Danaher (NYSE:DHR) is built through acquisitions, but it's an odd company in that it doesn't necessarily (or even often) buy great companies. Instead, Danaher seems to focus on buying companies that can be made substantially better under its aegis. With that profile in mind, Danaher's acquisition of IRIS International (Nasdaq:IRIS) makes a great deal of sense.
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The Deal Danaher Proposes
Danaher announced Monday that it had reached an agreement with small-cap diagnostics company IRIS to acquire the company in a tender offer. Danaher will be paying $19.50 per share, for a total consideration of about $338 million. At that price, Danaher is giving IRIS shareholders about a 45% premium to Friday's close and the highest price they've seen in roughly five years. At this price, Danaher is paying about 2.4 to 2.6 times 2012/2013 revenue. While that is a relatively low multiple for med-tech, IRIS has struggled of late with its margins and is consequently not as profitable as most med-tech companies.
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What Danaher Is Getting
In buying IRIS, Danaher is buying a company that has long seemed to have good technology, but where the management execution and market valuation have not kept pace. IRIS is a leader in automated urine microscopy, a market that should be increasingly valuable as hospitals find themselves squeezed between increasing lab volume and a tight lab-tech labor market. Despite having a technological edge on Japan's Sysmex, IRIS's small size has limited its ability to really gain share and momentum in a market that is still under-penetrated with automated solutions.
While most of the $600 million urinalysis market is dominated with chemistry systems from companies like Roche (OTC:RHHBY) and Siemens (NYSE:SI), roughly half of clinical reference and hospital labs use manual microscopy for urinalysis. That leaves a roughly $250 million addressable market for automated microscopy systems - a market that was growing more than 20% before the major cap-ex slowdown in healthcare.
What is especially attractive about this market is that once a system is installed, it creates a stream of captive revenue to the company for high-margin consumables. This ought to be especially appealing to Danaher - integrating IRIS should create the potential for better placements (through a larger, better-funded sales force) and better margins for the consumables.
This is not all that IRIS offers. The company has also been working to build its sample processing and molecular diagnostics business. In particular, IRIS has been working for years to develop and market its NADiA ProsVue test - a highly sensitive prostate cancer test. While PSA testing has started to fall out of favor with some clinicians, there are still reasons to believe that this could be a high-value test for monitoring prostactecomy patients for recurrence.
Definitely Some Work to Do
There are definitely some valid reasons why Danaher is not having to pay upwards of three times revenue to get IRIS. While I am not aware of much debate regarding the quality of IRIS's technology, IRIS frustrated many analysts and investors with delays in getting the Velocity and iRicell products on the market. Likewise, there have been frustrations regarding manufacturing leverage and overall margin improvements, to say nothing of questions as to whether the company can develop and monetize promising technology for the hematology market.
Now the question will be the extent to which better sales and marketing support and improved manufacturing efficiencies can improve the returns from this business. I still do believe that automated urine microscopy is under-penetrated in the U.S., and I also believe that Danaher has done a solid job of improving its Beckman Coulter diagnostics business - another business that was in need of improvement at the time Danaher bought it.
The Bottom Line
I used to follow IRIS International back in my sell-side analyst days, and although the stock did not perform especially well for me, or my clients, I'm glad to see that management is getting a solid buyout offer. The company has had its challenges, but I think Danaher is buying in at an opportune time and I think it can do good things with IRIS's technology and products.
For Danaher, there is some risk to this deal, but I think simple execution ought to fuel solid returns on this deal. Given that execution is one of the things Danaher does well, that ought to de-risk this deal for shareholders. IRIS is not very likely to be a huge factor in the value of Danaher in 2013 or 2018, but this strikes me as the sort of incrementally value-additive deal that has long helped build shareholder value at Danaher.
Disclosure: Author has owned shares of Roche since 2011.