Amid Buying Spree, Inverness to Sell More Stock—But Some Observers Skeptical

It’s been buy, buy, buy, for the last couple of years. Then last Thursday, Waltham, MA-based Inverness Medical Innovations (AMEX: IMA) announced it plans to sell 7 million new shares—the second such offering the company has made this year. (In January, Inverness sold 6.9 million shares at $39.65 apiece.) It’s all part of a plan to reach $3 billion in annual revenues within the next five years by focusing largely on “timely, data-driven” tests, CEO Ron Zwanziger told investors during the company’s October 31 earnings webcast.

In particular, Inverness wants to get more tests out of centralized labs and into doctors’ offices. It also wants to sell more diagnostics for home use, like the pregnancy and fertility-monitoring tests for which the company is already well known. The plan relies heavily on buying other diagnostics firms, distributors, and anyone else that can help Inverness expand its product offerings or its reach. In the last year alone, Inverness has bought about a dozen companies (see table on page 2).

It all sounds very intriguing, and investors must like it because the company’s stock has risen from about $25 in spring of 2005 to a recent high of $65. But the particulars don’t sit well with some observers.

In August, Motley Fool’s Brian Orelli commented that Inverness would no doubt grow, but, he mused, “The biggest question is whether it overpaid for that privilege.” After all, last spring Inverness paid a premium price of $1.6 billion for Biosite—a hot property in cardiac point-of-care (POC) testing that it snatched away from Beckman Coulter in a bidding war. Orelli warned investors to stay away from Inverness for a few more quarters.

Then early this month, David Trainer, president of independent research firm New Constructs, came out with a scathing report that placed Inverness among his company’s “dangerous” stock picks. “[Acquisition sprees] have been a popular strategy on Wall Street to make everyone a lot of money except investors,” Trainer says. “What I see with IMA is a bomb about to go off. You have a terribly unprofitable business with a valuation that is way beyond what the company can meet.”

Despite the question marks around Inverness, though, Zwanziger is painting a particularly rosy picture of his company’s outlook. During that last webcast he said, “We have never been better positioned for growth and profitability,” that management gets better at integrating new companies “with each new acquisition,” and that Inverness may reap maximal cost savings from its recent acquisitions by 2009—earlier than originally anticipated.

Much of that savings will come from having a consolidated sales force, which Zwanziger called the largest in the U.S. that’s focused on these kinds of products. Personnel cuts and shifting some manufacturing to China will also help. Zwanziger also anticipates being able to cut production costs at Biosite’s California facility.

And the acquisitions have helped Inverness expand its offerings—and its global reach. Within the last year, the company has picked up key tests for heart disease, coagulation and cholesterol monitoring, and cancer detection. It has also nabbed new distributors and a home health care company, and finalized a consumer diagnostics joint venture with Procter & Gamble.

All this has impressed other analysts, including Stifel Nicolaus’s Greg Simpson. While he conceded that there is talk that “IMA is just a ‘roll up’ and largely a financial engineering play,” in his most recent report Simpson re-iterated a “buy” recommendation on Inverness because the company had exceeded expectations in key areas such as revenues and earnings per share. “We expect earnings momentum and earnings visibility to improve markedly in the fourth quarter of 2007,” Simpson wrote.

Xconomy tried to speak to Simpson, but just before our scheduled interview, he got word of Inverness’ pending stock offering and had to bow out, as Stiffel Nicholas is one of the companies handling that offering.

But Trainer is focusing on a somewhat different mix of indicators than Simpson and the other analysts who’ve given Inverness good ratings. Trainer says that according to his model, to justify the current stock price, “Inverness has to grow their profits at 50 percent compounded annually for 15 years, and I don’t know if a company has ever done that.” Alternatively, the company could turn in a “reasonable” revenue growth rate of about 6 percent for 100 years or more.

“The disconnect between revenue and profit is substantial,” Trainer says.

Revenues at Inverness grew 64 percent in the third quarter compared to the second quarter, to $237 million. But that included a boost of $80 million in new revenue from Biosite. During that most recent webcast, Zwanziger said future profits would come “half from acquisitions and half from organic growth.”

But some observers question the POC market’s ultimate potential for growth. Ken Rubenstein of California-based Lion Consulting says, “Frankly, you just can’t imagine that many tests that will be useful in a doctor’s office.” According to him, a ballooning of the POC market is still “pretty much a vision that’s out there.” The idea caught a lot of interest in the 80s, when people imagined moving a lot of tests to doctor’s offices and into consumers’ hands in order to speed and expand treatment. But many attempts to capitalize on this potential fell through. “Biosite is the shining example, and just about the only exciting thing that came out of that era,” Rubenstein says.

Undaunted, Zwanziger is promising both new products and more acquisitions, though he hasn’t said exactly where he is looking. And he’s not worried about how to keep paying for all these deals, either. “We have historically leveraged the stock to six times trading and then de-leveraged it,” he said in the webcast.

He also mentioned that his previous acquisition targets, by and large, have been pleased to be purchased all or in part with Inverness stock. “With the obvious exception of Biosite, which was not the friendliest transaction, sellers want the stock,” Zwanziger said.

Given the trajectory of Inverness so far, can you blame them? But you also have to wonder how that trajectory can be maintained over the long term.

Inverness’s 2007 Acquisitions*

Deal Announced Company/HQ Location
Value Key Assets
October Alere Medical Inc./Reno, NV $302M Disease management network, including home monitoring for heart and respiratory diseases
October Biostate Healthcare Group/UK $33.4M UK distribution network
October Pan Bio/Australia $37M Worldwide infectious disease test sales, including Dengue Fever
August Hemosense/San Jose, CA $165M POC and home-based coagulation monitoring
August Matritech/Newton, MA $36M POC bladder cancer test
June Cholestech/Hayward, CA $326M Cholesterol and related POC monitoring tests
May Biosite/San Diego, CA $1.6B POC cardiac tests, marketing strength, and R&D
May Orange Medical/Netherlands $5.7M Benelux distribution network
February Promesan/Italy $4.9M Italian distribution network
February First Check Diagnostics LLC (assets only)/Lake Forest, CA $25M Home-based tests for drug abuse
January MedOx/Ottawa, Ontario $5.4M Canadian distribution network
Approx. total   $2.5B  

*as of 11/12/07

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