Morningstar | Corporate Action: Take Up Sonic SPP to Fund U.S. Acquisition
Narrow-moat-rated Sonic Healthcare has announced its acquisition of Aurora Diagnostics, or Aurora, for USD 540 million, or AUD 750 million. The acquisition will be funded via a AUD 600 million fully underwritten institutional placement and a non-underwritten share purchase plan, or SPP, to Australian and New Zealand retail clients to raise up to AUD 100 million. The placement price of AUD 19.50 per share, represents an 8.8% discount to the last closing price of AUD 21.39. After incorporating the acquisition and making subsequent adjustments, we reduce our fair value estimate 6% to AUD 24.00. We recommend eligible investors apply for the full allocation of shares offered in the retail SPP considering its material discount to our valuation.The price paid by Sonic appears reasonable when we compare it with current multiples of Aurora’s peers in the industry. USD 540 million reflects a multiple of about 9.2 times pro forma EBITDA for the 12 months ending Sept. 30, 2018. This appears in line with Aurora’s major peers, Laboratory Corporation of America Holdings and Quest Diagnostics. The acquisition is expected to be about 3.0% EPS-accretive post the placement on pro forma fiscal 2019 basis. Management also expects the transaction to deliver a year 1 return on invested capital, or ROIC, between 9% and 10%, which exceeds Sonic’s fiscal 2018 group ROIC. The transaction is expected to complete in early calendar year 2019 and is subject to regulatory approvals.
The SPP will open on Tuesday, Dec. 18, 2018 and close on Monday, Feb. 4, 2019. New share applications will be capped at AUD 15,000 per eligible shareholder. The issue price will be the lower of the AUD 19.50 institutional placement price and a 2.50% discount to the volume weighted five-day average price of Sonic shares prior to the close of the SPP.
Incorporating the Aurora acquisition into our valuation and making subsequent adjustments to our future assumptions drives the 6% reduction in our fair value. First and foremost, we incorporate Aurora’s pro forma revenue of AUD 431 million and the pro forma EBITDA of AUD 82 million into our numbers from fiscal 2019 onwards. On the other hand, we pare back our assumed top-line revenue growth rate assumptions in the business in our forecast period by 100 basis points to 5.0%, largely driven by a paring back of domestic pathology growth rate assumptions. When we also factor in the equity dilution created through the funding of the transaction, our fair value falls by AUD 1.50.
A leading provider of U.S. anatomical pathology services, Aurora provides a platform for Sonic to grow its U.S. operations. With approximately 1,200 staff located across 32 anatomical pathology practices in 19 U.S. states, the jewel in the crown here is the approximate 220 pathologists within that workforce. The acquisition will immediately diversify Sonic’s business mix, practice portfolio and customer base. A highly fragmented market where no competitor is believed to have a market share in excess of 5.0%, the U.S. anatomical pathology sector has an addressable market of about USD 16 billion and benefits from favourable macro tailwinds. These include a growing and ageing population, increased focus on wellness and prevention, and advances in personalised medicine and new testing technologies.
The acquisition further strengthens Sonic global market positioning and revenue diversity, as well as increasing economies of scale in the U.S. With leading market shares in Australia, Switzerland, Germany and the U.K., Sonic will now be the third-largest player in the U.S. market. Representing about 7.0% of total Sonic revenue, the Aurora acquisition will move the U.S. as a share of global standalone revenue from 20% to 26% on pro forma fiscal 2018 basis. Geographically, Australia now falls to the second-largest revenue source at 24%, followed by Germany at 19%.
The funding of the transaction is largely equity to maintain a strong financial structure that will allow management to continue to embark on future acquisitions. With a healthy proforma net debt/EBITDA ratio of 2.5 times post the acquisition, there appears adequate headroom for more acquisitions. However, financial leverage looks materially higher once we factor in operating leases, whereby the ratio currently sits closer to 4.5 times--without factoring in the operating lease obligations of Aurora. As such, we believe any large acquisition would likely require another equity raising.
Sonic Healthcare is involved in the provision of medical diagnostic services and the provision of administrative services and facilities to medical practitioners. Co. provides specialized pathology/clinical laboratory and diagnostic imaging services to clinicians, hospitals, community health services, and their patients. Co.'s segments are comprised of: Laboratory, which provides Pathology/clinical laboratory services in Australia, New Zealand, the U.K., the U.S., Germany, Switzerland, Belgium and Ireland; Imaging, which provides diagnostic imaging services in Australia; and Other, which Includes medical center operations and occupational health services.
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