Attention value investors: Another smart acquisition for Ascendis Health

I met Gary Shayne, a CA, and Cris Dillon, a chemical engineer, of private equity firm Coast-2-Coast at the Berkshire Hathaway AGM in 2011. They were enthusiastic about building a healthcare business called Ascendis that made its debut on the JSE late last year. The duo, who model themselves on Warren Buffett and Charlie Munger, recruited Karsten Wellner as CEO and have been steadily building Ascendis into a serious force. Today the company announced the R145m acquisition of RCA, a top end medical equipment distributor which fits in snugly alongside last November's R300m acquisition of Surgical Innovations. The Ascendis shares trade at a discount to their listing price of R11. With the energy that Shayne, Dillon and Wellner are applying to the business, the price is unlikely to stay there for much longer. Especially if they manage to secure more deals like this one, which adds almost a fifth to their profit for an investment of just over one twentieth of the equity. With further benefits due when NHI kicks in, it's a stock to consider adding to your long-term portfolio. – AH   

ALEC HOGG: Drug maker Ascendis Health has entered into an agreement to acquire 100 percent of the issued capital of Respiratory Care Africa (RCA). Karsten Wellner, Chief Executive of Ascendis Health is in our Cape Town studio. Karsten,it's another acquisition – this time, very much earnings enhancing. If I did my numbers correctly, you're paying about six percent of your market cap and adding 18 percent to your bottom line?

KARSTEN WELLNER: Hi, Alec. Yes, that's right. Eighteen percent headline earnings attributable for the six-month results so for us it's a big step forward in our medical and pharma business. We're very happy that it was possible for us to buy RCA.

ALEC HOGG: How is it possible that it is so earnings accretive?

KARSTEN WELLNER: This business has been going very nicely over the years with an average compounded growth rate in the double digits. They are very strong in hospital, in the theatre rooms, and in the ICU. From that side, it's a very complimentary business to us. On top of the 18 percent added to headline earnings per share, we see a lot of synergetic opportunities by joining it with Surgical Innovations (Acquired in November for R300m) – very strong in surgery – and this business, which is very strong in ICU, neonatal ICU, as well as a little bit in surgery.

ALEC HOGG: Before going on to the integration benefits, you are paying cash and shares. I know that your colleagues at Coast-2-Coast are big Warren Buffett followers and Buffett doesn't like paying out in shares. What is the split and why have you decided to issue some equity in this case?

KARSTEN WELLNER: The split is 75 percent in cash, and around 25 percent in shares. Yes, we usually try to have a mix in our deals of 30 percent shares, 30 percent cash, and 30 percent via bank funding with debt. That's normally our model and of course, it always depend on what the sellers are prepared to do, to do a deal. From that side, in this case it makes sense to have quite a high portion of cash payment and a part of shared portion, which is also linked to performance (and that is quite important). The R145m deal can possibly be a little bit more, depending on certain hurdles from a performance point of view.

ALEC HOGG: Are you keeping the management team?

KARSTEN WELLNER: Yes. That's very important to us. It was the same with Surgical Innovations – a strong management team. Sean Reitz has built his business over many years…I think probably 15 years. He started in 1998. He stays with us, and he and Stavros, the gentleman who runs our Surgical Innovations business, are very confident about getting a very strong business for us in surgery, ICU, and in Critical Care in hospitals – private hospitals and even State hospitals, too.

ALEC HOGG: That's really my question. On paper, it looks fantastic. You have these two businesses, but business is about people and if you're keeping the management team of both of them, and then putting them together… There's only going to be one job, presumably, for the top guy. Take us through how you're going to overcome that tricky hurdle?

KARSTEN WELLNER: This was discussed from the beginning with both management teams, and both teams are aligned in their strategy. There are many complementary possibilities between these two businesses. They don't cannibalise each other. Middle management and senior management will work together very well. From the beginning…from the first day of the discussions, our existing management at Surgical Innovations was involved with the talks with Sean Reitz from RCA, so from that side, we hope we have done everything right there. You never know. As you say, people are important and people are the biggest asset in business, so from that side it was an important point for us in this acquisition – that everybody seems to be aligned. Whether that will be the case in four or five years' time, we don't know, but we have linked the management with long-term contracts plus a restraint of trade, which is the same thing we did with Surgical Innovations.

ALEC HOGG: Just to unpack the business opportunities a little bit more, these two business (both of them), sell high-tech equipment to private hospitals and to the public sector, as I think you told us a moment ago.

KARSTEN WELLNER: Yes.

ALEC HOGG: What share of the market do they have? You speak about agencies that they have from other parts. Are they the top ones in the country, or are there other companies that you might be wanting to put into the mix as well?

KARSTEN WELLNER: The medical device market in South Africa is a market where 95 percent of the products are imported. The market, according to estimations, is around R13bn. The biggest players in this market are probably R1bn companies. There are many family businesses in this area with many consolidation opportunities. We're talking to further, more built-on acquisitions, to ones, which we merge. Yes, there are still many opportunities in this market and we still have our fishing rods out in the market to look for further targets. Both of these businesses hold international agencies. You mentioned Surgical Innovations. They had a big agency, like Olympus. RCA has very important agencies in the ventilator business, in the monitoring business, and defibrillators etcetera – all high-tech equipment. When we look at the RCA business, the majority is capital equipment, but there's also consumables and a service part. At Surgical Innovations, they also have a very strong service department. They even started servicing equipment for Olympus. Probably from the Middle East and even other African countries are coming to South Africa, and being serviced in the Surgical Innovations technical centre. Both of these companies have equipment. Both of these companies have technicians, so there's a lot of synergies we expect from a backwards integration. Not the front, because the front…they're going to surgery. The other guys (RCA) goes to ICU and neonatal ICU. That's a little bit different – still in the hospital sector – but in the back office end of going forward, we can do a lot. Both of the top leaders between both businesses are aligned with their ideas of what they want to do. For me of course, as the Head of Ascendis, it's very important that my management team talk the same language.

ALEC HOGG: The opportunities in Africa I guess, as the continent grow in wealth there would be greater demand for upmarket healthcare, which is clearly the sweet spot for you. Are you seeing that coming through yet?

KARSTEN WELLNER: That's definitely a potential. If I look at our Pharma Med division, we're talking about Surgical Innovations as mainly active in South Africa – probably 99.9 percent. RCA already has three percent of their business outside of South Africa. They even have a little subsidiary in Botswana, have done activities in the surrounding countries, and they are growing there. With them, Surgical Innovations can actually go outside of South Africa as well. Of course, we have to look at agency rights. Do we have from the major international principals, the right to actually go into middle or northern Africa? Quite often, you get the agency rights for Southern Africa, so that really opens the market in front of your own doorstep. However, as we've seen in the case of Olympus for Surgical Innovations, they are ready to talk with us to do all the servicing for all African markets, plus the Middle East, from our South African technical centres. There's a lot of opportunity there and it's upside potential because so far, as I said, Surgical Innovations [inaudible 0:08] and RCA started with three percent of their turnover in export, but much more can be done.

ALEC HOGG: Karsten, just to close off with, we have the National Health Insurance wave or tsunami that's going to hit the South African hospital sector in the next few years. Is this a good thing for you?

KARSTEN WELLNER: Definitely. The health sector will have to… Regulations are changing. The health sector has to adapt. In the end, what does the health insurance want to do? It wants to make medicines and medical equipment more accessible and more affordable for the majority of the people in South Africa. For us as a business, it means we have to focus maybe in slightly different areas. Maybe some of our medical device businesses or both businesses are in the private sector and in the State sector. Surgical Innovations is not in the State that much yet, but they will go more into the tender sector. In our Pharma business, we have affordable medicines (generics), which go into the dispensing doctor's market and into State tenders, so we will profit from the ideas of the NHI. From the country's point of view, NHI will definitely be good for us. Of course, the businesses have to adapt their business model a little bit. However, what could be wrong with affordability and accessibility if it's implemented in the way it was actually designed to be implemented? Of course, we all ask ourselves that question. Is it possible to implement? What is the timeframe etcetera?

ALEC HOGG: That was Karsten Wellner. He is the Chief Executive of Ascendis Health.

For further information here's the official statement from Ascendis Health:

Ascendis announced the 100% acquisition of specialist medical devices company Respiratory Care Africa for R 145 million in a cash and shares deal. Group CEO Dr. Karsten Wellner commented: "We are extremely excited about the integration of RCA into our group as it falls neatly in line with our stated growth strategy of acquiring mature, well managed brands with excellent organic growth potential. RCA will strengthen our existing Pharma Med division through complementary synergies with Surgical Innovations, our existing medical device business, allowing us to become a leading provider of medical devices throughout South Africa and also abroad."

RCA is a 15-year old medical device business which distributes and services a range of capital equipment and related surgical consumables, specialising in critical care. They hold key agencies for medical equipment catering to the intensive care unit, neonatal intensive care unit and the operating theatre. The company employs over 100 highly trained staff achieving compound annual revenue growth of circa 18% over the last five years. The business is also well positioned to expand into sub Saharan markets with activities already in Botswana, Namibia, Mozambique, Zimbabwe and Malawi. Sean Reitz, the founder and CEO of RCA, has entered into an employment contract with Ascendis to continue driving the business forward.

RCA is well positioned to take advantage of planned new private hospital builds and expanding requirements in the public sector. They have also been identified as a complementary distributor to the existing medical device division, which will enhance Ascendis' ability to service hospitals, clinics and government tenders within a growing market.

The acquisition is subject to the regulatory consent of the South African Competition Authorities.

Dr Wellner concludes: "RCA is a strong cash generative business in a market sector with a high barrier to entry offering low volume, high value products with aligned specialist services. We envisage immediate positive benefits through the integration with Surgical Innovations in the fields of procurement, servicing, sales and marketing which could lead to other targeted acquisitions in this sector as we push towards a further improved customer focus by providing turnkey client solutions. RCA is an important milestone for the Pharma Med division and for Ascendis in general as it adds, alongside our strong organic growth, approximately 18% to our published earnings per share for the 6 month period ended 31 December 2013 and thus contributes towards our continued success story."