Description

Dräger is a “hidden champion” with market-leading niche products in the medical and safety technology industries trading at approximately 10x FCF (through the common shares: DRW8).

Dräger is a leading global provider of medical and safety technology based in Germany.  Approximately 60%, 20%, and 15% of revenue is from Europe, the Americas and Asia, respectively.  The Medical division’s acute point-of-care products are sold primarily to hospitals, whereas the Safety division’s gas detection and personal protection products have diversified end-markets including industrial, energy, mining, chemicals, utilities, and municipalities.

Strong positions in niche markets

Dräger products occupy powerful market positions (generally top 3 in Europe, US and worldwide; see exhibits A and B) in anesthesiology, respiratory care, neonatal care, medical monitoring/IT, gas detection systems, alcohol detection and firefighter breathing apparatus.  Dräger’s excellent competitive position is mentioned in Hermann Simon’s book, Hidden Champions of the 21^st Century.

The Medical segment is in a strong competitive position despite competing against larger and more diversified competitors (e.g., GE, Phillips, and Covidien) as demonstrated by high, consistent market share in niche products and strong financial results (21% 10-year pre-tax return on capital).  Additionally, after the company terminated its relationship with Siemens, it did not experience a revenue decline (from fewer cross-selling opportunities).   The total addressable market should grow in the mid/high-single digits over the medium-term.

The Safety division is a gem: history of strong financial results (27% 10-year pre-tax return on capital, over the past 10 years EBIT increased 151% while capital employed only increased 23%) and market-leading niche products.  The €5bn total addressable market should grow in the high-single digits over the medium-term, driven by GDP growth and higher safety standards in developing countries.

Dräger has a significant moat from customer captivity and economies of scale in R&D

Dräger products are relied on to keep people alive.  With an average order of only €50-100k, the purely economic switching cost is insignificant compared to psychological and institutional switching costs manifested by the long-standing trust developed over many years (more than 120 years in some markets).  While not as broadly known as “Google” or “Xerox”, Dräger has a powerful brand/reputation (“draegerman” is synonymous with mine rescue staff member and “Dräger-Tubes” is synonymous for hazardous gas spot check).

Dräger invests heavily in its product offerings.  R&D is significant at 7% of sales, allowing the company to innovate and defend its market position.

Run for the long-term

Dräger has a long-term orientation that US investors are unaccustomed to seeing. The business is run by a fifth generation family member. The family owns 40% of the equity and controls the firm.

Family control is a red flag for many investors.  While there are legitimate risks, Dräger is a business that has survived five generations: it clearly has positive attributes.  Additionally, the family has the freedom to focus on long-term value creation, as opposed to distractions like quarterly performance and meeting estimates/guidance (“As a listed family company we don’t think in terms of quarters, but of decades” – Stefan Dräger).

Improving Capital Structure

In 2010, Dräger completed the purchase of Siemens’s 25% stake in Dräger Medical and subsequently converted Siemens’s cash-settled option to an equity-settled option.  The company then repurchased 41% of its outstanding participation certificates in April. Currently, Dräger has 10.2mm common shares (DRW8), 6.5mm preferred shares (DRW3), 1.3mm preferred share options outstanding (€64.12 strike; from Siemens transaction).  Additionally, the company has 0.8mm participation certificates outstanding.  At the current market prices and assuming dilution/exercise, the company has a €1.3bn market capitalization and €1.6bn enterprise value. Preferred shares currently trade at an approximate €10 premium to common shares due to the dividend structure (first €0.13 per share, €0.06 more than common) and greater liquidity.  

Risks & Limitations

• Larger medical competitors bundling products
• Dependent on capital spending (Medical division products have 5-10 year lifetime)
• Trading illiquidity – 15,000 and 2,000 shares per day for DRW3 and DRW8, respectively
• Short-term margin compression – after aggressive cost cutting program
• Lack of a catalyst – family control reduces likelihood of a takeover, MBO, etc.

Valuation & Conclusion

Dräger Safety’s competitors have been active consolidating the already-consolidated space.  Acquisition multiples have averaged 11x EBITDA (see Exhibit C) and Mine Safety Appliances Company (NYSE: MSA), a direct competitor, trades at 9x EBITDA.

Using a sum-of-the-parts analysis, I estimate Dräger is worth €120 per share (see Exhibit F).  Dräger’s normalized free cash flow is over €7 per share, resulting in a 10% FCF yield through the common.  Dräger’s strong competitive positioning in growing, niche markets and a cheap valuation provides a significant margin of safety.

Exhibit A:  Products – Medical Division

Source: Company filings

Exhibit B:  Products – Safety Division

Source: Company filings

Exhibit C:  Safety M&A

Source: Company filings, news reports

Exhibit D:  Medical Financials (in millions Euros)

Exhibit E:  Safety Financials (in millions Euros)

Exhibit F:  Valuation (in millions Euros, except per share)

Note: Sum-of-the-parts EBITDA includes corporate overhead allocation.

Catalyst