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Gamble of the week: Healthcare minnow punching above its weight
This small biotech company should benefit from NHS outsourcing - and could prove a tempting takeover target for a larger suitor, says Paul Hill.
One of the biggest challenges facing governments around the world is providing top-notch medicine for their expanding and ageing populations without blowing a big hole in their debt-reduction targets. America for one spends a whopping 17% of GDP on healthcare, compared to Britain's more modest 9%.
One solution is to copy what the manufacturing sector has been doing for decades: implementing new technologies, automating processes and driving down costs by outsourcing to specialists.
This is where Source Bioscience comes in. With a 47% market share, it's already Britain's biggest provider of cervical cancer screening for the NHS. It also provides a wide range of other vital diagnostic activities, such as testing patients to match which drugs will be most effective for them. Its healthcare division accounts for 51% of turnover and is the group's cash-cow for investing in its rapidly expanding LifeSciences (41%) and PharmaBiotech (8%) operations.
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The former offers ultra-fast DNA sequencing for academic research, together with online access to the largest portfolio of cloned DNA, RNA and antibody products sold by a single provider in Europe. The latter unit, meanwhile, carries out clinical trials support for pharmaceutical and biotechnology customers to help with the discovery of new therapies.
Last December's purchase of Berlin-based genomics outfit imaGenes further enhances SourceBioscience's chances of selling more services abroad. That's a huge future growth engine that currently represents less than 10% of revenues.
So, in an era of tighter budgets, the NHS and healthcare industry can save a small fortune by outsourcing these type of life-saving tasks to Source Bioscience. What's more, the firm is already profitable, has £3.8m of net cash, and is set to turbo-charge the top line by nearly 20% per year over the next two years. With high operational gearing, much of this growth should hit the bottom line.
House broker Singer is forecasting 2012 revenues and unadjusted EBITDA of £19.3m and £1.9m respectively. But if all goes to plan, I could see profit margins jumping to 20% in five years' time, by which time EBITDA could have shot up to £5m. On this basis, I would value the firm on an eight-times 2015 multiple. Discounting back at 12% and adjusting for the cash, that generates an intrinsic worth of 13p per share.
Sure, there are execution risks. Being a relative minnow may mean the firm gets squeezed by either larger rivals or NHS cutbacks. All the same, it punches way above its weight. Given its cutting-edge technology for the development of personalised medicine, it will also be viewed as a juicy takeover candidate. Singer has a target price of 12p.
Recommendation: SPECULATIVE BUY at 7p (market cap £14m)
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Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.
Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.
Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.
