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Kinetic Concepts: Going Private
Posted by: Anh Hoang (IP Logged)
Date: July 15, 2011 10:43AM

Kinetic Concepts (KCI), a maker of medical devices used in wound care, has agreed to be bought out for $5 billion cash from a private equity and two leading Canadian pension funds.

Kinetic is the global medical technology company devoted to the discovery, development, manufacture and marketing of high tech therapies and products designed to increase the ability of the body to heal. It has three operating segments which are: Active Healing Solutions (AHS), LifeCell and Therapeutic Support Systems (TSS). In the fiscal year of 2010, 70% of total revenue coming from AHS segments, and more than 75% of revenue derived in the United States. For AHS, the largest customer is Medicare, taking account around 12% in the US.

Kinetic enjoyed more than 10 years of profitability, while the growth in earnings reached 26.7% compounded annually. The book value per share had increased from -$3.2 per share in 2001 to $20.7 per share at the end of fiscal year 2010.

Cashflow

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Operating Cash Flow 30 76 280 188 238 236 349 427 388 353
Cap Spending -44 -55 -76 -93 -94 -92 -96 -131 -103 -86
Free Cash Flow -14 22 204 95 144 144 253 296 284 267

Figures in millions

For the cash flow, the table below has indicated the cash flow from operating has kept increasing, whereas the capital expenditure hasn’t seemed to change much during the past 10 years. That leads to the growth in free cash flow, standing at US $250-300 millions. With the valuation of $5 billion, it valued Kinetic at free cash flow yield of 5-6%.

Balance sheet strength

The largest item on its balance sheet is the amount of goodwill and intangibles, taking 55.5% of the total assets, whereas the firm has half of its assets financed by the liabilities, mainly the long-term debt. The large amount of debt is not very comfortable for any value investor. However, Kinetic has shown in the past the ability to continually generate growing operating cash inflows as well as free cash flow, giving the firm more cushion of taking a little bit more interest-bearing debt.

Relative valuation

KCI HRC SYK Industry
P/E 18.10 19.16 18.41 25.27
P/B 3.1 4 3.2

The deal has valued Kinetic at 18 times earnings and 3.1 times book value. Comparing with its closest competitors and the industry, it seems to be somehow the cheapest.

Conservative DCF valuation

In order to be conservative, we estimated the growth for the next five years in the FCF to be 8%, then 1% annually to infinity. As the company takes on large amounts of debt, the discount should be little bit higher to reflect the risk in taking more debt. The assumption for discount rate is 12%.

Year 2011 2012 2013 2014 2015 Terminal value
FCF 288 311 336 363 392 9906
PV FCF 257 248 239 231 223 5019
Total value 6217

Figures are in millions

With those conservative assumptions, Kinetic should be valued at around $6.2 billion. If we change to a little bit more optimistic assumption of the next five-year growth in free cash flow to 10%, the value would stay at $12 billion.

It is expected that the deal would be closed by the end of this year. The firm has 40 days to solicit other bids. I personally think that the current bid is a little bit (but not too) low for Kinetic.

This is not recommendation for buying, holding and selling the stock. Any investor who wishes to do so should conduct his/her own research for his/her own actions, bearing his/her own risks.


Stocks Discussed: KCI,
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