Is Life Technologies Overvalued?

Saurabh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On April 15, Thermo fisher announced its acquisition of Life technologies (NASDAQ: LIFE) for $13.6 billion plus approximately $2.2 billion in net debt. This report analyzes the growth of Life technologies and concludes whether LIFE is over- or undervalued.

About Life Technologies

Life technologies produces systems and reagents that enable and simplify biological research within academic, clinical, and commercial research applications.

First Quarter results and outlook

Revenue for the first quarter 2013 increased by 2.5% to $962.5 million over the $939 million reported for first quarter of 2012. However, the operating margin saw a dip by 80 basis points (29.4%) compared to the same period the prior year. The business output in Asia pacific grew 10% compared to 5% in Americas, 3% in Europe, and 1% in Japan. Asia pacific grew in all its business segments – research consumables, genetic analysis and applied sciences.

The management expects the revenue for the second quarter to be in the range of $950 - $955 million.

LIFE has witnessed around a 60% increase in stock price in the last one year. The graph below demonstrates that it has vastly outperformed the S&P 500.

Source: Yahoo Finance

Competition and industry

Life Technologies is currently trading at a Trailing PE ratio of 31.32 in comparison to the industry average Trailing PE of 24.34[1]. Its competitors Meridian biosciences (NASDAQ: VIVO), Abaxis (NASDAQ: ABAX) and Omnicell (NASDAQ: OMCL) are currently trading at trailing PEs of 25.47, 16.04 and 36.9 with expected EPS growth rates of 8%, 17% and 32%, respectively. Life has a clear competitive advantage over its competitors on the following:

  • Price: The economies of scale equips Life to sell the products at competitive prices
  • Robust e-commerce platform : Life gets almost half of the orders[2] from the online platform
  • Growth & Investment in Asian markets: Expansion into emerging markets such as China, India, Korea and Latin America is one of the key growth strategies. The recent acquisition of KDR biotech, a leading reagents distributor based in Seoul, Korea is just one example
  • Innovation: Life has strong capabilities in next-generation sequencing and has wide portfolio of consumables for genomics, and molecular and cell biology

Relative Valuation

The regression of Trailing PEs of 24 companies in Medical Supplies Non-Invasive category against their expected growth in EPS provides the following:

PE = 16.4 + 65.74*Expected growth in EPS

The predicted Trailing PE of LIFE, by plugging its expected growth in EPS of 9.5%, provides a PE of 22.6 which is lower than the Trailing PE of 31.32. That signifies that LIFE is overvalued by 39%.

The scatter plot below demonstrates whether the stock LIFE is cheap or too expensive. In order for the stock to be cheap, it should have low PE and high growth rate in EPS. The stock LIFE does not fit the criteria for ‘cheap stock’ as the median growth rate of the companies is 11% while the LIFE’s growth rate is 9.5%.

Growth Story

Life had a steep increase in operating income since 2008. However, the growth has slowed down since 2010 although it fares better than its competition.

 

 Growth Projections

Based on analysts’ estimates, LIFE is expected to grow by 6%[3] this year. However, the fundamentals of estimating growth led us to conclude differently. In order to estimate the growth, we analyzed the following:

  • How much it reinvested in 2012 : Reinvestment rate of 22%
  • How well it reinvested by analyzing its return on capital(ROC): 6.7%

This provides us a growth rate of around 1.5%[4] for this year which is consistent with the percentage change in drop in operating income since 2010.

Are we paying too high or low for the future growth?

As a mature company, most of LIFE’s growth comes from its existing assets than from its growth assets. LIFE has two options from its existing assets:

  • It can pay out all its earnings to shareholders and lenders
  • It can reinvest a portion to achieve growth

Let us assume that LIFE pursues a no-growth policy. This implies that earnings will remain the same in perpetuity and LIFE should keep returning its entire earnings as dividends to its shareholders. The value of those assets i.e. value of LIFE without growth would be then after tax EBIT/cost of capital, i.e. $4.9 billion[5].

The Enterprise Value is $14.87 billion[6].

Hence, the price we pay for growth would be EV – Value of assets in place = $9.97 billion that constitutes around 67% of the price paid for future growth.

Growth with reinvestment

Now let’s assume that LIFE reinvests at its current rate of 22% with an ROC of 6.7%[7]. The value of the company with growth can be obtained as after tax EBIT *(1- reinvestment)/ (cost of capital - growth rate).

Value of LIFE with growth = $4.6 billion

Value of growth = - $0.3 billion

The value of growth is negative which is obvious because LIFE’s return on capital is 6.7% which is less than its cost of capital i.e. 8.6%[8].

Conclusion

In order to have a positive value for growth, LIFE needs to earn excess returns, i.e. its return on capital should be higher than the cost of capital. Since this is not the case, I'm inclined to pass on the stock.

 

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[3] Yahoo Finance

[4] Growth rate = ROC*Reinvestment rate

[5] Operating Income = $650M; marginal tax rate = 35%

[7] ROC obtained by after tax EBIT/(Book value of equity + Debt – Cash)

[8] Risk free rate= 2.14%, Equity risk premium =6.19%, Levered Beta = 1.16, pre tax cost of debt =3.4%


Saurabh Mishra has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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