I have spent some time looking at EHHA. Because EHHA has not yet filed its preliminary proxy materials or released any financial information for XLNT Veterinary, the company that it is acquiring, EHHA is a bit of a black box. When EHHA first announced the acquisition of XLNT on September 11, 2006, XLNT owned 11 animal hospitals. It has since acquired another 15 animal hospitals, and now owns 26 clinics. On April 10, 2007, EHHA announced that XLNT had reached the minimum revenue goal ($57.5 million) targeted in the acquisition agreement, and that both companies would be working on closing the transaction by the end of the fourth quarter. The actual termination date for the transaction is March 31, 2008.
According to the acquisition agreement, the shareholders of XLNT will receive EHHA common shares in an amount equal to two times the pro forma revenues of the clinics acquired by XLNT, divided by $7.20. (That is the basic calculation. The actual calculation is much more complicated. However, given the absence of any hard numbers, I am going to ignore the numerous adjustments that may factor into the final calculation.)
If we assume that the pro forma revenues for the XLNT clinics are $57.5 million, the shareholders of XLNT will receive approximately 16 million shares of EHHA ($57.5 million times 2, divided by $7.20). Add in the 8,750,000 shares that are already outstanding, and the 24,750,000 shares that will be outstanding post-merger have a current value of approximately $191.565,000 based on Friday’s closing price of $7.74 per share. If we reduce that balance by the net of the cash that EHHA currently has in escrow ($56.9 million) and the XLNT debt that EHHA will be assuming ($16.5 million), the 26 animal hospitals are being valued at $151,165,000. That works out to approximately $5.8 million per clinic. The average clinic would appear to be generating approximately $2.2 million in revenue per year.
Is that a fair valuation? Obviously, it is impossible to reach a definitive conclusion without reviewing the financial statements for XLNT. However, we can sift through the tealeaves and hazard a guess.
For comparative purposes, I was able to find one public company, VCA Antech, Inc., formerly known as Veterinary Care Centers of America, Inc. (stock symbol: WOOF), which currently owns 431 clinics and 33 diagnostic laboratories. WOOF has spent years rolling up clinics, yet the company owns less than 2% of the 25,000 clinics operating in the U.S. In early June, the company closed on the acquisition of 44 clinics at an average cost of $3,475,000 per clinic. Based on Friday’s closing price of $37.67 per share, the company has a market cap of approximately $3.2 billion and an enterprise value that exceeds $3.5 billion. As of March 31, 2007, the tangible net worth of the company was a negative $207.6 million. WOOF has outperformed the market over the last year and is currently selling at 27.3 times its estimated earnings for 2007 (see Business Week article below).
Because the per-location revenue and overall profitability of the diagnostic laboratories far exceeds the numbers generated by the clinics (during the first quarter of 2007 WOOF generated half of its gross profit from the laboratories), the WOOF clinics and laboratories need to be assigned separate valuations.
Some miscellaneous statistics from WOOF’s 10-K for the year ending December 31, 2006:
Operating statistics
Gross margin – Diagnostic laboratories: 39.5%
Gross margin – Animal hospitals: 16.6%
Selling, general, and administrative expense: 7.9%
Overall operating margin: 19.6%
The clinics and laboratories generated $970.3 million in revenue during 2006, 73.4% of which was generated by the clinics.
Over the course of 2006, WOOF owned an average of 373 clinics (367 at the beginning of the year and 379 at the end of the year), each of which generated approximately $1,908,839 in revenue.
Over the course of the same year, WOOF owned an average of 32 diagnostic laboratories (31 at the beginning of the year and 33 at the end of the year), each of which generated approximately $8,073,281 in revenue.
As of March 31, 2007, WOOF owned 387 clinics and 33 diagnostic laboratories. If we evenly divide the $3.5 billion enterprise value between the two segments, each of the WOOF clinics and laboratories would be valued at $4.5 million and $53 million, respectively. Based on the year-end statistics, each of the clinics and laboratories generated gross profits in 2006 of $319,000 and $3.2 million, respectively.
As noted above (based on the information currently available), each of the XLNT clinics is generating about $2.2 million in annual revenues, approximately 16% more than the average WOOF clinic. It should be noted that the XLNT clinics may or may not be more profitable than the WOOF clinics. It should also be noted that the XLNT clinics are more clustered than the WOOF clinics, a fact that could enhance their overall profitability.
Each XLNT clinic is being valued at approximately $5.8 million, a valuation that is about 28.9% greater than the valuation of the average WOOF clinic.
Based on these facts, the EHHA shares may be slightly overvalued relative to WOOF. We should have a better handle on the relative valuations when the proxy materials are filed.
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On June 1 2007, WOOF completed the acquisition of Healthy Pet Corporation, the owner of 44 animal hospitals with annual revenues approximating $80, for $152.9 million in cash. The average cost per clinic: $3,475,000.
On July 1, 2005, WOOF acquired Pet’s Choice, Inc., the operator of 46 animal hospitals, for $78.9 million. The average cost per clinic: $1,715,217.
On June 1, 2004, WOOF acquired National PetCare Centers, Inc., the operator of 67 animal hospitals, for $88.8 million. The average cost per clinic: $1,325,373.
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The SEC filings for WOOF can be found at:
sec.gov
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Note: According to the most recent 10-Q, Gene Burleson and Joel Kanter, respectively the Chief Executive Officer and President of EHHA, each own shares and warrants of XLNT.
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Why VCA Antech's Tail Is Wagging
JUNE 25, 2007
INSIDE WALL STREET
Tainted pet food from China caused a spike in the demand for animal health care, and that has been a boon to VCA Antech (WOOF ), the largest operator of U.S. veterinary clinics. It has 376 clinics and 33 diagnostic testing labs. There was "a short-term gain from the China pet food issue," says Robert Mains of Morgan Keegan, who rates the stock "outperform." But VCA's long-term appeal, he adds, is the overall rise in demand for diagnostics and preventive medicine for pets. The sizzle, Mains says, is in the surge in lab tests, which are big profit generators. He forecasts earnings of $1.38 a share in 2007 and $1.61 in 2008, up from 2006's $1.17. The stock has been on a tear, vaulting from 28 a year ago to 38.37 on June 13. VCA recently bought Healthy Pet, which operates 44 animal hospitals in 10 states, with 150 vets on staff. Michael Cox of Piper Jaffray (PJC ) says the acquisition made "good strategic and geographic sense." Even after the buy, VCA represents less than 2% of the 25,000 total U.S. vet clinics, he notes. Cox rates VCA "outperform" with a 12-month stock price target of 46.
Note: Unless otherwise noted, neither the sources cited in Inside Wall Street nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.
By Gene G. Marcial
businessweek.com
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A good overview of the terms of the EHHA-XLNT acquisition, as well as a rationale for the transaction, can be found at:
sec.gov |
