August 10, 2009 - 3:48pm EST by
2009 2010
Price: 5.72 EPS $0.37 $0.50
Shares Out. (in M): 6 P/E 15.4x 11.4x
Market Cap (in $M): 37 P/FCF 11.1x 8.6x
Net Debt (in $M): 8 EBIT 4 5
TEV ($): 45 TEV/EBIT 10.9x 8.8x

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Summary: The management of MTSI, a microcap company with an interesting razor-razorblade business model, just announced a going private offer for its stock at a lowball price, $5.75 per share, which is no premium at all from the stock's recent range.  The odds are high that this offer will have to be increased. If so, there could be a good 25% or more upside in the near future, and if not, the downside to the tender price so far is nonexistent.  If the deal falls apart for some reason, the stock is still a buy.  Essentially, the company has been successful in recent years pushing out lots of new "razors" at very low margins, while the high margin "blade" sales associated with those machines are just beginning.  Management is trying to steal the company before the numbers get good.


Business: MTSI makes medication adherence packaging systems designed to improve medication dispensing and administration, with the intent of making it easy for patients to comply with their doctors' orders.   MTS manufactures automated packaging machines, which are typically low margin, and the necessary consumables such as blister pack cards that have much higher margins. MTSI's main customers are institutional pharmacies in North America and Europe whose main customers are nursing homes, assisted living facilities, prisons, and other group homes. 

The basic problem that MTSI is attacking is medication non-adherence, i.e., patients not taking medication as prescribed.  This is huge problem, especially in the elderly with multiple medications to be consumed at varying intervals during the day.  Government estimates claim that people not taking medication as prescribed results in 125,000 deaths per year, 10% of hospital admissions, and more than $60 billion per year in extra health care costs.  Rather than a patient having a bunch of pill bottles around and trying to follow directions of which ones to take when (and trying to remember whether or not one took them),  MTSI's systems allows the meds to be prepackaged in blister cards in which one pushes the pills through the other side when prescribed. These cards are made by MTSI's equipment for the specific patient; every card is different.  A nurse looking at the blister pack can easily check to see if the patient has forgotten to take any doses or taken too many.  In 2006 a study conducted at Walter Reade published in the Journal of the AMA showed the use of MTSI's Multi-Med packaging in elderly patients with four or more medications substantially boosted the compliance rate and decreased the death rate.

MTSI has been around for 25 years and is probably the biggest in its business.  Once a pharmacy has purchased MTSI's equipment, it needs to buy the consumable supplies (punch cards, labels, etc.) from MTSI, and it may also have a service and maintenance contract.  MTSI is willing to earn low margins on the equipment to gain the higher margin follow on business.

Many pharmacies already have manual equipment for filling punch cards, but these require a relatively skilled technician to operate.  MTSI's big push in recent years has been to sell higher priced, more efficient, high speed automated equipment to the large institutional pharmacies both independent and national in scope (such as Omnicare and PharMerica) that are gaining share from the smaller local competitors.  In the last two years MTSI has sold about $17MM of new advanced equipment to Omnicare alone, at minimal gross margins.  This should generate $1.5MM/year in service and maintenance revenues and, over time as Omnicare grows its business, on the order of another $5MM/year in consumables, all at high margins, 41% last fiscal year, versus minus 5% on equipment sales.  Note that the company didn't aim for minus margins on the equipment sales, but got them because of the complexity of the initial installations of the high speed equipment for Omnicare.  As additional machines were delivered to that customer, margins improved, and the goal on future equipment sales is to have gross margins closer to 30%.

Besides fast growing but low margin equipment sales, MTSI has been spending heavily developing new products that address big potential markets.  Multi-med equipment, that packages all a patient's meds in one punch card, has the potential to gain substantial market share at retail chain pharmacies for ambulatory seniors and others with chronic illnesses requiring a variety of meds.  MTSI will soon introduce its MedTimes equipment, which allows a pharmacy to stock a client nursing home with a variety of commonly used drugs including narcotics.  The pharmacy at the behest of the physician can remotely change what pills are issued to patients from that equipment, which would let the patient get the drugs much sooner, cut the pharmacy's delivery costs, and save the nursing home substantial expense on medication documentation and nursing time.

Some or all of these new products could be very big winners.  It appears that management would like to keep that upside for itself rather than share any with shareholders, who have seen the stock decline from the mid-teens several years ago, partially because of MTSI willingness to sacrifice current profits to develop these products.

Valuation:  The stock is reasonably cheap on current numbers, and very cheap if we see a big leap in margins that I expect over the next few years, as high margin consumable demand accelerates due to recent growth in machine placement.   EV at $45MM is 0.59 times sales  of $76MM, of which $54MM were high margin consumables, and 6.38 times trailing 12 month EBITDA.  P/E and Price to free cash flow aren't crazy cheap at 15.5 and 11.8 respectively, but keep in mind that earnings and cash flow have been depressed as the company has invested heavily in new products, which look to be paying off soon.

With the big order to Omnicare complete, equipment sales will fall sharply over the next year, but what sales they do have will come with a positive gross margin at least.  Consumable and service revenues should be strong.

As I write this, the stock is still selling below the $5.75 offering price, let alone the $8.00 or more that management probably should pay to take this recession resistant, nicely growing and steadily profitable company over.  I could mine Bloomberg and the company's statements for more data to make this report look more authoritative, but I would rather get this online now.  I see already two law firms have put out press releases fishing around for a shareholder plaintiff to bring a suit demanding a higher price; the case for that is very solid.


Attempt at an insider buyout at a ridiculously low price will either draw new bids, draw lawsuits to push the buyout price up, or call attention to the value in the stock at this price.

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