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Tuesday, October 20, 1998
Respironics Inc.
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Phone: 412-731-2100
Website: http://www.respironics.com
Price (10/19/98): $12 1/2
HOW DID IT FIND TROUBLE?
Breathe in, breathe out. Investors in medical device maker Respironics have taken up meditation since the stock's early April free fall left survivors searching for that Zen state of patient endurance. Waiting for the U.S. government to determine Medicare reimbursement policies is never something to hold one's breath over.
Respironics seemed healthy and happy at the beginning of the year. While Uncle Sam placed new restrictions on reimbursements for home oxygen therapy after some well-publicized Medicare fraud by other market participants, Respironics was poised for more growth. It greatly expanded its product line by acquiring the well-regarded Healthdyne Technologies after that company went to great lengths to resist an unwelcome offer from Invacare <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IVCR)") else Response.Write("(Nasdaq: IVCR)") end if %>.
Then on April 1st, Respironics announced that third quarter results would fall well short of expectations, with EPS in the $0.12 to $0.14 range versus estimates of $0.29. Government policymakers met in February to talk about the clinical criteria for use of noninvasive ventilation devices. Uncertainty surrounding reimbursement policies left some customers taking a wait-and-see stance.
Along with cutbacks in oxygen therapy, Respironics found itself facing a "challenging market environment." The "C" word is synonymous with "Look out below!" Respironics closed down $10 11/16 on the day to $18 3/8.
Attempts to rally were thwarted by continued uncertainty. U.S. sales of noninvasive support units for home use accounted for less than 10% of fourth quarter revenues, which fell by 7% overall. Draft reimbursement guidelines announced in July also proved more restrictive than the industry expected. With final guidelines not set for release until the end of the year at the earliest, Respironics' stock itself looks in need of a ventilator.
BUSINESS DESCRIPTION
Pittsburgh-based Respironics is a leading designer, manufacturer, and marketer of medical devices used to treat respiratory disorders. Equipment accounts for 72% of revenues while consumable and single-use products make up the rest. Over 90% of the company's sales are to the home healthcare market.
Thanks to the February 1998 merger with Healthdyne, Respironics now claims over 60% of the market for devices to diagnose and treat obstructive sleep apnea, selling continuous positive airway pressure (CPAP) units as well as bi-level positive airway pressure units. It also sells products that monitor newborns for Sudden Infant Death Syndrome (SIDS). Sleep products account for 48% of total sales.
The other major division serves the respiratory market (43% of total sales), offering invasive and noninvasive ventilation units and oxygen concentrators and monitoring devices. A smaller unit offers peak flow meters, drug delivery devices, and other products for the asthma/allergy market and to original equipment manufacturers.
Competitors include ResMed <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RESM)") else Response.Write("(Nasdaq: RESM)") end if %>; DeVilbiss, a division of Sunrise Medical <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SMD)") else Response.Write("(NYSE: SMD)") end if %>; Nellcor Puritan Bennett, a subsidiary of Mallinckrodt <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MKG)") else Response.Write("(NYSE: MKG)") end if %>; and Invacare.
FINANCIAL FACTS
Income Statement*
12-month sales: $351.6 million
12-month income: $27.3 million
12-month EPS: $0.82
Profit Margin: 7.8%
Market Cap: $415 million
(*Excluding acquisition charges.)
Balance Sheet
Cash: $14.9 million
Current Assets: $194.7 million
Current Liabilities: $57.1 million
Long-term Debt: $69.3 million
Ratios
Price-to-earnings: 15.2
Price-to-sales: 1.2
HOW COULD YOU HAVE SEEN IT COMING?
Between FY94 and FY97, Respironics inspired investors with 26.3% compound annual sales growth and 30.2% compound annual growth in earnings per share. However, the company was no stranger to breathtaking plunges, making one in late 1996 after acquiring Lifecare International. Major acquisitions often provide as many reasons to worry as to celebrate, since consolidating operations is always a challenge.
Given that Invacare was willing to pay just $15 per share for Healthdyne (or 70% above what it traded for at the beginning of 1997), Respironics was clearly paying a premium with its $24 a share all-stock bid. (Respironics issued 12 million shares to do the deal.) In addition, the crackdown on home oxygen therapy reimbursements promised trouble for the firm's customers. New guidelines for sales of home-based noninvasive ventilation units also created serious uncertainty for one of Respironics' two major units.
WHERE TO FROM HERE?
With the stock trading around $12 on August 24th, Respironics announced plans to repurchase one million shares. CEO Dennis Meteny said, "At current price levels, we believe Respironics stock to be an excellent investment opportunity for the company."
Some insiders have been buying, both in May at prices in the mid-teens and during August at prices between $12 and $14. However, former Healthdyne Chairman Parker Petit has been consistently trimming his substantial stake the whole way down. Not a great sign.
Zacks shows consensus earnings estimates of $1.05 a share for FY99 and $1.33 for FY00 with long-term growth of 19.5%. That suggests an attractive PEG of 0.71. While results will no doubt depend on how the reimbursement issues play out, Respironics did manage to maintain fourth quarter gross margins of 47.6%, not far from the 49% gross margins reported for the last three years.
Sleep product sales also increased 16% in FY98, while asthma/allergy sales shot up 21%. Respironics plans to launch new sleep and respiratory products in the first half of FY99. Moreover, the firm has just completed a speedy installation of new R/3 enterprise resource planning software from SAP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SAP)") else Response.Write("(NYSE: SAP)") end if %>, which should help it manage sales and inventories and squeeze out even more operating efficiencies from the Healthdyne merger.
Nonetheless, Respironics is facing a tough environment. Respironics and others have now responded to the restrictive draft ventilation guidelines, but it should be a few more months before that matter is decided. While negative expectations are, to some extent, already built into the stock, the shares seem likely to key off the issue. Favorable payment guidelines could make this stock look cheap in a hurry.
-- Louis Corrigan
([email protected])
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