Is ResMed doing too much?

There’s a never–ending supply of investors, analysts and business gurus telling company managements that they can – and must – do more. Robert Peters urges executives to harness the power of ‘Growth Hacking’, whereas John Bernard offers timeless advice on doing ‘Business at the Speed of Now’.

Then there’s the ever-present incentive for managements to go on empire building shopping sprees. A bigger company validates a bigger pay packet.
Yet most problems don’t stem from managements doing too little – things usually go wrong when they're trying to do too much.

We have a lot of respect for ResMed’s executive team, but its decision to buy US-based software company Brightree from venture capital firm Battery Ventures left us scratching our heads.

Brightree provides cloud-based ‘software as a service’ covering things as diverse as billing, patient resupply, procurement and business analytics ‘to improve clinical and business performance in the post-acute care industry’.

This brings us to our first concern. RedMed has been building a cloud-based software platform of its own called ‘Air Solutions’. It organises diagnoses, monitoring and treatment, then constantly feeds information and patient data wirelessly back to the healthcare provider.

What’s more, ResMed has done very well with it. Just a few weeks ago management said ‘We've taken significant market share … I think we've now clearly proven to our customers that we can drive efficiencies in their business with the [Air Solutions] platform’.

So why buy Brightree?

Management’s response has been lacking. Chief financial officer Brett Sandercock says its ‘revenues are certainly not material or anything like that ... I think there's going to be a bunch of opportunities, but, certainly, I don't think we’re going to try to reckon the numbers around at this stage. But in the connected care world, and what we're trying to do with informatics, you'd certainly have to think that there's plenty of opportunities that the team is looking at to deliver real value to customers.’

ResMed’s head of informatics was a bit clearer, saying the company intends to integrate ResMed’s Air Solutions platform with the work flow functionality of Brightree’s software to improve efficiency for healthcare providers.  

Still, business management and workflow solutions software is a far cry from ResMed’s core operations – CPAP device design and manufacturing – despite the company’s recent success with its Air Solutions platform. In other words, the acquisition doesn't strike us as being within management's 'circle of competence'.

But let’s put aside the possible fallout from smashing two dissimilar companies together like a twisted Play-Doh Fun Factory experiment. The acquisition cost gives us the jitters too.

ResMed is paying US$800m for the business – around 10% of ResMed's market cap – which is seven times Brightree’s 2015 revenue of US$113m. Ouch.

The company had earnings before interest, tax, depreciation and amortisation (EBITDA) of US$43m in 2015. Management went on to say ‘The purchase price of $800m represents a valuation multiple of 13.5 times 2015 EBITDA’.

Wait, just a few lines before management disclosed 2015 EBITDA of US$43m, implying a multiple of 19. What’s going on?

The 13.5 multiple was arrived at after management deducted ‘tax synergies’. The company expects the transaction to reduce income taxes over the next 15 years to the tune of around US$300m. Management then calculated (we use the term loosely) the present value of the tax benefit and estimated it to be around US$225m. It then deducted this theoretical amount from the $800m in real cash it is handing over, before calculating the EBITDA multiple.

We'll use the more conservative multiple of 19, which is mighty expensive no matter which way you look at it. ResMed is funding the acquisition using US$100m of existing cash and US$700m of new debt. The company is suspending its share buyback for the next 12 months and, post acquisition, will have around US$500m of net debt.

That’s only around one times ResMed's EBITDA so we aren’t concerned by the added leverage. ResMed will still have a clean balance sheet. However, given the cost of the acquisition and dubious strategic merit, we’re sceptical of ResMed's decision to buy Brightree at all.

Whilst we still own the stock in our growth portfolio, we’ll be reviewing its position in more detail over the coming weeks. It’s a HOLD for now, but the initial impression of this deal is not a good one.