citi: IVGN: Reduce to Hold; Business Fluctuations Create
Uncertain Outlook
HOLD (2)
High Risk (H)
Mkt Cap: $3,272 mil.
October 26, 2006 SUMMARY
* We are downgrading IVGN to a Hold (2H) as the company surprised on the downside missing revenue & EPS expectations and reducing FY06 guidance with next year's outlook uncertain despite the near completion of a strategic business review. IVGN indicated operating margins will improve by 100bp in FY07 although this is off of a reduced base given recent results and significantly below our expectation of an improvement of 400bp.
* Q3 EPS was $0.72 vs. our est of $0.80 and cons est of $0.78, due to lower GM of 58% vs. our est of 62% with revs at $311MM vs. our est of $318MM. Q4 rev guid is $310MM below our est of $340MM and street est of $338M. EPS guid, incl SOE, is low $0.70s below our and St est of $0.92 due to weak margins.
* We have revised our EPS ests to $2.95 from $3.23 for FY06, to $3.30 from $3.90 for FY07, and to $3.60 from $4.55 for FY08. Our target price is revised to $68. All else equal, we would be buyers if the stock drops into the low to mid-50s range.
FUNDAMENTALS
P/E (12/06E) 20.3x
P/E (12/07E) 18.1x
TEV/EBITDA (12/06E) 9.1x
TEV/EBITDA (12/07E) 6.5x
Book Value/Share (12/06E) $65.43
Price/Book Value 0.9x
Revenue (12/06E) $1,243.7 mil.
Proj. Long-Term EPS Growth 15%
ROE (12/06E) 5.8%
Long-Term Debt to Capital(a) 0.0%
IVGN is in the S&P 400(R) Index.
(a) Data as of most recent quarter
SHARE DATA . RECOMMENDATION
Price (10/26/06) $59.71
Rating (Cur/Prev) 2H/1H
52-Week Range $74.66-$55.88
Target Price (Cur/Prev) $68.00/$86.00
Shares Outstanding(a) 54.8 mil.
Expected Share Price Return 13.9%
Div(E) (Cur/Prev) $0.00/$0.00
Expected Dividend Yield 0.0%
Expected Total Return 13.9%
OPINION
We are downgrading the shares of Invitrogen to a Hold (2H) rating from a Buy
(1H) rating as the company surprised on the downside missing revenue and EPS
expectations and reducing guidance a second time this year. Furthermore,
although the company indicated it has nearly completed its strategic review of
its business, management did not provide sufficient clarity on the potential
steps it may take to improve next year's outlook given recent operating margin
pressures. Specifically, the company guided a flat sequential fourth quarter
for revenues and earnings. This lower-than-expected guidance is being driven
by reduced gross margins and significantly lower-than-expected BioDiscovery
revenues. Importantly, the company has provided limited visibility on
improvement in revenues with only a potential improvement of 100 basis points
in operating margins. Our prior model had assumed product margins and revenues
would increase significantly during fiscal 2007. We remain on the sidelines
until there is improved visibility on the growth trends for the company's
BioDiscovery and Cell Culture Systems business segments, and evidence of
improved operating margins.
Stock Outlook. Invitrogen's stock was down approximately 9.6% in the after
market to $59.71. All else equal, we would be buyers if the stock drops to the
low to mid-$50s and a seller in the high-$60s to $70. Our target price is now
$68 per share (see below for our analysis.)
Disappointing Third Quarter. Invitrogen reported fiscal third quarter 2006 EPS
of $0.72, including stock option expenses, which were below our estimate of
$0.80 and consensus estimate of $0.78, due to lower gross margins of 58%
compared to our estimate of 62%. Margins were negatively impacted by
unfavorable product mix and manufacturing variances. The company reported
total revenues of $311 million compared to our estimate of $318 million and
consensus estimate of $311 million. Overall revenue growth of 7% included a
positive impact from acquisitions, divestitures and currency translation and 3%
organic growth. Foreign currency translation had a +1% impact on sales growth
rate. The company repurchased $287 million or 4.7 million shares at an average
price of $61 per share in the third quarter under its three year $500 million
stock buyback program that was announced in August.
BioDiscovery Business. Revenues were $201 million compared to our estimate of
$209 million, which represented 10% year-over-year growth and 2% organic
growth. The BioDiscovery segment demonstrated growth in areas such as cellular
and protein analysis and was somewhat offset by less than anticipated growth in
selected acquisitions and continued weakness in Japan. Gross margins were 64%
below our estimate of 70%, due to an unfavorable mix of lower margin products
and higher manufacturing costs. The company indicated that it is planning on
altering its compensation scheme for its sales force in order to drive the
sales of higher margin products. Invitrogen highlighted the challenges it has
been facing in integrating the sales forces from its numerous acquisitions in
2004-2005 (15 acquisitions) as part of the explanation for the shortfall.
Cell Culture Systems Business. Revenues were $110 million compared to our
estimate of $109 million, which represented an increase of 4% in organic
growth. The revenue growth was driven by continued healthy demand for cell
culture research media. The sera production business continued to decline
year-over-year, although the decline was less than the company originally
anticipated. The BioReliance business experienced modest growth. The
BioReliance business currently represents about $100 million in revenues.
Revised Guidance. The company lowered it financial guidance for the second
time this year. Specifically, management indicated that it expects revenues
for the fourth quarter will be flat to the third quarter or approximately $310
million. This is significantly lower than our forecast of $340 million and the
Street consensus estimate of $338 million. This implies fiscal 2006 revenue of
$1.24 billion, which is below the company prior revenue guidance of $1.26-$1.30
billion that was issued in August following the company's second quarter
results. In addition, the company continues to expect weak gross margins in
the fourth quarter that were similar to the third quarter. Fourth quarter EPS
is expected to be in the mid-$0.80s range excluding stock option expense, and
in the low-$0.70 range including stock option expense. This implies a pro
forma fiscal 2006 EPS in the mid-$3.50s range, which is below the company's
previous EPS guidance of $3.70-$3.90 (excluding stock option expenses).
Portfolio Review. Invitrogen has completed a full review of its portfolio to
identify potential product or service lines to retain or to divest. The
company indicated it expects some divestitures to occur but have not made any
definitive decisions on which businesses. The company indicated that any
divestiture would be EPS neutral, as the company expects to offset any earnings
dilution with share repurchases. In terms of improving the company's operating
margin, Invitrogen has been consolidating various facilities it gained through
acquisitions, shifted the operations of acquired companies onto a common IT
platform, and reduced workforces where appropriate. The company indicated it
expects most of this integration work to be completed by the end of the year.
With this consolidation and integration effort as well as potential
divestitures, the company expects to improve operating margins by 100 basis
points in fiscal 2007. We estimate this implies operating margins will be
about 20% for fiscal 2007, which is still considerably below our prior estimate
of nearly 24%.
The company previously indicated that it was considering divesting its legacy
Sera business, as customers switch to serum-free chemically defined media.
Invitrogen's legacy Sera business or FBS represents approximately $100 million
in revenues of which $65 million represents sales for research production and
$35 million represents sales for commercial production (i.e.,
Biomanufacturing). The company indicated it plans to retain its business in
research production given its higher margin and greater stability. The company
also indicated that it is not planning to divest the commercial FBS business
despite pricing pressures. Instead, the company plans to reduce its capital
investment into the business, which suggests that this business may eventually
disappear as customers convert to serum-free chemically defined media.
The company had previously indicated that it was reviewing the BioReliance
business as well but was not prepared to provide any updates regarding its
intentions at this time. Given the challenges the company has been facing with
this acquisition, we believe the company is considering whether a sale or
divestiture would be appropriate.
Revised Earnings Estimates. Given the company's fiscal third quarter results
and financial guidance, we are revising our EPS estimates to $2.95 from $3.23
for fiscal 2006, to $3.30 from $3.90 for fiscal 2007, and to $3.60 from $4.55
for fiscal 2008 based on reduced revenues and lower margins. Our detailed
revisions are provided in a table below.
REVIEW OF FISCAL THIRD QUARTER 2006 FINANCIAL RESULTS
We provide a summary of the fiscal third quarter 2006 financial results in the
table below.
Line-Item Actual CIR Estimate Variance to Actual
BioDiscovery $201MM $209MM -$8MM
Cell Culture Systems $110MM $109MM +$1MM
Total Revenues $311MM $318MM -$7MM
COGS $130MM $122MM +$9MM
Gross Margin 58.2% 61.8% -3.6%
S&M Expense $59MM $61MM -$2MM
G&A Expense $28MM $32MM -$4MM
R&D Expense $26MM $29MM -$3MM
Net Income $38MM $44MM -$6MM
EPS (including stock option exps) $0.72 $0.80 -$0.08
EPS (excluding stock option exps) $0.87 $0.95 -$0.08
Shares outstanding 53MM 55MM -2MM
Source: Citigroup Investment Research
REVISED FINANCIAL GUIDANCE
Invitrogen management provided fourth quarter financial guidance. We provide a
summary of the company's financial guidance below.
For fiscal Q4:
Revenues: Consistent with Q3 or $310 million
Interest Income: $3.5 million
Interest Expense: $8 million
Pro Forma Tax Rate: 31.4% (excluding stock option expenses)
Pro Forma EPS: Consistent with Q3 or mid-$0.80s range (excluding stock option
expenses). This implies EPS in low-$70s range including stock option expenses.
FAS123R (stock option expense): $10 million pre-tax expense or $0.16 per share
Share Count: 50 million
Free Cash Flow: Slightly higher than Q3, which was $59 million
With this Q4 guidance, this suggests fiscal 2006 guidance of:
Revenues: $1.24 billion versus prior guidance of $1.26-$1.3 billion
FAS123R (stock option expense): $40 million pre-tax expense or $0.59 per share
Pro Forma EPS: in the mid-$3.50s range (~$3.54) versus prior guidance of $3.70-
$3.90 (excluding stock option expense). This implies EPS in the mid-$2.90s
range including stock option expenses.
FINE-TUNING OUR FINANCIAL MODEL
We have fine-tuned our financial model given third quarter results. We provide
our prior and revised forecasts for fiscal 2006 and fiscal 2007 in the table
below:
FY 06 CIR FY 06 CIR FY 07 CIR FY 07 CIR
Estimates Estimates Estimates Estimates
(previous) (revised) (previous) (revised)
BioDiscovery $845 million $811 million $929 million $846 million
Cell Culture $436 million $433 million $479 million $432 million
Systems
Total Revenues $1.3 billion $1.2 billion $1.4 billion $1.3 billion
COGS $487 million $496 million $533 million $514 million
Gross Margin 62.0% 60.1% 62.2% 59.7%
S&M Expense $247 million $239 million $268 million $241 million
G&A Expense $130 million $123 million $127 million $117 million
R&D Expense $113 million $105 million $127 million $115 million
Operating Margin 20.5% 19.4% 22.7% 20.0%
Net Income $177 million $157 million $210 million $162 million
EPS (incl SOE) $3.23 $2.95 $3.90 $3.30
EPS (excl SOE) $3.82 $3.54 $4.30 $3.70
Shares outstanding 55 million 53 million 54 million 49 million
Source: Company reports and Citigroup Investment Research estimates
INVESTMENT THESIS
We rate the shares of Invitrogen Hold, High Risk (2H) with a target price of
$68 per share. Invitrogen continues to face challenges in delivering
consistent revenue and earnings growth given management's lack of ability to
adequately predict its customer order patterns. In addition, the company
continues to face operating inefficiencies with lower than expected operating
margins. We remain on the sidelines until there is improved visibility on the
growth trends for the company's BioDiscovery and Cell Culture Systems business
segments, and evidence of improved operating margins.
VALUATION
Our revised 12-month target price of $68 per share from $86 per share is based
on applying a fiscal 2007 P/E multiple of 19x, in-line with the comparable
group median of 19x, to our revised fiscal 2008 pro forma EPS estimate of $3.60
(previously $4.55).
Based on Invitrogen's position as a leading provider of life science tools, we
believe Invitrogen shares should trade in line with the peer group's median
fiscal 2007 P/E multiple of 19x.
RISKS
We rate IVGN High Risk due to the following factors which could prevent the
shares from reaching our target price:
Vulnerability to customers' R&D budgets: Approximately 60% of the company's
revenues are derived from government-sponsored academic labs and non-profit
institutions that rely on the National Institutes of Health (NIH) for their
funding.
Significant foreign currency exposure: Invitrogen derives approximately 50% of
its revenues from outside the United States. In particular, the company is
sensitive to fluctuations in the euro and yen since Europe represents a
significant 35% of the company's revenues and Japan represents 15% of the
company's revenues.
Acquisition risk: Invitrogen has traditionally grown through acquisitions (15
acquisitions in past three years) While the right acquisition at the right
price will add value to shareholders, a misstep in this strategy by acquiring
the wrong target or overpaying will decrease shareholder value.
ANALYST CERTIFICATION APPENDIX A-1
I, Elise Wang, research analyst and the author of this report, hereby certify.. |
