With Piramal Healthcare stock slowly and steadily marching
northwards (Disclaimer: It has been my favorite stock for almost a year, so
this post may be a little biased ) following a slew of acquisitions (and a Rs17.5
dividend per share coming up), I once again pause to take a look at the latest
acquisition – Decision Resources Group for a sum of approximately $635 million. All the reasons given in their investor
presentation indicate the attractiveness of holding this company in the
portfolio. But again the question arises (as earlier with Vodafone India’s stake),
have they paid an appropriate value for this? So, I make an attempt to value
DRG, but the same being a privately held company a lot of assumptions need to
be made.
As a start, let us consider the information available:
1) Projected
revenue of $160mn for 2012
2) Revenue
growth of 20% CAGR over past 5 years
3) Industry
EBITDA margins in the range of 15%30%
For valuing the company, I need to make assumptions for the
following factors:
1) Growth
Rate for next 4 years
Two cases have been considered: 20%
and 17.5%
2) Discount
Rate
As the buyout would be in
debt/equity ratio of 1:1, I have assumed that this would also be the final
capital structure. The cost of debt is taken as 5.5% (based on Piramal‘s call
transcript) and equity is taken as 13%, thereby coming to a discount rate of
9.25%
3) EBITDA
Margins
Various cases have been considered
for the same.
4) Net
CapEx in future
For estimating the same, I have
taken into consideration the ratio of Net CapEx required per unit increase in Sale. This has been taken
from that of Cognizant, which also has an analytics practice (for lack of a
better comparable). The average value for the past two years was found to be
0.475. This means, for a dollar increase in sale, $0.475 needs to be the net
capex (New CapEx – Depreciation).
5) Change
in Net Working Capital (Non Cash)
For estimating the same, I have
taken into consideration the ratio of change in Net Working Capital required
per unit increase in Sale.
This has been taken from that of Cognizant, as in the earlier case. The average
value for the past two years was found to be 0.065. This means, for a dollar
increase in sale, $0.065 needs to be added to the working capital.
6) Effective
Tax rate
I have taken a
very conservative assumption of 30%.
7) Terminal
Growth Rate
Again two cases are taken – 3% and
5%
Result of the
valuation exercise
Based on the EBITDA margin and terminal growth assumptions I
have taken into consideration, we get six cases as shown in the tale below:
Terminal Growth of 5%


a

b

c


EBITDA Margin

Fixed 22.5%

Increasing
from 18% to 26% in 9 yrs

Increasing
from 20% to 26% in 9 yrs

Valuation ($mn)

$738.91

$960.76

$972.14

Discount on Deal

16.36%

51.30%

53.09%

Terminal Growth of 3%


a

b

c


EBITDA Margin

Fixed 22.5%

Increasing
from 18% to 26% in 9 yrs

Increasing
from 20% to 26% in 9 yrs

Valuation ($mn)

$561.50

$709.13

$720.46

Discount on Deal

11.57%

11.67%

13.46%

On considering a terminal growth of 5%, all valuation show
the deal gave Piramal a discount of at least 16.36%. But for a terminal growth
rate of 3%, in case of a fixed EBITDA margin of 22.5%, the value comes 11.57%
lower than the deal value, while for the rest it is above the deal size.
All in all, the deal seams to be very lucrative, as the
analytics business generally has EBITDA margins in mid 20s. Moreover, my
calculations have considered lower EBITDA margins during initial phase of 9
years and maturing to 26% (which seems attainable to me). I have also not
considered the synergies between Piramal and DRG and the benefits of entering
the global Analytics industry (which is growing faster than the IT/ITES
industry).
Verdict: I still maintain a BUY on Piramal Healthcare and feel that
the company is employing its cash well.
[You can refer to my valuation excel sheet at: https://sites.google.com/site/saumitraambegaokar/drg]
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