When conducting due diligence on a company for investment (which I do regularly for private equity and VC firms) there are sort of three cardinal rules:
- Follow the money.
- Follow the assets.
- Follow the customers.
Obviously in the case of 1) we are all trying to understand Anteo Diagnostic’s (ASX : ADO) investment thesis. Although I watched a lot of adulation and high-fiving of rabid ADO shareholders on HotCopper the last 48 hours, I would also say there was a surprisingly healthy degree of debate about what the investment really means in practical terms, and how the company will drive the financing to complete the transaction. I am personally skeptical that ADO will pull this off but we’ve also seen, on several occasions, that the company is able to pull rabbits out of its … er… hat.
In my last post, I focused mostly on “following the assets”. My objective was to illustrate how many people have flipped this company around, partially to show how long-in-the-tooth the asset is, and partially to illustrate how many major firms in the diagnostic medicine space have simply shunned DIAsource’s major revenue-generator, namely radioimmunoassays (RIA). To be clear, RIA still has a very die-hard user base in detecting certain immune complexes, hormones and a few rare cancers, but the market size is very small and is dominated by Beckman Coulter and CISbio. The RIA market is also essentially flat/eroding in developed markets with some increasing sales volume in China, Taiwan and Korea, though not growing in any particularly spectacular way*. DYOR.
In this post I would like to briefly transition from money and assets, to customers. I understand the RIA space fairly well and so I reached out to several large customers (in the hormone space) to find out what has been going on. I was particularly interested to contact CISbio customers because I wanted to get a sense of whether DIAsource was a competitive threat or not. Some of the answers have dribbled in over the past 24 hours and it’s pretty interesting. It turns out that over the past 18 months, there has been a bit of a price war between CISbio and DIAsource. Starting at the end of 2013, DIAsource undertook a very aggressive pricing campaign targeted at price-sensitive customers in order to increase their overall market share. Because of the fairly “generic” nature of these RIA kits in hormone testing, several customers switched to DIAsource. This price-war between CISbio and DIAsource around RIA appears to be well-known in the industry.
In the key area of hormone testing, I have been able to verify through competitive pricing benchmarks, that DIAsource pushed a significant volume of product out at, or very near, cost. I was also able to contact Berthold Baldus, President of CISbio, and he personally verified that the information I had received from a couple of the larger testing labs was accurate. His position is that there is very little growth in RIA outside of Asia and that the RIA pricing war is basically financially unsustainable for DIAsource as a minor player in the space.
This should be a red flag to Anteo Shareholders, because this is classic “danger sign” behaviour of a company setting itself up for a sale, and it can spell disaster for the new acquirer when the music stops playing. Although several enterprising (and obviously not very bright) HC commentators noted that from 2009-2014 the company’s revenue’s increased by 30% (woop-dee-doo) and arguably the profitability increased “dramatically” too, a few hundred thousand Euros of profit (on average, €269,000) is financial noise as far as I am concerned and hardly cash generative. The plain fact of the matter is, this is a flat business and DIAsource’s numbers reflect this. If indeed DIAsource has sacrificed margin for top-line growth, then this is a huge warning sign for me. It is my position that it is not acceptable for Geoff Cumming to imply spectacular growth in the company, without qualifying that the growth came from unsustainably flooding the market with deeply discounted product in order to inflate the revenue numbers :
DIAsource recently achieved its fifth consecutive revenue growth quarter and fifth consecutive best quarter ever in the company’s history.
Now, there are two scenarios. The first scenario is that Geoff knows that the company cannibalised profitability to drive the top line to make it more attractive for acquisition, but doesn’t care because he wants to sell a great story to shareholders in order to buy an assay development capability. He may also feel that there isn’t enough readily accessible public domain financial information about the company to overtly refute his claims (and he would be right). Besides, how many shareholders are going to track down a few testing labs and find out whether the pricing for RIA kits has changed in the last 18-24 months? In which case, this tells you everything you need to know about the integrity of the deal and, quite frankly, the integrity of the company. Alternatively, Geoff and the team aren’t that smart, didn’t really do their diligence and actually don’t realise that DIAsource artificially plumped up their top-line. Maybe the Boyz from Briz Vegas got trumped by the Lads from Louvain? In which case, as a shareholder or prospective investor, you should take your money and run for the hills doubly fast.
So, to conclude and bring together the two parts of my analysis on the ADO-DIAsource “deal”:
- This deal is of no added value.
- The revenue stream is not sustainable.
- The acquisition is “cheap” relative to revenues precisely because the revenues are artificial.
- This is not a cash generative acquisition and never will be.
- It is fraught with execution, regulatory risk and liabilities that are not commensurate with the up-side.
- Anyone financing this deal will never get the IRR they need to justify it.
However, perhaps the most important take-home message is that ADO has demonstrated yet again that it doesn’t have the foggiest idea of how to execute the business it claims to be a leader in, let alone diligence a prospective acquisition. As I said in one of my comments on the last post, ADO probably needs to buy a stagnant asset like this in order to learn how to deliver what it has been “selling” to the market all along. Fine, that may be a reasonable and possibly even necessary business strategy. However on the basis of financial performance, technology value-add and risk management, this deal should not be supported.
*I should note that many commentators on trading platforms focused on DIAsource’s vitamin D technology as future “upside”, but this is neither the major thrust of the business, nor is it realy DIAsource’s great differentiator because there are plenty of viable competing offerings available in the market. DIAsource also outlicences this technology to several other players, so it is not intrinsically a “captive” business model from a selling vantage.
Correction note: in my exchange with CISbio, I also received corrected revenue numbers at the time of the MBO, which I have added to the previous post.
Photo cred: Black Adder, BBC. Hopefully a new series will make it out soon… controversial!