Paul & Spek: I've been looking hard at BAX since it has many of the features I'm drawn to in a stock: Collapsing price, deteriorating earnings/biz model, excessive debt and 'interesting' accounting.
Here's an analysis of the 02 10k:
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03/12/03 JPM BAX $27.27 KEY TAKE-AWAYS FROM BAXTER 10K
* ONE-TIME GAINS. Management disclosed that the company recognized insurance related reversals for its plasma-based therapy and mammary implant businesses that benefited the company's SG&A ratio by 30 basis points in 2001 and 70 basis points in 2002. The favorable insurance recoveries added 3 cents and 7 cents to '01 and '02 EPS, respectively. Cash Flows Come Up Short. In 2002, the company fell short of their operating cash flow objective of $500 million. Operating cash flow came in at $427 million for the year, with continuing operations generating $468 million while discontinued operations resulted in cash outflows of $41 million.
* FACTORING RECEIVABLES. In 2002, the company continued its policy of factoring out its receivables through a special purpose entity that is not consolidated under GAAP accounting. In 2002, $721 million of receivables were sold through this entity, compared to $683 million in 2001.
* 2003 CASH OBLIGATIONS. Baxter's contractual cash obligations in 2003 total $1.15 billion, including the $800 million convertible debenture that is puttable to the company this May. This does not include the company's remaining equity forward purchase contracts, which amounts to $750 million, which management has committed to settle in 2003. Baxter recently raised $600 million through a notes offering and has a $1.6 billion line of credit at its disposal to settle the equity forward contracts and the convertible debentures, should they get put to the company.
* EQUITY FORWARD PURCHASE CONTRACTS. As of December 31 2002, Baxter had outstanding equity forward agreements related to 15 million shares, with a weighted average exercise price of $49. Of note, the company was involved in stock repurchases worth $1.17 billion in 2002, of which $1.14 billion were a result of the settlement of equity forward agreements. In total, equity forward agreements related to 22 million shares were settled in 2002.
* EMPLOYEE PENSION PLAN SIGNIFICANTLY UNDERFUNDED. With regards to Baxter's pension fund related obligations, the company's accumulated benefit obligation (ABO) for 2002 was $1.8 billion while the fair value of plan assets declined to $1.2 billion. Consequently, Baxter's pension plan enters 2003 under-funded by roughly $600 million. The timing of when Baxter would need to step up and fund its employee plan with a cash infusion is unclear, but management indicated that this is unlikely to occur in 2003. Anticipating the question of whether this will occur in 2004, Baxter states "this will depened on future market conditions." Of note, at year-end 2002 the company recorded a net-of-tax reduction of $517 million to stockholders' equity, in order to establish an additional minimum liability in the consolidated balance sheet for its defined benefit pension plans.
* MANAGEMENT STOCK PURCHASE PROGRAM CREATES OBS LIABILITY. The company's liability related to its management stock purchase programs is $219 million. Recall that this is a program that allows Baxter managers to take out loans for personal share purchases with Baxter guaranteeing the obligation. The plan also includes a risk-sharing provision whereby the company is responsible for 50% of all losses incurred by the participants related to a stock price decline. In view of the depreciation of Baxter shares in 2002, a loss appears inevitable, though no liabilities to date have been recorded in relation to this program.
* EXPOSURE TO PREMIER. Of note, Management disclosed that sales to the hospital buying group Premier comprised 8.9% of total Baxter sales in 2002. What percentage of these contracts are sole source arrangements is not disclosed (IV systems is one); however, Premier has stated its intention to substantially reduce the number of such contracts in 2003. This could hamper Baxter share in Premier accounts, most noticeably in the Medication Delivery business.
* ALTHIN DIALYZERS. Finally, the company has reached settlements with a number of parties affected by the deaths of hemodialysis patients treated with Baxter's dialyzers. Six civil lawsuits, however, are still outstanding and the US government is investigating the matter. Baxter has received a subpoena to provide documents. A government criminal investigation concerning the patient deaths is pending in Spain.
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Even with the 'Here come's the choo-choo' version, I'm having a tough time putting a number on total equivalent net debt, but it looks like EV/EBITDA is north 17 and possibly quite a bit north depending on what's included. Also, forecasting the extent that high margin earnings can deteriorate in the face of increasing competition is a really tough call even if you're wired into the industry, which I'm not. After my experience with Elan and SGP, I'm inclined to sit this one out so far. |
