The rumors have finally been put to rest. After three months of a bidding war, Thermo Fisher Scientific Inc. (NYSE:TMO) ultimately beat other contenders to acquire Life Technologies Corp. (NASDAQ:LIFE) for $76 per share, or approximately $13.6 billion (plus net debt at close).
This transaction, expected to be completed in 2014, is expected to propel the growth of Thermo Fisher in the area of genetic analysis and molecular diagnostics. For a company that makes products to help with scientific research and healthcare, being able to create products that aid genetic analysis would be one of the most empowering things to provide to their customers. Let’s take a deeper look into the value and implications of the deal.
The deal
After months of speculation, Life Technologies Corp. (NASDAQ:LIFE) accepted Thermo Fisher Scientific Inc. (NYSE:TMO)’s bid over an offer from Sigma-Aldrich Corporation (NASDAQ:SIAL) and a $65 per share bid from a consortium including Blackstone, Carlyle, KKR, and Temasek Holdings. The price of $13.6 billion was a surprise to many analysts that were expecting bids in the range of $11 billion.
Life Technologies comes with 5,000 patents, a revenue CAGR of 17%, and EBITDA CAGR of 19% over the last 10 years. Its products include reagents and consumables as well as instruments and systems, but the main attraction is its recent investment in next-generation genetic-sequencing technology.
On its recent earnings call, Thermo Fisher Scientific Inc. (NYSE:TMO) mentioned that genetic testing was an important field going forward and wanted to get into it as an industry leader. There are a number of experimental technologies, but if the company wanted to succeed and needed something more functional, it would need either Illumina, Inc. (NASDAQ:ILMN) or Life Technologies’ Ion Torrent business. And this is exactly what it did, acquired Life Technologies Corp. (NASDAQ:LIFE), which is considered a notch behind Illumina in the race to produce faster and less expensive gene sequencing technology.
Numbers
Thermo Fisher acquired Life Technologies for $76 per share or $13.6 billion in cash. The payment is expected to be in cash and debt of $9.5 billion to $10 billion and equity of up to $4 billion. Further, Thermo Fisher will take over Life Technologies’ $2.2 billion debt.
Both companies sell their products to the same customers, which creates opportunities for cost and revenue synergies. Thermo Fisher Scientific Inc. (NYSE:TMO) expects the deal to add $0.90 to $1 to its EPS in the first full year and targets $275 million in operating income synergies, composed of $250 million cost synergies and $25 million revenue synergies by the third year.
30% of the cost savings would come from eliminating public company expenses, and the balance will be the benefit of combined business scales and consolidation of facilities and functions. On the revenue side, it expects to benefit from existing customers by leveraging the combined product line and using Life Technologies Corp. (NASDAQ:LIFE)’ strong e-commerce platform (it transacts over half of its orders through its e-commerce business).
Further, the combination will also help it to gain a strong foothold in Asia-Pacific, especially China, thereby tapping the increasing demand in life sciences and healthcare.
The combined company will have pro-forma revenue of more than $16 billion. Life Technologies has 85% recurring revenue (consisting of consumables and service) and this will add about 6% to Thermo Fisher Scientific Inc. (NYSE:TMO)’s existing consumables mix, thereby expanding its share of recurring revenue.
From a ROIC perspective, Thermo Fisher currently generates low 9% range but expects it to step-down to mid 7% in the first year of the acquisition and thereafter rises up to 8.5% by the fourth year from the acquisition. Previously, Thermo Fisher had guided for 4% to 6% organic growth, but acknowledged on the conference call that Life Technologies is growing at a slower rate and expects it to grow organically by 3% on an average going forward.
Higher debt is the problem
There is no doubt that the synergies will help in increasing cash flows and improving the EPS, but these sort of deals generally weaken the balance sheet due to accumulation of goodwill and debt.
As of Dec. 31, 2012, goodwill accounted for 45% of Thermo Fisher’s total assets and similarly, goodwill accounted for 52% of Life Technologies’ total assets for the same period. Further, Thermo Fisher already has a huge debt balance of $7 billion and plans to add on Life Technologies Corp. (NASDAQ:LIFE)’ $2 billion debt, apart from the additional debt that it will take on to finance the acquisition.
As a result, this acquisition, will just add on to Thermo Fisher’s debt as well as goodwill, further weakening its credit profile. Following the announcement, credit rating agencies Moody’s and Fitch have put Thermo Fisher’s rating on review for downgrade and S&P has lowered its rating to ‘BBB’ from ‘A-‘ because of its significant debt. Similarly, Fitch has placed Life Technologies rating on Negative Watch.
Thermo Fisher Scientific Inc. (NYSE:TMO) has mentioned that its pro-forma Debt/EBITDA is expected to rise to 4.3x to 4.4x, and expects to use majority of its $2.5 billion combined free cash flow to help in reducing the debt rapidly to its target ratio of 2.5x to 3x within two years. Hence, as can be seen, at least in the initial years, the increased cash flow will be mainly utilized for reducing debt levels and consequently have a negative impact on dividend distribution and share repurchase.
Versus competitors
The only strongest contender of Life Technologies is Illumina, Inc. (NASDAQ:ILMN). Illumina has not only been able to retain, but has also expanded its lead in sequencing. It is focused solely on sequencing (and ancillary genetics businesses) as compared to Life Technologies, which focuses on a wider variety of markets. Further, Illumina spends a considerable amount on research and development, spending 20% of its 2012 revenue as compared to Life Technologies’ 9% spending.
Another large player in gene sequencing and analysis is Roche Holding . The company tried to acquire Illumina recently, but the deal fell through. Life Technologies Corp. (NASDAQ:LIFE)’ acquisition may nudge Roche towards making another attempt to acquire Illumina, Inc. (NASDAQ:ILMN) in order to increase its market share.
Conclusion
The combined company will definitely benefit from Life Technologies’ Ion Torrent franchise, exciting technology pipeline, its inherent stability through recurring revenue and its number two position in the market. But, at the same time, investors will also be exposed to the combined company’s weakened balance sheet and a very high debt.
The article This Deal Brings Benefits Along With a Huge Debt originally appeared on Fool.com.
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