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Vitaliy Katsenelson
Vitaliy Katsenelson
Articles (126)  | Author's Website |

IMS Health - Think Longer-term

July 27, 2009 | About:

IMS Health (RX) did not have a spectacular quarter to put it mildly. Revenue decline (on constant currency basis) accelerated to 4% from a 2% decline last quarter. Pharmaceutical companies are becoming more stingy and thus RX’s business got pinched. However, most of the revenue damage is taking place on the consulting side of the business which accounted for about 20% of total revenues and less than that on a net income basis. Note that consulting is a lower profit margin business, and the revenues in that segment fell 17% for the quarter.

The company lowered earnings guidance for the year by 10 cents, though this is not uncommon in today’s environment, but the management was pounding the table only last month that $1.70 was a set-in-stone number. As of today the set-in-stone number is $1.60 (lower side of the guidance). Wall Street obviously did not like that and took down the stock.

But here is how I look at the quarter. First of all, the company did not change free cash flow guidance for the year – $380 million ($320 if you take out the one-time stuff). That is good news. Also, the company is going to cut costs by $80-85 million by 2011. In other words, they’ll be rightsizing the company for a new operating environment. Things are not improving in the pharmaceutical sector. We knew that, but the pharmaceutical sector worldwide is not falling off the cliff.

Another thing to consider, the most revenue decline at RX is taking part in the lower margin consulting business. Thus, as we saw this quarter, the impact on the bottom line is a lot lower than the top line would lead you to believe.

Finally, this quarter’s performance reminds me of eBay’s (NASDAQ:EBAY) performance a couple of quarters back. It seemed then that there was no end of bad news in sight. Consumers were retrenching and sales declines were accelerating. eBay reported numbers yesterday and suddenly investors realized that its business has a fairly high competitive advantage and high recurrence of revenues and was not completely destroyed by Amazon (NASDAQ:AMZN) and the economy. RX shares these qualities too, to an even greater degree.

I don’t know when (do you ever really know?) but in the not so distant future IMS Health will likely be turning around and its numbers will be less bad. Then they’ll become better and then good. At today’s valuation – IMS is trading at 7.8 times earnings. I am not particularly worried about when they’ll become less bad, as long as they don’t turn horrible – which my research leads me to believe is an unlikely scenario.

Vitaliy Katsenelson


About the author:

Vitaliy Katsenelson

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email or read his articles click here.
Investment Management Associates Inc. is a value investing firm based in Denver, Colorado. Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy’s book Active Value Investing (Wiley, 2007).

Visit Vitaliy Katsenelson's Website

Rating: 4.0/5 (4 votes)


Budlab - 8 years ago    Report SPAM
Nice find. Can you tell us a bit more about its competitive position going forward? I agree with there likely being a bargain here if it can continue to outrun competitors.
Alex Garcia
Alex Garcia - 8 years ago    Report SPAM
"IMS operates a hard-to-replicate database of drug sales information, covering more than 1 million products from more than 3,000 drug manufacturers. Any potential competitor trying to build a similar repository on a global scale would require significant resources and time."- Morningstar
Budlab - 8 years ago    Report SPAM
My concern here (...hard-to-replicate database of drug sales information ) is that another data crunching company could come along and play in this field. What are the major barriers to entry?

Alex Garcia
Alex Garcia - 8 years ago    Report SPAM
Read the quote carefully
Chihin - 8 years ago    Report SPAM
Multiple-based valuation is difficult for IMS due to numerous "one-off" items like restructuring & failed-merger expenses, gains/losses from investments, etc. In fact, with the exception of 2002, operating and net profit for every single year since 2001 has necessitated such adjustments. I also note that this is not helped by sometimes mischieveous reporting of such "one-off" items, e.g., try reconciling their one-off expenses for the failed merger with VNU in 2005 (shown as an exceptional item on the face of the P&L statement) against the total US$60 million compensation that they received from VNU (which is hidden in "other income" and the notes, hoping you'll overlook it).

Under the cover of such "one-off" items, it is generally little noticed that IMS' operating profit margin (after adjustments) has decreased from 33.2% in 2001 to 21.8% in 2008 (with a corresponding decrease in return on capital from 71.4% in 2001 to 49.1% in 2008). While this may be partially rationalised by increased contribution from the lower-margin consulting business (comprising 25% of 2008 revenues), this does not negate the fact that gross margins in the Information & Analytics (I&A) business has fallen significantly over the past 9 years.

Given that IMS' data supplier costs are generally indexed to inflation, this appears to suggest that IMS is not passing through its entire increased cost base to its core customers. My question is whether this is indicative of latent pricing power, or simply competitive pressures. In particular, Cegedim has had quite a number of contract wins recently, although their operations remain regional rather than IMS' global in nature.

IMS' moat is probably still intact, but are they utilising its inherent pricing power? Perhaps some scuttlebutt insight on the evolution of IMS' selling prices from an existing pharmaceutical customer's perspective would assist in this assessment.

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