Boston Scientific’s Acquisition Of EndoChoice Is A Good Buy, Despite The Premium

Medical device maker Boston Scientific (NYSE: BSX) announced the acquisition of EndoChoice (NYSE: GI) in a deal valued at about $210 million. While a small move, it will boost Boston Scientific’s endoscopy portfolio. Although the transaction is at over 90% premium to the market price at the time of announcement, it does not look expensive buy given the growth and cost rationalization opportunity.

Our price estimate for Boston Scientific is $25, which is slightly higher than the current market price

Is There A Strategic Fit?

Boston Scientific is one of the largest players in endoscopy segment with close to $1.4 billion in revenues. It has wide range of products for diagnosis and treatment of Gastrointestinal (GI) and pulmonary conditions. The company has been making small targeted acquisitions to grow. Last year, it acquired Xlumena Inc. for an upfront payment of $62.5 million and another $12.5 million on FDA clearance of one of its products.

EndoChoice is focussed mainly on gastrointestinal endoscopy. The company designs, manufactures and sells Fuse Systems, a colonoscopy device which the company claims, provides better visualization of the GI tract as compared to other available devices. The company is banking heavily on the increased use of this device. We believe this to be a good addition to Boston Scientifics endoscopy product portfolio.

Other than devices, the company also provides endoscope repair and maintenance services and GI pathology services through its laboratory.

Based on 2015 Revenue

The company generates close to 90% of its revenue from the U.S. It sells directly, through its representatives, in the U.S. and Germany and through distributor network in 30 other countries. In the U.S., EndoChoice has been able to penetrate about one-third of gastrointestinal departments. This provides good opportunity to Boston Scientific to further monetize these products using its own extensive sales-network in the U.S. as well as globally.

The Deal Makes Sense Financially

Boston Scientific would be paying $8 per outstanding share which amounts to about $210 million. As of June 2016 EndoChoice has about $14.5 million in cash and cash equivalents and another $42.5 million in highly liquid marketable securities. It also has about $42.7 million in long-term debt. This translates into a deal value, inclusive of net-debt, of about $196 million.

EndoChoice first listed on NYSE in April of 2015. The IPO was priced in the range of $15 – $17 per share. Since then it has lost about three-fourths of its value and was trading just over $4 per share before the deal was made public. The company has been making operating losses since its inception. The premium is over 90%, which makes the deal look expensive. However, we need to look at some other metrics. First, despite the premium paid, the acquisition price is significantly below where EndoChoice was trading at the time of listing last year. Second, the sales multiples look reasonable. EndoChoice generated about $74.6 million in revenue over the last 12 months. The Enterprise Value-to-Sales ratio for the deal stands at 2.6x, while Price-to-Book ratio is around 3.4x.  The deal compares favourably with Boston Scientific’s Enterprise Value-to-Sales ratio of  3.1x, based on our 2016 estimated sales, and Price-to-Book ratio of 4.9x.

EndoChoice has been accumulating losses over the years, which has eroded the book value of its equity. However, it has increased sales by nearly 12% CAGR over the last 3 years. The chart below shows the revenue generated by EndoChoice over the years:

*2016 figures are Annualized | Revenue In Million USD

Third, there is an opportunity to reduce costs. Bulk of the losses are resulting from high sales, marketing and other general expenses, which stood at nearly 70% of revenue for EndoChoice in 2015. The same figure for Boston Scientific is 33%. We see a significant opportunity to cut costs by leveraging Boston Scientific’s marketing muscle and distribution network. There is an opportunity to rationalize R&D expense as well. Additionally, the accumulated losses of EndoChoice would also help Boston Scientific reduce its tax expense.

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