By: Steve Rubis
In March 2007, Michael Eisner, with the help of Madison Dearborn Partners, made a $9.75 per share all cash offer for Topps, Inc. Recently, the Upper Deck, LLC the sole rival to Topps in the trading card business submitted a $10.75 all cash offer. In our eyes, the Topps buyout discussion is signaling a top (no pun intended) in the Private Equity industry. Any investor who understands the landscape of the trading card market of the past 15 years knows that such a buyout makes no sense. In essence, the deal makes perfect sense for Upper Deck, but not for Private Equity. Any Private Equity firm interested in Topps has money burning a whole in the company’s pocket.
First, why would anyone want to buy a company like Topps, Inc.? The company has nearly $81M in cash, or about $2.10 per share and a $5.24 book value. These facts make Topps an attractive buyout candidate because there is no debt on the balance sheet. In essence owners of Topps shares are getting $2.10 in cash, $3.14 in tangible assets, and finally paying $5.18 per share for the business. On the look of it, a price range of $9.75 to $10.75 per share looks cheap. The problem is that anyone with an understanding of the trading card business should be baffled by Eisners offer, quizzical of Upper Deck’s offer, and understanding of Topps anti-trust concerns.
To understand our discontent with the coverage and analysis of this situation, investors must start with a simple history of the trading card market over the last 26 years. In 1981, Topps lost its monopoly on baseball cards when Donruss and Fleer were allowed to licenses for baseball cards. These companies were the big three until the late 80s when Score, Sportflics, and Upper Deck came alive. Upper Deck’s product would revolutionize the industry, which helped send trading cards on a downward spiral beginning in 1991. With the advent of premium brands such as Studio, Leaf and Topps Stadium Club, trading card producers started to price themselves out of the market. Children paying $0.50 for a pack of 15 cards and stick of gum were no longer the target market. Rather, the companies sought to reach more adults with prices of nearly $3.00 for a pack of 15 cards and no gum.
This premium mania caused numerous bankruptcies, mass consolidation, and inflated prices. During the 1990’s, companies like SkyBox, Hoops, Score’s multiple sub-brands, Pacific, Playoff, Classic, Collector’s Edge, GameDay, and even Ted Williams attempted to obtain market share. The result was extreme market saturation with each company producing nearly 10 different brands a year on average by 1999. Beckett Publications, the main price guide for trading cards, had to substantially condense their pricing coverage in order to provide pertinent pricing data. By the early 2000’s, the market was so saturated that Beckett had to begin producing a monthly guide and a quarterly guide in order to provide adequate pricing for all of the product on the market.
Ultimately, the mass market saturation resulted in numerous bankruptcies. Many of the smaller brands listed above would be gone before 2002, e.g.: Ted Williams, GameDay, Hoops, SkyBox became part of Fleer. Playoff would be bought, along with Score and Donruss. Pacific would become extinct due to a lack of licenses from the MLBPA and NFLPA needed in order to produce cards. The consolidation would leave Fleer, Topps and Upper Deck as the big three. As these companies competed, the target market became even more luxurious, as the companies began to offer packs of cards at $100 for 4 cards. This attraction to the high luxury market led to the fiscal insolvency of Fleer, which apparently is now part of Upper Deck.
History now brings us to the current paradox: why would Mr. Eisner want to buy Topps? Secondly, does Upper Deck really think the FTC would allow them to buy Topps? Lastly, why do analysts think Topps is wrong to suggest anti-trust problems regarding Upper Deck’s offer?
Mr. Eisner and Madison Dearborn Partners are interested for the cash position and the ability to purchase a cheap business. The beauty of the transaction is that Mr. Eisner would be getting a premium brand for a discount of about $81M. This means that rather than paying $377.9M for the company, he really pays $296.3M. The cash position acts as a discount since no debt exists. Mr. Eisner and Madison Dearborn like this position because Topps has $326.7M in revenue and they would be paying only $296.3M for this revenue stream. At first glance not a bad deal, especially if these private equity investors are able to turn the business around. The problem is that we do not believe the problems that face Topps, Inc. can be turned around by intelligent financiers given the climate of the industry as a whole.
The major problem facing the trading card industry is that per pack prices have seen Weimar Germany like inflation over the last 15 years. In 1990, a collector could purchase a pack of 15 premium cards for about $2.00. Today that same pack averages $3.00 for 3 or 4 premium cards. The price per card in 1990 was about $0.13 and today that same card costs collectors $1.00. This results in about 669% inflation for the 15 year period.
Secondly, why does Upper Deck think they will be able to purchase Topps? Upper Deck is probably interested for the same financial reasons as Mr. Eisner, however. Upper Deck has more enticements to complete the transaction. The company’s product is superior to Topps, adding the Topps brand to Upper Deck would give it a monopoly and prestige among collectors that has not existed since 1981; in essence there would be a trading card monopoly with Upper Deck being the winner.
The problem is that Upper Deck made an inferior offer if they want to be taken seriously. To understand why, investors need to analyze the goodwill that the Topps brand would bring to Upper Deck. Trading card collectors would probably agree that the value of the Topps brand is worth more than the $1 premium over Mr. Eisner’s offer. As stated earlier, if the Upper Deck purchase were to be completed, a monopoly in trading cards would exist. This is highly unlikely, since the FTC would most likely halt the transaction. That being said, it would seem justified that Upper Deck would offer a higher bid if it truly wanted to secure the Topps brand. The $10.75 per share price is truly inferior to the $9.75 price due to the unlikelihood of completion.
Lastly, Topps is warranted in its concerns that the Upper Deck bid would not be consummated due to FTC concerns. If Upper Deck bought Topps a monopoly would exist, and the FTC exists so such scenarios do not unfold. This reason alone makes Mr. Eisner’s bid superior even though his offer is $1.00 less than Upper Deck. We believe that Upper Deck does not adequately compensate investors for the amount of risk that exists regarding its offer for Topps.
Here are some articles so that our readers may see what other people are saying about Topps:
Clyde Milton's Take On Mr. Eisner's Offer for Topps
Gannon On the Topps Take Out Offer
Rick Munarriz's, The Motley Fool, Take On the Bidding War
We do not recommend investors purchase shares in Topps, Inc. Investors would be better off going to www.ebay.com, and purchasing as many 1986 Topps Traded sets as possible for whatever amount one would invest directly in Topps, Inc. Investors are better compensated for the risk inherent in the latter investment.
*The author does not own any shares in Topps, Inc. and will never purchase any
**The author cannot be held responsible for gains or loss achieved based on trades undertaken because of information presented herein.
***The author owns long positions in: Agilent Technologies (A), Brasil Telecom Participcoes S.A. (BRP), ConocoPhillips (COP), ChipMOS Tech Bermuda (IMOS), and Verigy, Ltd. (VRGY)
Wednesday, July 11, 2007
Sunday, July 08, 2007
Quest Diagnostics, Inc. (DGX)
By: Steve Rubis
Leading Clinical Testing Company Seems Primed For Purchase
Recommendation: UNDERVALUED, possibly in play.
Quest Diagnostics is the industry leader in clinical testing solutions. The company provides both clinical testing and anatomic pathology testing. Strong management performance coupled with an attractive equity value causes us to provide further research on Quest.
Investment Thesis:
Recent offers to buy Bausch and Lomb (BOL) by American Medical Optics, Inc. and Warburg Pincus suggest that Quest Diagnostics could be the next to be bought. Management performance is strong in terms of Return’s on Assets and Equity; the fact that Quest is the industry leader further confirms our assessment of management. Investors should pay close attention to the current valuation of Quest Diagnostics, Inc. A few days ago, we provided some links to the trading action in Quest shares. The heady action in July $55 and $60 calls suggests price movement to the upside. Current share prices are due to the loss of UnitedHealth Group, Inc. (UNH) as a client, due to UNH’s demand for cheaper prices. Based on the financial data at hand, it seems that DGX is undervalued and offers investors an opportunity to achieve a 30% return.
Valuation:
The thesis above argues that Quest Diagnostics is a take out target based on other purchases currently pending. In order to fully understand the fair value of Quest shares, multiple comparisons are in order.
Table 1: Value of Quest Diagnostics, Inc. Shares in Comparison to the Industry
The table suggests that the industry leader is undervalued in terms of the entire Medical Labs and Research Industry. First, Price and EV to EBITDA values are the key component of our valuation analysis. These values provide us a preliminary valuation range for what a private equity investor or another firm might be willing to pay for Quest. The next three prices give the investor an idea of what Quest is worth on a relative basis in terms of the entire Medical Labs and Research Industry. Quest performs quite well, despite a lackluster showing on Price to Book Value. Lastly, our analysis considers Earnings Power Value and Reproduction Value in order to get a better sense of what Quest is truly worth. These last two values allow investors to obtain a price of Quest’s income stream, as well as, what it would cost to reproduce the business or start over from scratch. Reproduction value helps understand what it might cost a competitor to recreate Quest’s business rather than making the outright acquisition.
Table 2: Comparison of Valuation Metrics for Quest Diagnostics, Inc., Laboratory Corporation of American Holdings, and the Medical Labs and Research Industry
Table number two compares the valuation metrics of Quest to its main competitor and the industry. Quest is mildly under value in terms of its main competitor Laboratory Corp of America. Each are similarly valued on a take out basis, but the similarities end there. Quest appears undervalued on both a Price to Sales and Price to Earnings basis. A reason for this undervaluation can be attributed to the 7% loss of revenue due to losing UNH as a client (see 4/30/07 10-Q).
Table 3: Valuation of Quest Diagnostics in Terms of Laboratory Corp. of America Holdings and the Medical Labs and Research Industry
Table Three applies the values illustrated in Table Two in order to develop a valuation range for Quest Diagnostics, Inc. Our original range as described in a previous article was $75 to $85. The analysis in this article places that range a little lower at $68.07 to $77.82.
Despite any issues about revenue growth, Quest should be trading closer to the $68 to $71 range. Since Quest is the industry leader, an investor can reasonably expect DGX to trade a price near or above the same valuation of the main competition.
Table 4: Selected Financial Data
The key takeaways of Table Four are the slowing EPS growth as well as the impressive Altman Z Score. An assessment of the financials shows that the company is no likely to hit insolvency, has strong management, and despite a slowing growth rate, EPS is not declining.
Business Prospects / Model:
Quest Diagnostics, Inc. is the leading provider of diagnostic testing services, which include clinical testing and anatomical testing. Over 90% of revenues were generated by the clinical testing business through over 2000 testing centers. The clinical testing service offerings are as follows: blood cholesterol levels, blood chemistries, complete blood cell counts, Pap tests, urinalyses, pregnancy and other pre-natal tests, alcohol and other substance-abuse tests, and asthma and allergy tests. The services offered by the anatomical or esoteric testing segment are: endocrinology and metabolism, genetics, hematology, immunogenetics and human leukocyte antigens, immunology, microbiology and infectious diseases, oncology, serology, and toxicology.
The revenue can be broken into five major segments: patients; Medicare and Medicaid; physicians, hospitals, employers and other monthly-billed clients, Healthcare insurers-Fee-For-Service, and Healthcare Insurers-Capitated. Fee-For-Service makes up between 40 and 45% of annual revenues, with the Healthcare Insurers-Capitated being the most problematic and price sensitive. UNH’s policy changes, which demanded lower pricing and unattractive contracts for DGX, drove flat earnings in the 1st Quarter of 2007. Quest expects the loss of UNH as a customer to slow growth between 7 and 10%.
*Note: the author does not own any shares in Quest Diagnostics, Inc.
**The Author cannot be held responsible for any gains or losses achieved through trades based upon information presented herein.
***The majority of data comes from Yahoo!Finance, Google Finance, and the 10-K and 10-Q reports.
****The author current holds the following on the long side: Agilent Technologies (A), Brasil Telecom Participacoes S.A. (BRP), ConocoPhillips (COP), ChipMOS Tech Bermuda (IMOS), Verigy Ltd. (VRGY).
Leading Clinical Testing Company Seems Primed For Purchase
Recommendation: UNDERVALUED, possibly in play.
Quest Diagnostics is the industry leader in clinical testing solutions. The company provides both clinical testing and anatomic pathology testing. Strong management performance coupled with an attractive equity value causes us to provide further research on Quest.
Investment Thesis:
Recent offers to buy Bausch and Lomb (BOL) by American Medical Optics, Inc. and Warburg Pincus suggest that Quest Diagnostics could be the next to be bought. Management performance is strong in terms of Return’s on Assets and Equity; the fact that Quest is the industry leader further confirms our assessment of management. Investors should pay close attention to the current valuation of Quest Diagnostics, Inc. A few days ago, we provided some links to the trading action in Quest shares. The heady action in July $55 and $60 calls suggests price movement to the upside. Current share prices are due to the loss of UnitedHealth Group, Inc. (UNH) as a client, due to UNH’s demand for cheaper prices. Based on the financial data at hand, it seems that DGX is undervalued and offers investors an opportunity to achieve a 30% return.
Valuation:
The thesis above argues that Quest Diagnostics is a take out target based on other purchases currently pending. In order to fully understand the fair value of Quest shares, multiple comparisons are in order.
Table 1: Value of Quest Diagnostics, Inc. Shares in Comparison to the Industry
The table suggests that the industry leader is undervalued in terms of the entire Medical Labs and Research Industry. First, Price and EV to EBITDA values are the key component of our valuation analysis. These values provide us a preliminary valuation range for what a private equity investor or another firm might be willing to pay for Quest. The next three prices give the investor an idea of what Quest is worth on a relative basis in terms of the entire Medical Labs and Research Industry. Quest performs quite well, despite a lackluster showing on Price to Book Value. Lastly, our analysis considers Earnings Power Value and Reproduction Value in order to get a better sense of what Quest is truly worth. These last two values allow investors to obtain a price of Quest’s income stream, as well as, what it would cost to reproduce the business or start over from scratch. Reproduction value helps understand what it might cost a competitor to recreate Quest’s business rather than making the outright acquisition.
Table 2: Comparison of Valuation Metrics for Quest Diagnostics, Inc., Laboratory Corporation of American Holdings, and the Medical Labs and Research Industry
Table number two compares the valuation metrics of Quest to its main competitor and the industry. Quest is mildly under value in terms of its main competitor Laboratory Corp of America. Each are similarly valued on a take out basis, but the similarities end there. Quest appears undervalued on both a Price to Sales and Price to Earnings basis. A reason for this undervaluation can be attributed to the 7% loss of revenue due to losing UNH as a client (see 4/30/07 10-Q).
Table 3: Valuation of Quest Diagnostics in Terms of Laboratory Corp. of America Holdings and the Medical Labs and Research Industry
Table Three applies the values illustrated in Table Two in order to develop a valuation range for Quest Diagnostics, Inc. Our original range as described in a previous article was $75 to $85. The analysis in this article places that range a little lower at $68.07 to $77.82.
Despite any issues about revenue growth, Quest should be trading closer to the $68 to $71 range. Since Quest is the industry leader, an investor can reasonably expect DGX to trade a price near or above the same valuation of the main competition.
Table 4: Selected Financial Data
The key takeaways of Table Four are the slowing EPS growth as well as the impressive Altman Z Score. An assessment of the financials shows that the company is no likely to hit insolvency, has strong management, and despite a slowing growth rate, EPS is not declining.
Business Prospects / Model:
Quest Diagnostics, Inc. is the leading provider of diagnostic testing services, which include clinical testing and anatomical testing. Over 90% of revenues were generated by the clinical testing business through over 2000 testing centers. The clinical testing service offerings are as follows: blood cholesterol levels, blood chemistries, complete blood cell counts, Pap tests, urinalyses, pregnancy and other pre-natal tests, alcohol and other substance-abuse tests, and asthma and allergy tests. The services offered by the anatomical or esoteric testing segment are: endocrinology and metabolism, genetics, hematology, immunogenetics and human leukocyte antigens, immunology, microbiology and infectious diseases, oncology, serology, and toxicology.
The revenue can be broken into five major segments: patients; Medicare and Medicaid; physicians, hospitals, employers and other monthly-billed clients, Healthcare insurers-Fee-For-Service, and Healthcare Insurers-Capitated. Fee-For-Service makes up between 40 and 45% of annual revenues, with the Healthcare Insurers-Capitated being the most problematic and price sensitive. UNH’s policy changes, which demanded lower pricing and unattractive contracts for DGX, drove flat earnings in the 1st Quarter of 2007. Quest expects the loss of UNH as a customer to slow growth between 7 and 10%.
*Note: the author does not own any shares in Quest Diagnostics, Inc.
**The Author cannot be held responsible for any gains or losses achieved through trades based upon information presented herein.
***The majority of data comes from Yahoo!Finance, Google Finance, and the 10-K and 10-Q reports.
****The author current holds the following on the long side: Agilent Technologies (A), Brasil Telecom Participacoes S.A. (BRP), ConocoPhillips (COP), ChipMOS Tech Bermuda (IMOS), Verigy Ltd. (VRGY).
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