in terms of remediation costs, among others. Based on adjusted earnings power, the business trades around 20 times earnings now, while leverage is still coming in far above three times.
After shares are cut in half since the deal announcement day about two years ago, with the company having lost value which is roughly equal to the purchase price, this does not seem to be the time to get overly bearish at current levels. On the other hand, shares do not look cheap enough to get involved just yet, as wrong execution and capital allocation are not advertising investors to pay up for the shares either.
For further details see:
ICU Medical: Continued Disappointments