Description

THESIS

BIOC is a neglected micro-cap trading at ~10x EV/FCF based on my conservative estimates for 2010. The strength of BIOC's business model is misunderstood as BIOC's bookings/earnings were down in 2009 as a result of delays in pharma/biotech R&D spending due to the economic turmoil. However, BIOC's business model is not broken and its disappointing 2009 results provide an opportunity to cheaply purchase this healthcare gem with the following characteristics:

- Strong competitive advantages and barriers to entry
- High ROIC and a scalable business model
- Revenue visibility with a backlog of signed contracts
- Strong balance sheet ($13M cash ($0.86 per share) and no debt)
- Experienced management with a solid track record
- Growth: even if clinical trials decline in this environment, the FDA's push to include imaging as part of clinical trials highlights the long-term growth in BIOC's core segment.

COMPANY SNAPSHOT AND COMPETITIVE LANDSCAPE

BIOC is a leading healthcare services company that provides services for clinical trials run by pharma, biotech and medical device companies. The Company has the following two divisions:

BioImaging Division: BIOC designs, conducts and manages the imaging component of clinical trials to evaluate the effectiveness of potential drugs and medical devices. BIOC focuses on phases II, III and IV of clinical trials, although the majority (~75%) of revenue is from phase III. BIOC specializes in the oncology, musculoskeletal, central nervous system (CNS) and therapeutic segments. BIOC's clients include many leading pharmas/biotechs as well as medical device companies and major CROs.

eClinical Division: The eClinical Services division provides full service electronic data capture (EDC), a combination of EDC, interactive voice/web response (IVR/IWR), reporting and data management solutions in order to make the process of collecting and analyzing data from clinical trials more efficient and reliable. BIOC entered the eClinical services market in 2008 by acquiring Phoenix Data Systems (PDS), a company specializing in EDC services for pharmas/biotechs. In September 2009, BIOC expanded its eClinical presence by acquiring Tourtellotte Solutions, which adds IVR/IWR functionality and supply chain management software to its eClinical offering.

Positively, in January 2009, BIOC sold Capmed, a loss-making and non-core division that specialized in electronic medical records.

BIOC'S CORE BIOIMAGING DIVISION

BIOC's core imaging division accounts for ~70% total revenue.

• Scale advantage: BIOC has the scale to undertake large, complex trials which require BIOC's technology to be installed at thousands of worldwide imaging centers, on the desktops of its network of readers, at the client's offices, and at the FDA. At each imaging center, images are captured across multiple modalities (CT scan, MRI, SPECT, etc) by BIOC's software. BIOC works with each imaging center to ensure that images are captured according to the clinical trial requirements. Once BIOC receives these images, they are digitized and stored at one of BIOC's server farms in the Netherlands or Pennsylvania. The images can then be accessed by BIOC's network of readers, experienced doctors who are paid as consultants to analyze the images. BIOC's image analysis software helps readers to measure key indicators of drug efficacy. The analysis is then compiled by BIOC for the client's final submission for drug approval to the FDA. In order to compete, a new entrant would have to replicate the extensive network of technology and relationships BIOC has developed over two decades. Moreover, given that BIOC can spread its infrastructure and service costs across the multiple specialties it has developed over the years (in particular, cardiovascular, oncology, musculoskeletal, and CNS), competitors in any one of these niches struggle to compete cost effectively with BIOC.
• Track record: In the complex field of clinical trials, track record is a barrier to entry to winning deals. Pharma/biotech clients cannot risk using unproven entrants in a key part of a clinical trial that can cost hundreds of millions of dollars. BIOC has successfully completed over 1,000 projects to date, and our channel checks confirm that BIOC is the largest and most experienced in managing the imaging portion of a trial.
• Steady income stream: BIOC's revenues derive from long-term engagements (average 3 years). BIOC reports its signed contract backlog quarterly which gives visibility to future revenue and profitability.
• Market growth: The imaging market has grown at ~10% the past decade and should continue to grow at a similar rate in the next 5 years even if trial volumes decline. The FDA has been vocal in advocating imaging as proof of drug effectiveness (it has issued official imaging guidelines), and as a result the use of imaging has increased. Pharma/biotech companies are realizing that the use of images in clinical trials often speeds up the approval process. Also, as imaging technology continues to develop, the opportunity to use imaging in clinical trials becomes greater. Adoption will also increase as more imaging biomarkers (or, surrogate endpoints) are defined as standard measures of efficacy.
• Cost savings: Imaging enables drug companies to make go/no-go decisions on experimental drugs more efficiently, realizing both cost and time savings.

BIOC's ECLINICAL DIVISION

BIOC's eClinical division accounts for ~30% total revenue. BIOC is in the process of building a full service, end-to-end, eClinical solution. BIOC entered the eClinical services market by acquiring Phoenix Data Systems (PDS) in 2008. PDS collects/manages data from clinical trials using electronic data capture (EDC) technology. PDS has participated in >600 trials across all therapeutic specialties. In September 2009, BIOC expanded its eClinical services presence by acquiring Tourtellotte Solutions, a company providing Interactive Voice/Web Response (IVR/IWR) and supply chain management software. Tourtellotte software is being used in over 150 active clinical trials. Our channel checks suggest that by integrating a leading IVR/IWR service with its eClinical offering, BIOC is well positioned in the eClinical services market.

The eClinical services market has grown at 10-15% over the past decade and this growth is expected to continue in the coming years. As 50%+ of clinical trials are still paper-based, EDC still has a significant portion of the market to capture. Paper based trials are deficient: they take longer to run, are more expensive, and have higher error rates than data captured electronically. BIOC's offering is specifically tailored to the small/medium pharma/biotechs. Our channel checks indicate that the breadth of functionality of the eClinical offering and the number of completed trials (and associated referral list) are enabling BIOC to increase its share of this market as biotechs/pharmas are risk adverse when selecting an eClinical vendor.

The eClinical division is not yet a great business like the Bioimaging division but BIOC is positioned to become a leader in this growing segment. There is a risk that the two large players (Phase Forward, Medidata) migrate down to the smaller trial market. However, to date this has not been an issue as BIOC is able to provide a higher level of service to small/medium clients than large player systems, which are structured more towards conducting EDC for the major pharma/biotech clients.

FINANCIALS AND VALUATION

Applying a 15x multiple to my estimate of 2010 FCF and taking in to account the excess cash, I value BIOC at ~$6.25 per share, ~50% higher than the current stock price. Our channel checks suggest that the clinical research delays have subsided and that the imaging and eClinical businesses are positioned to return to their long term growth rate of ~10% in the coming years. There is also significant operating leverage in this business and 10% EBIT margins should prove conservative based on my 2010 revenue forecast. Given the growth opportunities and the operating leverage, I believe that my estimate of BIOC's value is conservative.

As soon as the market realizes that BIOC's business model is robust and the Company begins to benefit from the development/growth of its eClinical Division, the market should reward BIOC with a higher valuation.

Note: Reimbursement revenues are expenses that are reimbursed by the client and therefore carry 0% GM. Excluding the reimbursement revenues shows that BIOC's core service business yields an operating margin of ~14%. The eClinical division includes results for only three quarters in 2008 while the 2009 eClinical results exclude revenue from the recent Tourtellotte acquisition. In 2010, I include an additional $3M revenue for Tourtellotte (which is easily achievable as Tourtellotte had ~$5M run rate prior to the acquisition).

INVESTMENT RISKS

- Significantly less R&D spending in the pharma/biotech space over an extended period of time. As discussed above, imaging is becoming a larger part of clinical trials (and the FDA is pushing for it) so even if there are fewer trials the level of imaging should hold up well.
- A large number of cancellations (this is not likely as there is minimal project concentration given that BIOC simultaneously undertakes >200 projects)
- Another "CapMed style" acquisition (let's hope management learned a lesson) or overpaying for acquisitions in the eClinical space

Catalyst

- Solid 2010 guidance (to be released in February)
- FDA becomes even more vocal in advocating imaging in clinical trials
- Acceleration in revenue growth from the eClinical Division
- Acquisition by a CRO (such as eResearch Technology looking to expand in to the imaging space) or a private buyer looking to take advantage of BIOC's strong balance sheet and attractive valuation
- Analyst coverage