1. Changing industry drives strategy response. Kendle is outperforming its much larger peers in revenue growth and net income margin in a rapidly growing industry due to increasing pharma outsourcing of CRO services. Above industry average growth and profitability usually signal sustainable competitive advantage but client needs are changing to have one source of Phase 1-4 services on a global basis. Combined with the keep-the-CEO awake at night issue of customer concentration (50% to one customer; 80% to three customers), Kendle’s strategy needs to adapt.
Even with a strong client reference for Celebrex at Searle, Kendle must grow in scope of services offered and geographic areas served or face likely strategic challenges 2. Strategic responses are either sell or acquire. Organic growth options aren’t going to result in sufficient change on a timely basis. Selling the company based on comparable EBITDA multiples (use FCF or EBITDA multiples whenever possible to best estimate market prices) in the industry for public companies results in a price of approximately $25m.
It’s unlikely that Kendle will sell at above industry average multiple since significant operating cost synergies (Kendle is outperforming others in margin) are unlikely; some revenue synergies due to client reference and software may exist but revenue synergies are rarely valued for premiums. So, the $25m value is reasonable. Determining if the company is fairly valued based on market multiples, one needs to compute a DCF to determine economic value. If economic value is less than market prices, consider selling. If economic value is more than market prices, don’t sell.
The Kendle excel file on BB shows the economic value to be approximately $28m. Therefore, don’t sell. 3. European acquisitions are viable strategies but risky. U-gene and gmi add missing services in the CRO value chain, increase geographic diversity and reduce customer concentration. The deals are at or below comparable market prices reflecting the lack of potential bidder alternatives (i. e. , companies with reduced stock prices rarely acquire since their Boards and investors believe prices will rebound and dilution would occur at a low stock price).
However, the risk of a small company buying overseas companies due to retention of management, going to the market together in a coordinated manner, building common platforms, etc is very high. One way to mitigate the risk is to create some small wins such as going to Searle and capturing the non-US portion of the Celebrex and other work going forward. 4. Putting a timeline of IPO and acquisitions is critical. IPOs are rarely done right after acquisitions since investors want to see the results first.
Management is going to be diluted between managing the IPO process, integrating acquisition(s) and managing the business. 5. Downside risk of IPO process is completing the acquisitions but unsuccessfully monetizing the company. Kendle would add approximately $30m of debt and without an IPO would pay approximately $2. 4m of interest. However, their proforma net income of $1. 5m/quarter or $6m per year results in 2. 5x interest coverage; this financial result is risky but within normal leverage ratios.
Bottom line is even without an IPO the acquisition strategy is sufficiently financed with debt. 6. Combination of acquisitions and IPO creates shareholder value! The sum of the parts (Kendle at $25m, U-gene at $15m and gmi at $12m) equals $52m. But the value of 7. 5m pro forma shares at $13/share shows a market cap of approximately $96m! The market is saying that the monetization and the strength of the post-acquisition Kendle is significantly stronger than the three pieces on their own.
Note that the pro forma shares include shares for Nationsbank, 3 million new shares (referred to as primary shares in an IPO) and the reduction of 600k shares (referred to as secondary shares) that the Bergens are selling in the IPO. The Bergens are selling to diversify and monetize their investment in the company. 7. Successful roll-up strategy. Subsequent to these acquisitions, Kendle bought more than 30 CROs on a global basis prior to selling themselves last year to a larger CRO. Candace did quite nicely over those years strategically and financially.