US heavyweight bids for Sirtex Medical

Three weeks ago in Is Sirtex a takeover target?, we explained how a few things were falling into place that could draw the attention of acquisition-hungry competitors: sizeable cost cuts and rising free cash flow; the end of all clinical trials and non-core research, which simplified the business; and a share buy-back a few months ago that suggested management thought the stock was undervalued. ‘There isn't quite a ‘for sale' sign in the window, but our guess is that there may be a few investment bankers tapping on the glass.'

There were, it turns out. US-based radiotherapy maker Varian Medical Systems has made a takeover offer of $28 per share, with Sirtex's board unanimously supporting the deal.

Varian is a $13bn company that designs and sells radiotherapy hardware for delivering treatments to cancer patients. Varian also offers a range of products in Sirtex's niche of internal radiotherapy (brachytherapy), though none that directly compete with its flagship liver cancer therapy SIR-Spheres.

We can see why the board likes the deal. Sirtex would fit nicely into Varian's internal radiotherapy division and the offer price of $28 per share is 49% above the stock's closing price before the deal was announced – and twice what the stock was trading at a couple of months ago.

The offer values Sirtex at $1.58bn, around 30 times underlying free cash flow or 19 times forecast earnings before interest tax, depreciation and amortisation (EBITDA) for 2018.

Better yet, it's an all-cash offer, not some mix of cash and shares in Varian, which would tie shareholders to the future of a different company and make the final value of the deal impossible to nail down until it goes through.

Higher bids unlikely

Shareholders will get to vote on the deal at the scheme meeting to be held in mid-May, though a few bits of paperwork still need to be signed off.

First, an independent expert and the court must agree that the deal is in the best interest of shareholders. The company also needs approval from various regulators, including the Foreign Investment Review Board and competition regulators in the US and Australia. However, given that Varian doesn't have any directly competing products, it's unlikely that the Australian Competition and Consumer Commission (ACCC) or foreign regulators will have any qualms with the deal.

Varian has plenty of cash and a clean balance sheet, so we aren't concerned that the deal may fall through due to affordability. There also appears to be strategic sense in a merger, given that Sirtex operates in a similar market to Varian, which could then sell SIR-Spheres through its large distribution network and doctor relationships. ‘We believe the risk that this transaction does not complete is very low,' said chief executive Andrew McLean during this morning's analyst briefing.  

Interestingly, management said the offer ‘follows multiple unsolicited, non-binding proposals … and subsequent engagement with a number of parties to determine whether a binding and attractive proposal would be put to Sirtex shareholders … Sirtex's advisers also contacted a number of additional parties to test potential interest in submitting alternative proposals'.

It's possible that a latecomer decides to make a superior bid for Sirtex, but the wording above suggests management has already flushed out any potentially interested parties, making it less likely that a new offer emerges.

What should you do?

Two years ago, in Is Sirtex's $20,000 teaspoon enough?, we said: ‘With a price-earnings ratio of 30, Sirtex looks expensive on traditional valuation metrics, but we think it deserves a premium price … The company has a huge untapped market for SIR-Spheres, profitable sales growth and more than $100m of net cash to fund its clinical trial and research programs.' With the share price at $27.70 at the time of writing, we were happy to Hold.

A lot has changed since then. Today Sirtex is a ‘cleaner' company, with all clinical trials out of the way. The solid balance sheet remains, and the business is still a font of free cash flow. However, sales growth is now a quarter of what it was; competition is on the rise with new oral chemotherapies gaining traction; the untapped market has shrunk 70% following the failed clinical trials; and there are two class-action lawsuits against the company for alleged compliance breaches.

A price-earnings ratio of 30 could be justified a couple of years ago, but it's harder to make the case today. That's not to say Varian is overpaying – its deep expertise in the field and formidable distribution network mean Sirtex would be more valuable under its umbrella than as a standalone company. However, as things stand, Sirtex's current share price of $27.46 is above what we consider the stock's intrinsic value. There's a good chance the deal will get across the line, but if it's voted down or fails due to a ‘material adverse change' in Sirtex's profitability – which voids the offer – then the share price is likely to drop significantly.

We don't think it's worth holding out for an extra few cents or a superior bid and recommend you forgo the offer altogether and sell your holding on the market instead. You'll get cash in the bank within a few days, rather than potentially wait months, and avoid any pain if the deal collapses.

The stock has risen almost fivefold since we first upgraded it on 8 Nov 10 (Speculative Buy – $5.90) for an annualised return of 24% including dividends. It was a bumpy ride, but worth the wait. SELL.