Azure's allure continues

We outline three potential bid scenarios for the healthcare technology company.

(Eureka Report is building a reputation not just as a publication that picks stocks but often as a reliable source that identifies opportunities before the rest of the market. In recent months we have had two sterling examples of leading the pack. In September last year, Tom Elliott named Warrnambool Cheese & Butter as a potential takeover target shortly before a bid from Saputo of Canada. At that time the stock was trading at $4.51 … the final acquisition price was $9.40, more than double the price when we identified the agribusiness stock as an opportunity.

Now Eureka Report has done it again: On March 12 this year Simon Dumaresq identified Azure Healthcare as an opportunity. In case you missed it, Simon recommended it again on April 16 – on both occasions the stock was at 30 cents. As you’ll read below, Azure announced it was in takeover negotiations this week with the stock soaring to 42c … it is trading at 37c as we go to publication today. As Simon explains, he did not put an ‘outperform’ recommendation on Azure because it was merely a takeover target. Rather he has picked it as a very good company, moreover he still recommends it. Nice work Simon and Tom!

Managing Editor James Kirby)

The announcement on Monday (April 28) that Azure Healthcare (AZV) has received a conditional takeover proposal from an unnamed bidder initially pushed the share price up to a high of $0.42.

Three days later very few details have been released regarding the potential transaction, and specifically who the bidder is, or how long the due diligence process will take. As a guess it could take up to two weeks.

The company stated to the ASX: “Azure has allowed the party to commence due diligence and such due diligence is ongoing. There is no certainty at the moment that a transaction will occur and as such the Azure board recommends that its shareholders take no action. At this stage, the company is not in a position to identify the party who submitted the proposal.”

With this is mind, I have run through some potential scenarios and the likely share price impact.

The general rule is don’t buy for a takeover, however with the strong earnings outlook there appears to be little downside.

  1. A formal non-conditional takeover offer that is recommended by the Azure board.

Given Azure’s positive earnings outlook, the board has a number of points to defend a low-ball takeover bid. In regards to how high an offer price could be, that is largely dependent on who the party is and its motivation for buying.

With CEO and chairman Robert Grey owning 29% of AZV, his views will obviously carry a large weighting. Grey has already retired once, after selling Austco Communications (founded in 1986) to Azure (then TSV Holdings Ltd) in 2007.

After founding the company and being a large part of its success for nearly 30 years, the decision to sell the company would not be easy for Grey.

The combined board owns approximately 42%, and there are five other shareholders who own a combined 20%.

In our first report on Azure, we discussed the potential value that could be created for a company acquiring AZV.

Recent transactions in the sector have been based on a wide range of multiples. A recent Hills Holdings (HIL) acquisition appears to have equated to an approximate 2.5 multiple of revenue. This multiple would imply a $0.46 AZV share price ($89 million) when using our FY15 revenue forecast of $35.2 million and considering the $0.8 million net cash position.

In regards to potential buyers, the value proposition for a local buyer versus a North American is critical. Also critical is whether or not the buyer has existing nurse call hardware capabilities or is a large software-based company trying to break into the sector. The US market is currently worth about US$275 million and growing at greater than 20% per annum.

AZV was originally a nurse call system manufacturer, and has successfully transitioned to become a provider of clinical workflow software and healthcare solutions.

The company has recently been approved to sell its healthcare solutions in the US, and has also commissioned a second manufacturing and assembly plant in the US to complement the existing facility in Australia. A new entrant to the US market could do so at least 1-2 years faster through an AZV acquisition benefiting from the approval processes the company has already been through.

On top of the software and hardware IP, Azure also has existing relationships with at least 8000 healthcare facilities. This is valuable, considering the supplier loyalty usually displayed by healthcare providers.

  1. Multiple bidders

This would obviously be the most favorable outcome for shareholders, leaving the potential of a takeover price at a large premium to what we consider fair value. With Azure announcing that a party is currently performing due diligence, it is an open invite for any other interested buyers.

  1. No formal offer post the due diligence

As the company stated, there is no certainty that a formal offer will be received. We can’t assess the likelihood of this scenario as no details have been announced regarding the conditions of the current proposal and due diligence process.

If this was to happen, we would anticipate the share price to drift back to the mid to low $0.30 range, with the FY14 full year result being the next share price catalyst.

As discussed on April 16 (click here) it is our view that the company is very well placed to exceed expectations for the FY14 result.

At the AGM in October last year chairman/CEO Grey provided guidance for 25% annual revenue growth. Given 42% revenue growth was achieved in the first half, it would appear that the company is on track to materially exceed this guidance.

Summary

We are maintaining our outperform recommendation, due to the earnings and/or takeover driven potential upside versus very limited downside.

With the due diligence process likely to take some time we would recommend to buy on weakness rather than strength – ideally below $0.35 and not higher than $0.38.

It is important to point out that the basis of our recommendation is the fundamental intrinsic value of the company. While we recognise that a potential takeover is likely to be at a premium to intrinsic value, buying just for a takeover is a high-risk strategy.

Ignoring the potential of a takeover, a strong FY14 result and positive outlook would see us upgrading our current $0.39 valuation.

To see Azure’s earnings forecasts and financial summary, click here.