Alere (ALR, Financial) delivers reliable and actionable health information through rapid diagnostic tests, resulting in better clinical and economic healthcare outcomes globally. Its high-performance diagnostics for infectious disease, cardio metabolic disease and toxicology are designed to meet the growing global demand for accurate, easy-to-use and cost-effective near-patient tests.
The company, formerly known as Inverness Medical Innovations, Inc., was formed in 2001. Since that time, it has grown its businesses through strategic acquisitions, tactical use of its intellectual property portfolio and organic growth. In July 2010, the company changed its name to Alere Inc.
Operating segment
- Professional Diagnostics
- Patient Self-Testing
- Consumer Diagnostics
Business outlook
The diagnostics area of the health care market has mildly flown under the radar as the sector has been primarily focused on the biotech industry. The share price has risen nearly 36% since September, and now we are assuming that the market is finally recognizing the upside ramp in the current calendar year.
The transition of the company's business model towards a concentrated portfolio of products with the objective of focusing on the rapid diagnostics area of the industry has progressed well. Management is now focusing on three primary areas:
- Cardio metabolic Diseases
- Infectious Diseases
- Toxicology
It already stood at the first position in the diagnostic field. The company’s market leadership has gone up to 49% in infectious diseases. The reason for the increase in its share is because of the growth in its liver, HAIs and sexual health product line, all of which contain expected growth CAGRs above 13%
The shift towards rapid diagnostics should be a boon to the business driven by the ACA reform actions. Reform response is already evoked to see, by providers switching more diagnostics to outpatient care. This switch plays into Alere's stability as 61% of its product portfolio is directed towards outpatient-focused business. With this a massive market opportunity as testing switches to a decentralized structure.
So far, 90% of medical diagnostics are done by commercial and hospital labs, however with these products there is likely to shift in the work toward physicians’ offices as more private practices conduct these tests in house. Moreover, rapid care clinics and other small triage offices will start carrying out these tests. This is a promptly expanding addressable market that, with lower product costs, will likely move its diagnostics into small offices and hospitals.
Another countenance of the development is the razor blade business model it is producing. At the end of 2014, they derived 76% of their revenue from the consumable while just 20% is derived from services. We think the stickier customer base is the persistent reason that drives its revenue higher, as that has been witnessed in the form of better quality revenue in their first quarter. The company posted higher earnings on lower revenue base as the low margin Alere Health was unloaded to Optum. We see that company is persistently switching to these focused markets and driving benefits from it. The tailwind effect to their core business should accelerate as they move into these decentralized MDx markets, namely small hospitals with less than 150 beds, and urgent care clinics –Â and as such they should be able to realize better margins through some pricing power.
Total adjusted operating expense trends continue to illustrate the progress the firm has been making. The 31.7% figure in the first quarter, while up marginally from the fourth quarter, displays the trend lower from 34.8% in 2012 and 33.7% in 2013. We see EBITDA margins inflecting higher while top line revenues will likely languish on a reported basis due to divestitures. Organic revenue should be persistent to look at traction from its slew of new products and market positioning capturing larger chunk. A lot of eloquent pieces are opening to come together for the company and produce a more centred, clean, and productive business.
Natural growth driven by emerging markets
The Alere platform is gaining momentum swiftly in its “I-business” segment which it launched at the end of the last year. The company acclaimed that its installed base on I-platform doubled and had approximately 1,000 instruments in the market. Although the contribution to revenue is small, at $4 million, the platform is elevating significantly, especially in the back half of the year. In the first quarter of the accounting period, the company got the news that it has the approval for its Strep A menu expansion. Now we are deducing that if it gets the CLIA waiver from the FDA, the company will all the way launch Strep A by the fourth quarter of this year.
A truly natural growth will be driven by expansion into emerging markets. The company noted that they accomplished strong growth in Latin America at +17% followed by Asia at +5% and the developed areas. The surge was driven by strong triage sales in China and sales of infectious diseases in Latin America.
The company is extending sales and distribution to achieve the opportunity in the blood based diseases business in the developing world, which we consider will be a long-term tailwind the business and a source of natural growth for many years to come.
Strong financial statement
The business has sold off many pieces to date, which it acquired from the nearly 100 acquisitions in the last decade. The disinvestment includes the sale of Alere Health and its subsidiaries to Optum. The company used the proceeds from the transaction in addition to the proceeds from the sale of Bionote, Veda Lab and Alere ACS, to reduce their outstanding debt load and decrease future contingent payments.
Management highlighted key aspects within their non-core assets that are on the table for divestment including the BBI business, Wampole/TECHLAB, and Swiss Precision Diagnostics. We think the company will sell all three of these businesses sometime this year and that the proceeds of the sales will exceed $500 million, which is additive to the $650 million already realized to date. Like the previous proceeds, management has indicated that it will use the capital to reduce its balance sheet leverage, still over 5x net debt/EBITDA.
Collectively, the three businesses generated $184 million in revenue and $59 million in EBITDA last year. Our $500 million is likely a floor to the net proceeds that are likely generated as we think the businesses could be sold for as much as 15x EBITDA, given other recent sales for similar businesses. At 15x, the proceeds would total $885 million to pay down the debt on the balance sheet further.
Progress on the balance sheet is starting to accelerate. From Q1 2013 to the end of last year, net debt declined from $3.53 billion to $3.35 billion. However, since the end of the year, the company had reduced the net debt position another ~$600 million as the divestitures reduced the net debt to $2.77 billion.
Valuation
Shares are beginning to re-rate higher with the EV/EBITDA and P/E increasing. Free cash flow should jump this year to over $340 million, up from just $131 million last year. While revenue should be fairly stagnant over the next two years as organic growth is offset by revenue lost to divestitures, we see core earnings inflecting higher. The consumer diagnostics business should cease being a drag on the top line (mostly due to the lack of any size to the business any longer). Lastly, infectious disease should continue to see strong organic growth while toxicology and cardio metabolic will likely be small contributors.
However, our margin estimates are likely to drive earnings results. Operating expenses should continue to boost margins although we believe we won't see the same sort of large gains made since 2012. In the first quarter, the company’s streamline and efficiency initiatives have shown through with SG&A falling to $167 million, down from $219 million in the first quarter a year ago. In addition, as we noted in the prior writeup, R&D has become more focused and declined to $26 million, from $36 million a year ago.
As revenue fell from $717 million in the first quarter of 2013 to $610 million in the first quarter of this year, operating profit rose to $117 million, up $3 million. We think EBITDA should be above $550 million this year and rise to $650 million next year and $680 million by 2017. Using a 11x multiple to those estimates, we get a strong upside case for enterprise value. We ran two scenarios, one with continued net debt declines and another with net debt static.
In the first, with static net debt, we think the shares still have some upside left in them with a $56.50 intrinsic value. However, we see upside to that forecast, should the company continue to deliver their balance sheet and drive down their net debt. In that alternative scenario, we think the shares are worth closer to $60 per share for upside of nearly 20% between now and the end of next year.
Conclusion
Shares of Alere have responded favorably to the restructuring of the business towards a rapid diagnostic company. That transition appears to be well on track and thus, the shares have responded to the decreased risk of execution missteps. While the easy money has been made, there appears to be some meat left on the table as the company de-risks its balance sheet as well as its business volatility, lowering its cost of capital and improving returns on invested capital. We think the shares are worth approximately $55 per share by the end of the year and near $60 by the end of 2016.
Disclosure
I don't have any investment in the aforementioned stock, nor do I get paid from the aforementioned stock company to write, and I have no plans to invest in the stock for the next 72 hours.
The above details are taken from the company filings 10K and an article of author Alpha Gen Capital is considered while writing this article.
