|Shares Out. (in M):||50||P/E||15.0x||9.0x|
|Market Cap (in M):||526||P/FCF||15.0x||9.0x|
|Net Debt (in M):||245||EBIT||58||77|
CompuGroup Medical AG ("CompuGroup" or the "Company") is a German-listed provider of medical software solutions and IT services. The Company has high recurring revenue, strong margins, good ROEs, a high single digit rate of historical organic growth, and insider ownership approaching 50%. Despite these admirable qualities, you can purchase the Company today at roughly 9x its 2012E cash earnings: a sizable discount to both intrinsic value and the trading multiples of most competitors.
CompuGroup segments its business into two primary categories, Health Provider Services ("HPS") and Health Connectivity Services ("HCS"). The HPS segment, which generated 83% of 2011 revenues, provides modular software to roughly 250,000 end users (doctors, dentists, and laboratory technicians), encompassing a wide range of practice sizes from single practitioners to large hospitals and central labs. This software addresses a broad range of practice management needs, including personnel management, billing, electronic medical records, administrative support, and pharmacy management. The HCS segment, accounting for the remaining 17% of 2011 revenue, provides data solutions to roughly 135,000 medical industry professionals and service/product providers (pharmaceutical companies, medical equipment manufacturers, and insurance companies). These solutions include databases (covering clinical trials, market studies, and therapies), clinical decision support systems, and fraud prevention tools. Geographically, over 90% of the Company's revenue is generated in Europe, with the U.S. market accounting for the majority of the balance.
The healthcare IT market has strong underlying demand characteristics. As aging global populations and growing wealth drive increased demand for healthcare services, both providers and payors are constantly looking for ways to increase their cost efficiency. CompuGroup is a key player in this effort. By electronically linking the various service and product providers in the healthcare ecosystem, it facilitates better coordination of care, reduces duplication of testing, helps minimize diagnostic and medication errors, assists in fraud control, and improves reimbursement efficiency. A growing recognition of the inherent historical inefficiencies in the healthcare system is driving a growing number of governments to either mandate, or provide incentives for, more widespread use of digital patient records and electronic data interchange. This trend directly benefits CompuGroup.
CompuGroup's basic business model is very attractive. The Company sells licenses to customers up front, and then collects annual recurring maintenance fees for both continued use of its software and ongoing access to product updates. Typically, about 60% of HPS segment revenue is recurring in nature. Migrating customer data to CompuGroup systems, and training personnel in their use, requires a material initial customer investment of time and resources. As a result, switching costs become significant once CompuGroup has established a customer relationship. These high switching costs lead to annual customer churn rates below 2% and low customer sensitivity to price increases. After CompuGroup has installed its core system at a customer's premises, it then focuses on upselling additional functional modules to that customer. This upsell potential presents a major revenue opportunity for the Company, as the Company's current revenue level of roughly €1,500/doctor/annum is well below best-of-breed competitors whom are generating close to €10,000/doctor/annum. Historically, this upsell opportunity has helped the Company drive organic growth rates in the mid-to-high single digit range.
CompuGroup has used an active M&A program over the last decade to rapidly expand its geographic and product footprint. This has driven a transformation of the Company from a single product, German-centric concern to a far more diversified healthcare IT provider operating in over twenty countries. As CompuGroup moves into a new region and increases its market share over time, EBITDA margins typically improve substantially. CompuGroup currently generates EBITDA margins north of 30% in it more mature regions, where its market shares can approach 50%. Thus, the current consolidated corporate EBITDA margin of 20% should grow over time as newer regions mature, and the benefit of corporate overhead leverage is realized.
CompuGroup's Chairman and CEO, Frank Gotthardt, founded the Company in 1979. He and his direct family members control over 45% of the outstanding shares. Like many one-time entrepreneurs, he is intimately involved in the Company's operational details, but tends to shun the job responsibilities that involve being the public face of the Company. Those responsibilities are primarily borne by CompuGroup's CFO, Christian Tieg. Mr. Tieg, who came to CompuGroup as a result of its 2008 purchase of Profdoc (where he was CEO), is an outstanding financial executive. He has a strong focus on value creation, and has brought a high level of rigor to CompuGroup's day-to-day financial management, as well as its M&A process.
As you would expect for a company with such an attractive business model, CompuGroup's financial characteristics are impressive: EBITDA margins are roughly 20%, return on equity exceeds 25%, and cash flow generation is strong. For 2012, I am modeling €455mm of revenues and €100mm of EBITDA. This is squarely within management guidance, and represents a mid single-digit rate of organic revenue growth on top of a full year's annualization of 2011 acquisitions. €100mm of EBITDA implies about a 250bp increase in the Company's EBITDA margin, driven by a combination of operating leverage and the transition of the U.S. operations to operating profitability (EBITDA margins were actually at the full-year implied 2012 margin level for the back half of 2011). Moving down the income statement, €36mm in D&A, €12mm in net interest expense, and a 32% effective tax rate yield €0.68/shr in earnings. I am adding back the expected €26mm (€0.52/shr) in acquisition-related intangibles that will run through the P&L in 2012 to get to my €1.20/shr in cash EPS.
CompuGroup's attractive valuation results, in part, from stumbles that the Company experienced during 2011. A number of factors led to successive reductions in its 2011 financial guidance, thereby damaging investor confidence. In Austria, an important market for CompuGroup, a government-driven healthcare reform initiative (focused on hospitals) led to a temporary cessation of many IT projects. In addition, across a number of European countries, CompuGroup didn't see the benefit of the typical year-end budget flush. As a result, the typical high single digit organic growth rates dropped into the low single digits. The other primary problematic market for CompuGroup in 2011 was the U.S. The U.S. is a relatively new market for CompuGroup. The Company made three modest purchases in the U.S. market during 2009 and 2010, and initially put forward a relatively aggressive integration plan to bring these previously money-losing businesses to profitability during 2011. Integration snags slowed the process down, negatively impacting the region's expected EBITDA contribution. By year-end 2011, however, these one-off issues had been largely solved. Both 3rd and 4th quarter 2011 results were ahead of the previously reduced expectations, IT projects in Austria were back on track, pipelines were refilling nicely, and the U.S. market had been brought to profitability.
I believe that 9x cash EPS is far too cheap for a company of CompuGroup's caliber. This multiple does not accurately reflect CompuGroup's strong organic growth potential, accretive M&A program, likely margin upside, and highly invested management team. U.S.-based competitors (Allscripts, Cerner, athenahealth) trade in a range of 15-50x forward EPS without, on average, possessing superior financial characteristics to CompuGroup. From both an operational and financial standpoint, last year's stumbles have largely been rectified, and I expect renewed investor confidence to drive multiple expansion going forward. In the meantime, continued cash accretion and value-enhancing M&A should underpin the current valuation.
|Subject||RE: German margins|
|Entry||04/02/2012 12:38 PM|
The quick answer is no, I haven't seen these filings. I guess that the key question (to the extent the filings are out there) would be how overhead is being allocated to the various geographic regions. With 80% gross margins, there would presumably be a fair amount of wiggle room with respect to management's ability to tinker with margins on a regional/national basis.
A few other random margin comments.
My understanding is that COP's market share in Germany is roughly 50%. This is, I believe, their largest share market so I would expect it to have the highest margins as well. Gotthardt (CEO) has talked in the past about 30-35% consolidated EBITDA margin targets. Tieg (CFO), who tends to be relatively conservative, has talked about 25-30% EBITDA margins. If you check out their most recent earning call transcript, they speak publicly about a "golden target" of 30% margin targets. I'm not sure how scientific this is; it may simply represent a compromise between Gotthardt and Tieg on public targets. They have also spoken in the past about their belief that, broadly speaking, once in a market they generate incremental (EBITDA) margins of roughly 50%.
|Entry||04/02/2012 02:14 PM|
Interesting idea and thanks for posting it. Any thoughts on capex usage going forward? In your "cash EPS" you add back the full €36mm of D&A (which is mostly A). What is your sense of how much capex is required to maintain the earnings power of the business and how much will the company typically spend going forward? Historically, it looks like maybe somewhere around €7.5-10?
|Entry||04/02/2012 02:36 PM|
Actually, I am adding back €26mm (€0.50/shr) for my "cash" EPS adjustment, which takes you from (rough nums) €0.70/shr in reported EPS to €1.20 in "cash" EPS.
€26mm is the projected acquisition-related intangibles amortization per the 2011 annual report (see the "Outlook" section). Management guidance calls for total 2012 D&A of €38mm, implying €12mm of what I would call economic depreciation/amort, i.e. that amount that needs to be replaced to maintain the earnings power of the business. Probably not coincidentally, this foots roughly to management guidance of €7mm in software development expenses and another €5mm in PP&E capex going forward.
Spend in recent years on capex and software development has been running a bit higher than the €12mm level, as the M&A activity has driven some integration spending, and software development costs have been running ahead of maintenance levels as they unify a number of platforms.
|Entry||04/04/2012 01:58 PM|
what do you think about their prospects in the US? i am leery.
from the press releases it looks like they spent ~$75MM (possibly more if Visionary gets its full earn out) to acquire ~$56MM and ~$9.1MM in pre-acquisition sales and EBITDA, respectively. it seems that right now sales are flattish and we are realizing a 10% EBITDA margin on a run rate basis, down from +16% pre-acquisition. something didn't go as planned.
while still early in my calls on this one, i have been able to track down a former Visionary sales person and have spoken with some friends who work in healthcare IT with experience in Europe.
the first contact told me that, in his view, the Visionary acquisition was a disaster. basically, the company promised their sales people that the products would gain various compliance accreditations in short order and they didn't. the delays pissed off customers and the sales pipeline dried up. my contact left three months after the acquisition when his VP told him things weren't looking good. it sounds like almost all of the sales force has left in the past year. he said that the headhunters he speaks with routinely target compugroup employees because they are known to be unhappy. considering that this was an acquisition of customers and the sales people are the ones with the relationships, i have to think we are not getting our money's worth here.
furthermore, those that i have spoken with in the healthcare IT industry have said that the European market is decades behind US IT standards and that those companies who are known to have problems gaining required compliance certifications are at a big disadvantage in the sales process.
these early discussions lead me to question whether the US expansion has much of a chance of succeeding. while you might say it is insignificant because less than 10% of sales come from the US, US acquisitions over the past two years total 10% of the market cap and, more importantly, this may raise questions about the soundness of an international healthcare IT rollup strategy.
|Subject||RE: US Market|
|Entry||04/04/2012 02:49 PM|
The U.S. has certainly been an Achilles heel for the last 18 months. It was a major driver of the guidance reductions in 2011. Integration took longer than expected, and revenue growth (which they expected to be driven in large part by the Federal incentives) has been below expectations as well. Hindsight is, of course, 20/20 but I don't think you had to be a huge visionary to realize that stitching together three 2nd tier platforms was going to be a challenge.
Notwithstanding the challenges, there is some modest room for optimism. They have clearly turned the corner from a cost and margin perspective. So the region is no longer a drag on value. Whether or not it will be a meaningful growth driver remains to be seen. With respect to the feedback you've gotten, the management overhaul is hopefully addressing this. There is no doubt that more serious issues existed than management expected at the time of acquisition. As a result, they've now overhauled the top tier of management, and have been seeing much better results with the new team.
You've already hit on one of the other points, i.e. the U.S. is still a reasonably modest part of the whole, so the investment thesis certainly doesn't hinge on them hitting it out of the park in this market.
The U.S. acquisitions were, to some extent, atypical for CompuGroup. They've tended (in Europe) to buy niche players with relatively strong market positions (take a look at their largest recent acquisition, Lauer Fischer, which they worked on closing for a number of years). The U.S. market is clearly much larger and more competitive, and COP doesn't have the firepower to do more than pick up small time players. Whether their strategy pans out remains to be seen, but I do have some confidence that given the atypical approach in the U.S., if it does not work out it isn't necessarily an indictment of their entire M&A process.
|Subject||RE: RE: US Market|
|Entry||04/05/2012 11:44 AM|
Thanks. That's a fair response.
I think you are quite correct in saying you didn't need to be a visionary to realize this was a challenging acquisition to pull off. But I think this is a problem. This investment is predicated on a rollup strategy. They are very likely going to use the cash they generate to buy more businesses. Over the past two years they spent ~$225MM on acquisitions and it looks like they did a really bad job spending +$70MM of that. The other acquisitions would have to knock it out of the park for the overall spend to generate acceptable returns.
Anyways, I do like this idea and am looking forward to speaking with management. They're just going to have to have a damn good explanation for why they did this, as well as some measure of indicating that they will not pursue (what I think is) a similarly misguided strategy going forward.
|Subject||RE: RE: RE: US Market|
|Entry||04/05/2012 12:24 PM|
Would appreciate whatever feedback you have after you've spoken with them. I think that Tieg is very good.
|Entry||03/24/2013 04:47 PM|
This was not sexy, but it has been a solid, safe investment. Thanks for the idea.
|Subject||RE: nice position|
|Entry||03/25/2013 07:22 AM|
Thanks. FWIW, I still like the business and really like the management team. This is still in my portfolio, albeit in smaller size than previously. I think that this is one of those names that could continue to compound underlying value at a nice clip for some time.