PropThink: MRGE Still In Transition; Fundamentals Or Acquisition Point To Higher Valuation
(Thomson Reuters ONE) -
By David Moskowitz
Merge Healthcare (NASDAQ:MRGE) reported adjusted 3Q 2012 revenues and EPS of
$61.0 million and $0.01, compared to Wall St. Consensus expectations of $62.9
million and $0.02, respectively. EBITDA for the period came in at $12.5 million
vs. the $12.8 million average estimate. The quarterly miss is a modest negative,
however investors are likely to look through the softer-than-expected earnings
results as the company continues to a work through its transition to a new
revenue booking model. Importantly, 2013 guidance was in-line with expectations,
and according to one analyst who rates the stock at Neutral, the 3Q results were
seen as "uneventful". Management noted on its earnings call that new 100%
subscription-based products are launching very well, but have yet to contribute
to quarterly revenues due to an anticipated delay in the ability to book those
revenues. Examples of this include the Merge Honeycomb and OrthPacs product
lines, which are gaining strong traction in the market. The company has already
seen a strong start in 4Q, with management stating that it had a "great
October", and upcoming radiology conferences offer MRGE the chance to accelerate
new contract signings in the near term.
Valuation remains attractive. Meanwhile, MRGE's low valuation relative to other
companies in the sector should also minimize any impact on the stock post
earnings. Management would not comment on its ongoing engagement with Allen &
Co. to explore strategic alternatives, however, this process could result in an
offer for MRGE at a significantly higher valuation. At current levels, MRGE
trades at an EV/2012E sales ratio (enterprise value to estimated 2012 sales) of
about 2.1x and roughly 1.9x 2013 sales estimates, while most of the healthcare
IT world trades in the 2.5-3.5x range on 2012 revenue estimates. Assuming MRGE
can trade in the middle of healthcare IT valuation range (an EV/sales ratio of
3.0x) on 2013 revenue estimates (consensus is ~$270M), this would value the
company at $8.80. In other words, as the business stabilizes on the new
strategy, MRGE shares could naturally trade higher unless an acquirer steps in
first to take advantage of the current valuation discount.
2013 guidance In-line with expectations. Recall that the key reason MRGE fell
from its highs earlier this year was because the company moved to offer
subscription-based pricing for its healthcare IT software solutions, rather than
booking the majority of its revenue in larger blocks as up-front licensing fees
(see PropThink's prior report). This accounting change led to a transition
period in which there is a lag in financials while the new revenue booking
strategy catches up. 3Q 2012 represents the 3rd quarter in the cycle, and by
early 2013, the company should be past the transition and growing on a more
consistent basis. In fact, in its earnings release, the company issued 2013
revenue guidance in the range of $265 million to $275 million with an adjusted
EBITDA margin ranging between 22%-24%. The revenue guidance is essentially in-
line with the Consensus forecast for 2013 of $271.6 million, and implies top-
line growth of approximately 10% off of the current sales run-rate. If one takes
the midpoint of the revenue guidance and applies the midpoint of the anticipated
EBITDA margin for next year, the company's guidance is also in-line with
Consensus EBITDA expectations of approximately $62.4 million for 2013.
2013 EBITDA growth looks strong, an incentive for acquirers to step up now. Note
that MRGE delivered an EBITDA margin of about 20.6% in 3Q, and the expected
improvement in operating leverage next year (EBITDA margin guidance above)
implies approximately 22% EBITDA growth next year. Management noted strong cash
flow in 3Q, and the company continues to pay down debt. The ability to re-
finance remaining debt next year at lower rates is also expected to improve
equity value. Despite EBITDA guidance that is simply "in-line" with
expectations, we think that the company is executing well, and these impressive
metrics could be attractive to private equity buyers that want to take advantage
of MRGE's growing cash flow stream. Should MRGE weaken today on the earnings
shortfall, we see this as a buying opportunity.
Read this article in its original format here.
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