Private Values
Friday April 15, 11:38 am ET
By Andrew T. Gillies
Fund manager Roger King looks for companies that an acquirer might like more than the market does.
Omnicell is Roger King's kind of stock. In barely a year the medical information company has let down WallStreet with its quarterly earnings and seen its market value shrivel 68% to $173 million. But King, comanager of the Fountainhead Special Value Fund, believes Omnicell could be worth $300 million and that one day the company will prove it. "Omnicell will make it on its own," says the 62-year-old Houstonian, "or somebody's going to put it under their umbrella."
After 36 years in the investing business King has settled on several ways to root out stock bargains. His favorite among them is to find stocks selling for less than what a buyer of the whole company might pay, the so-called private market value approach.
It's largely a matter of guts, King explains, as impatience or jitters will always lead certain investors to sell stocks at prices below their true economic worth. "If there's a significant discount," he says, "we're interested."
Chasing those discounts has worked well for King over the long haul. He cofounded King Investment Advisors in 1981 and now manages $700 million. Much of that total is in corporate accounts, but individuals can buy hisno-load Fountainhead mutual fund ($16 million in assets), which has returned an annualized 11% since its launch at the end of 1996 versus 8% for the S&P 500.
Dealing in downtrodden stocks like Omnicell can lead to stumbles; King has had his share. In 2002 Fountainhead trailed the S&P 500 by 22 percentage points with a -44% return, dragged down by losing bets on cable and wireless stocks.
Yet the private market value approach has brought King dramatic successes, too. In 2000 shares of Boston Scientific, the medical device maker, fell to a split-adjusted $8. The drop looked excessive to King and his team, who reckoned that the company had a private market value of $22 billion versus a public market value of $7 billion. "We thought, 'Look, if all else fails, these guys can liquidate this company,'" King recalls. He bought 86,000 shares for the Fountainhead fund in September 2000 and nearly doubled that bet the following February. The fund still holds 14,800 shares, now trading at $29.
In calculating private market value, King starts with a prospect's operating income in the sense of earnings before interest, taxes and depreciation. Trailing 12-month results will do, although King will also annualize operating income for the most recently reported quarter if a company is growing rapidly.
Next he digs around in that same industry for recent acquisitions and determines what multiple of operating income was paid in those deals. He then multiplies that number by his pick's operating income to determine a preliminary valuation. The private market value is that number less long-term debt, plus cash and equivalents.
Determining the appropriate operating income multiple for a company is tricky. King's team uses data fromMergerstat, a provider of M&A financials, and other sources to survey recent deals. But it's not as easy as downloading numbers. "It can't be just another company in the same industry," explains Leah Friday, comanager of the Fountainhead fund. "It has to have a similar business model."
Back to Omnicell. In its latest 12 months the company had $11 million in operating income. In mid-January a comparable company, Impac Medical Systems, accepted a bid at 23 times operating income. Applying that multiple to Omnicell suggests a value of $260 million. Consider also that the company has no debt and $31 million in cash.
King and colleagues suspect an acquirer would go as high as $300 million, given their view on Omnicell's earnings growth potential. The company sells technology that helps hospitals manage pharmacies and supplies. Its automated drug-dispensing system, for example, allows a doctor or nurse to punch up a patient's medical profile on a Windows-based, color touchscreen. Analysts expect Omnicell to post 25% annualized earnings growth over the coming years.
Why the sunny outlook? King cites the U.S. Food & Drug Administration's push to keep better track of drugs through bar codes and other technologies. Omnicell has built up a $47 million backlog with a steady stream of new business, some of it right in King's neighborhood. Last summer Dallas' Baylor Health Care System signed up to use Omnicell technology at its 11 hospitals in Texas. King expects more of the same to be forthcoming.
The generic-drug business is another area where King sees consolidation. Par Pharmaceutical, one of his current favorites, has dropped 45% from a 52-week high. Largely driving the selloff, in King's view, are worries about revenues and profits as Par faces competition for its knockoff of antidepressant Paxil.
But King and crew have their eye on Par's pipeline, which they say will pump out 30 to 35 products in the next year and a half. They also like it that Chief Executive Scott Tarriff saw fit to buy 5,000 shares at $40 last December. At a recent $34, the stock goes for just 15 times estimated earnings for the coming 12 months. And private market value? Based on recent deals in the drug business, King says Par could fetch $2.7 billion, 57% more than its present worth to investors.
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