April 06, 2010 - 9:32am EST by
2010 2011
Price: 8.28 EPS N/M N/M
Shares Out. (in M): 67 P/E N/M N/M
Market Cap (in $M): 555 P/FCF N/M N/M
Net Debt (in $M): -189 EBIT 0 0
TEV ($): 366 TEV/EBIT N/M N/M

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MDS offers the opportunity to invest in a misunderstood (albeit complex) situation with limited downside, 30-100%+ upside, and multiple catalysts that could result in relatively near-term appreciation.  The stock was written up on VIC on September 29th 2009 by Nails4, who gave a very good overview of the situation.  Now several months later, the successful completion of several important milestones, plus certain trends that have emerged have added to the underlying value of the company.   Most notably is the substantial and sustainable price increases in the Mo-99 market (300%) that should more than double EBITDA in that segment.  These price increases are not widely known outside the industry, and have not been discussed by the company or analysts.  A second development is the rapid growth and bright prospects for the company's Therasphere product.  In our valuation, we consider the value of each business segment, plus review two important "call options" that, in our opinion, could add even more upside.


Recent events

In recent months (culminating this week) several key events have occurred that dramatically alter the business:

(1)     Closing of sale of Analytics business (Jan 29):  To Danaher for roughly $650M

(2)     Sale of Early stage Pharma business (Feb 9):  To Ricerca for $50M gross, but roughly $0 when one accounts for retained liabilities

(3)     Completion of share buyback (Mar 29):  $450M at $8.50 per share

(4)     Extinguishment of entire senior secured debt balance (Mar 29):  $200M plus $23M in early termination fees

(5)     Replacement of CEO with president of Nordion division (Jan 10)

(6)     Extension of outage at NRU facility (ongoing)

All but the last are positive developments planned well in advance.  What is left at MDS is now a collection of: (1) two duopoly businesses (Mo-99 and cobalt) with tremendous barriers to entry, low capital requirements, steady growth (albeit moderate) and limited replacement options, and (2) a rapidly growing medical device unit that has significant potential.  Now that the dust has settled from all of the significant rearrangements, we expect the stock to appreciate as investors realize the substantial value in MDS's remaining businesses.


Current State of the Business

There has been a flood of numbers out of the company in recent weeks that has made it a bit difficult to observe some of the current balance sheet and valuation basics.  Here is a summary as we see it, after the share buyback of this past week.

First let's calculate the "true" net cash balance:

$'s Description


Cash stated on balance sheet as of 1/31


Additional items on the balance sheet 1/31 that should be considered as "cash"


Debt paydown (Feb 3)


Make whole payment on debt (Feb 3)


Share buyback (Mar 29)


Debt remaining on balance sheet (loan from Canadian gvt)


Additional restructuring / deal costs accrued but not paid yet


Net cash as of 4/1

Post buyback, there are now 67 million shares outstanding in the company.  The price as of this writing is $8.10.  This gives a market cap of $544M and an enterprise value of $355M.  The question is now: What are we getting for this?

Note: Again, we encourage you to read Nails4's write-up with more detailed background information on the various divisions, and instead will focus our write-up on filling in a few items based on our extensive qualitative research and channel checks.


Segment Analysis

1) Cobalt Business value = $280M

Co-66 is used in the sterilization of most single-use medical equipment.  In short, radiation from the cobalt kills any living bacteria or other organisms.  It can do this through sealed packaging, a huge benefit to manufacturers.  The industry has been growing at a low single digit rate for many years, and is projected to continue to do so for the indefinite future.   It is essentially a razor / razorblade business, with a huge installed base of expensive razors (which Nordion also manufactures) and razorblades (the cobalt) that, due to unavoidable radioactive decay, require partial replacement every year.  Because it deals with radioactive material, the barriers to entry are enormous, with significant technical know-how requirements coupled with massive regulatory hurdles.  In addition, MDS has tied up much of the available global supply of radioactive cobalt in exclusive contracts.  Its small market size (under $200 million in revenues) further reduces the attractiveness for any potential new entrants. 

Does this sound like a good industry to be an incumbent in?   It sure does to us, and MDS has an estimated 80% market share.   Conversations with industry experts, current and former company officials, and a careful review of public filings lead us to estimate an EBITDA of $35-40M for this division (cap ex requirements are very modest).  Using the conservative estimate of $35M and a 8x EBITDA multiple we get $280M of value for this business alone.

2) Mo-99 business (thru 2016) = $210M  

As described in the prior write-up, MDS sources the bulk of its Mo-99 from the 1950's era NRU reactor in Canada, which it then processes and sells (primarily to a US-based company called Lantheus).  NRU and MDS have historically provided approximately 40% of the world's supply of Mo-99.  The rest of the world's supply comes from a small handful of reactors across the globe, almost all of which are equally aged, though significantly smaller than the NRU.  The Mo-99 decays into an isotope called Tc99, which has an extremely short half life of less than one week.  The tc99 is then used in a wide range of medical imaging applications, for which there are few, if any, substitute procedures of equivalent efficacy.  The short half life of the tc99 makes stockpiling impossible. 

It is well known that MDS and a company called Covidien essentially have a global duopoly in the supply of processed Mo-99.  It is further well known that the unexpected shutdown of the NRU reactor (and its delayed repair schedule) plus the scheduled shutdown of the world's second largest reactor (Petten, in the Netherlands) have thrown the global medical community into a crisis in the area of medical imaging (try googling "mo99 isotope medical crisis").

What is far less known (or publicized) is the fact that pricing of processed Mo-99 has increased dramatically in recent months, from approximately $300/curie (cu) to $1,000-$1,500 per (cu).  This price increase began even prior to the NRU shut down.   We have obtained this information on the current pricing from multiple calls with customers (including a survey we had commissioned by an independent consultant), publicly stated information (including US and Canadian government panel testimony), press releases from Lantheus and Covidien (the two primary users of the Mo-99) and other sources.  Note that these prices were before the Petten shutdown at the end of February, and prices may be even higher today.

What is perhaps more surprising is that many of these same sources have stated with confidence that these new price levels will remain for the foreseeable future, even well after the global supply comes back on line.  Why?  Let's do some quick math.  As stated earlier, Mo-99 is the primary "ingredient" used to generate Tc-99, which is then used in a variety of medical imaging procedures.  The typical end-user cost of these procedures is approximately $800.  Prior to the price increases, the cost of a Tc-99 dose was approximately $4.  Tripling the price of the Tc-99 brings the cost of the procedure to $808.  Without the Tc-99, the procedure is impossible.  There is no equivalently accurate procedure.  In short, the crisis has revealed the dramatic historic underpricing of the Tc-99 and hence the Mo-99. 

We are confident that the new price levels are sustainable. What will this mean to MDS?  It is our understanding that MDS pays a fixed percentage (estimated at roughly 30%) of gross sales to NRU as a fee.  Thus, the majority of this price increase will fall directly to the MDS bottom line. 

This business did about $40M in EBITDA annually before the NRU reactor went down.  While we expect that prices will remain at 3x, in our base case, we model in pricing of 2-2.5x prior levels (about $750/mc).  We also conservatively model in volumes of just 80% of prior levels.  This is despite the fact that there simply are no other feasible meaningful global suppliers, and improvements made at the NRU during the shutdown could actually increase capacity somewhat.  Aside from the revenue share with NRU, the costs should remain essentially flat.  This results in EBITDA that is more than double previously reported levels.  Again to be conservative, we value this business using a DCF going out only to 2016, which is the license duration currently contemplated by the Canadian government. 

Of course there is the other key issue of when (and if) the NRU reactor will come back online.  It has been out of commission for 10 months, and is currently undergoing the final stages of repair.  The repair is very complex, and involves precision welding that requires several innovative technical solutions.  The expected completion date has been shifted back several times, from March to April to May to July.  We are not nuclear engineers and do not pretend to be experts on the technical issues.  We have, however, spoken to several sources who are, including a handful of individuals that are "one step removed" from the process.  The extremely strong consensus is that this is more a matter of when, not if, and that the current July completion date is a very viable target.   Each month of delay after that should knock approximately $4M of EV, or 6 cents per share, from our valuation estimate of this segment. 

3)  Therasphere value = $100M

Therasphere is a business that until recently was very much "under the radar" at MDS.  However with the repositioning of the overall MDS corporation, coupled with some dramatic traction in this division, it is now emerging as an important third leg of the MDS business.  Recent growth has been significant: 28% in 2009 and a whopping 50% yoy in Q1 2010.  Based on numerous conversations with physicians that use the product, we believe that this growth rate is sustainable and can potentially even increase (more on that below).

In short, therasphere is an innovative treatment option for inoperable liver cancer.  It works by delivering targeted radioactive seeds to the cancer site.   The product has one primary competitor, produced and sold by a company called Sirtex, which is a public company based out of Australia. 

Multiple physicians with whom we have spoken have praised the product for its efficacy and ease of delivery.  One issue that has held the product back in terms of its usage penetration has been the complex approval process required to use the product at an individual hospital.  Because Therasphere is approved by the FDA with HDE status, it must be approved by the institutional review board of each hospital, and be re-approved for each minor change in usage.  In the past, this process also included a step of getting written approval from the FDA.  However, in early 2010, the FDA changed its procedure on this (we have seen the letter it sent), and its written approval is no longer required.  According to several physicians, this will reduce the logistics hurdle dramatically.  In the words of one doctor: "As a therapy itself Therasphere is actually easier to use vs Sirtex ... but up until now, I used Sirtex 9 to 1 vs Therasphere due to the hassle ... it was too cumbersome time-wise with the paperwork ... ... now in the future it will be more like 50/50."

These same sources consistently cited the lack of attention historically placed on Therasphere sales and customer service by MDS employees ("It was as if they didn't care very much").  This was perhaps understandable back when MDS was a multi billion dollar company, and Therasphere was a speck of a division.  We believe, however, that now that this is the 3rd largest business unit at the company, Therasphere will receive increased attention from management.

In terms of valuation, Sirtex, trades for 5x revenue, 16x EBITDA, and has 33% EBITDA margins.  MDS stated 2009 Therasphere sales levels at $20 million, and growth of 50% in Q1 2010.  Conservatively, we use a run rate of $25 million and a revenue multiple of 4x, which gets to a value of $100 million. 

While we use this conservative valuation in our base case, we do believe that there is a possibility that the company could have a 'tiger by the tail' here.


"Free" Call Options

1) Post 2016 value of Mo-99 business = $0-400M

There are several possible outcomes for the Mo-99 division post 2016, which is when the proposed license extension is due to end:  (1)  MDS's contract with NRU could be extended (some experts believe the NRU reactor can be operated safely well past 2016, particularly with the recent fixes made during the outage), (2) MDS could find alternative sources for Mo-99, (3) MDS could sell the business (with its extensive infrastructure and operational capabilities), or (4) MDS could shutter the business. 

In our base case, we presume that the business has a modest "terminal value" of $100 million, reflecting either a sale of the division or vastly diminished production.  At current prices we are essentially getting this as a free call option. 

2) Potential value from Maple settlement: $0-$1.6B 

MDS is currently engaged in a complex lawsuit against the AECL (owner of the NRU facility).  The AECL had been contracted in 1996 by MDS to construct the MAPLE reactor, as the successor production facility to the NRU.  MDS contributed nearly $400 million in capital to the project, in exchange for an exclusive supply contract.  In 2008, the AECL stopped construction on the nearly-completed project, controversially deeming it unsafe.  MDS is suing the AECL for $1.6B for its money spent and future profits lost.  While we are not legal experts, the case in favor of MDS seems fairly intuitive, and the experts that we have spoken to believe that MDS has good grounds to obtain a meaningful settlement. The lawsuit is currently in arbitration, will be heard in late 2010, with a decision expected sometime in mid 2011.  In recent conference calls, management has emphasized the arbitration progress several times.  Given the amounts involved, a favorable outcome could have a dramatic impact on the stock.  For example, a settlement that merely recoups the cash spent by MDS, but ignores future profits lost, would result in a doubling of the enterprise value of the entire company.

In addition, we feel that this settlement possibility also acts as a natural hedge on the possibility that the NRU reactor never comes back online: if this were to happen, we understand, this would likely favorably impact the MDS arbitration result. 



Using a sum-of-the-parts analysis, we believe that a fairly conservative base-case valuation for the stock is $13.00.  This value breaks down as follows:


Key Assumptions



(1) Current cash value

Value of "cash" that exists on balance sheet today



(2) Cobalt

Annual EBITDA of $35 million @ 8x multiple



(3) Therasphere

$100 million value @ 4x run-rate revenues



(4) Mo-99 (pre 2016)

NRU restarts end of July.  80% capacity thru 2016.  Pricing @ 2.25 - 2.5 x old level



(5) Maple Lawsuit

Minimal settlement of $50M at end of 2011



(6) Mo-99 (post 2016)

$100 million of value for the business in 2016







We think that in a moderate bull case the stock is worth about $16.50.  This would be if the NRU returns to full capacity and Mo-99 pricing continues at current 3x historic levels.  If either of the "call options" hits, the stock value could easily exceed $20. 

On the downside, we believe that the stock is still worth about $8.00 per share even if the NRU never restarts again, the Mo-99 division is shuttered with no residual value and the Maple lawsuit comes up empty.  As we mentioned earlier, we consider each of those events highly unlikely, and the scenario where all three occur as quite a stretch.

In conclusion, it has been a rough ride for MDS and its shareholders over the last several years.  However, investors should take advantage of the negativity and uncertainty surrounding this company to take a deep dive and understand the undervalued jewels that remain.

Note: In our analyses, we include the future MDS corporate overhead costs in the Mo-99 division DCF calculations.  Thus the sum-of-the-parts analyses include corporate overhead expense.


-NRU restart

-Realization of pricing increases for Moly-99

-Favorable resolution to Maple lawsuit

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