Description

Crem3 has 50% of its market cap in cash, so it has the resources to be a leader in consolidating the distribution of disposable healthcare products sector. Crem3 offers a way to participate on the growing healthcare sector in Brazil at an attractive price (EV/Ebitda 3.3x 2009) along with one of the shrewdest investors group in the country. Cremer’s largest shareholder is Tarpon Investment Group (ticker: TARP11 BZ), which recently Trev62 has written about. All figures in Brazilian Reals.

BACKGROUND

 Cremer S.A. began as a manufacturer of surgical textiles and adhesives for the healthcare sector. Later on, it diversified into adhesives and plastics for the footwear and automotive industries. After being acquired and divested by private equity investors, the company is being transformed in a leading distributor of disposable healthcare products. Through its Call Center and the internet B2B website, the company serves hospitals, pharmacies, dentists, supermarkets and veterinary clinics throughout the country with the help of 11 distribution centers of its own scattered among the most attractive regions in Brazil. Acting as a third party distribution is a way to leveraging its installed distribution infrastructure via (1) an increase the number of suppliers, (2) an increase in number of products,  (3) increase client base and cross-selling efforts, and (4) the last front of our growth strategy is to explore the under-penetrated segments. One of this is the distribution of higher value-added disposable healthcare goods. Another is the online sales of dental products.

 The healthcare distribution business in Brazil is fragmented, where most of the companies have a local/regional reach, are undercapitalized, and family owned without scale. The company has a market share of 5% (it is the largest in the segment) and growing organically and by acquisitions. The sector is ripe for consolidation.

 The sector in Brazil is the largest in South America, which represents expenditures of US$ 40 billion, and Argentina is the 2^nd with US$ 25 billion. The Healthcare expenditures are growing around 14% since 2002.

The company has a large customer base which is growing around 13% CAGR in the last 3 years. In the 1Q08 Cremer has 33,477 customers and two years ago had 26,355 customers. Cremer is attending only 30% of the Brazilian hospitals and 19% of all Brazilian drugstores, so there is plenty of room for growth. In order to accelerate growth they are making small acquisitions of niche players and regional distributors in order increase their reach and product diversity.

Recently CREM3 acquired Hemocat and Biamed, which are regional distributors of disposable products in the segments of interventional cardiology, neurosurgery, neuroradiology and endovascular surgery, which are complementary to the Company’s products. In 2007, the companies Hemocat and Biamed had joint revenues of approximately R$13 million and a joint EBITDA of R$1.9 million. The price paid was 4.5x EV/EBITDA to be ascertained in the fiscal years of 2009 e 2010.

Cremer had net sales of R$ 245 million in the 9 months of 2008, which means an increase of 19% Y-o-Y. Revenues from their manufacturing division represent 69% of the total, last year was 73%. The distribution of third party products is increasing its share. However, the distribution business has lower margins than manufacturing. The company had Net Earnings of R$ 33.7 million (9 months -2008) and last year it was the same level. However, most of the gains (interest income) came from the huge cash balance, that pre-tax is R$ 31,8 million (9 months-2008) and last year it was R$ 6,6 million.

Crem3 disbursed R$15,432 in the period from October 1 to October 29, 2008 to repurchase 1,997,500 common shares. The average acquisition cost was R$7.73 with minimum price of R$6.85 and maximum price of R$10.08.

The IPO share price was R$ 17.50, and it happened on April/2007.

Financial / Valuation

Nr. of Shares                                     33,678,495

(-) Buyback on October                  (1,997,500)

Adj. Nr. of Shares                              31,680,995

Share Price                                      R$   9,40

Market Cap (million)                         R$ 297.8

                                               R$ million

Marketable Securities+Cash           R$ 176.1

(-) Loans ST+LT                                R$ (10.2)

(-) Tax Installments                            R$   (7.8)

Net Cash (Set 30, 2008)                  R$ 158,1

(-) Buyback Disbursement               R$ (15.4)

Adjusted Net Cash                            R$ 142.7

Enterprise Value                             R$ 155,1

Recently the company released its new guidance for 2008 results, so they expect  an EBITDA of R$42mn to R$44mn, The reasons for the revision were the already expected impacts of (1) workers’ strike in 4Q, (2) flood in Blumenau, (3) slowdown in plastics and adhesives and (4) a slow development of the retail channel. This means that the company is trading at 3.7x Ebitda 2008. Assuming a 10% growth in the EBITDA for 2009, the company will be trading at 3.3x Ebitda 2009.

Peers (Cardinal, McKesson, AmerisourceBergen) are trading at higher multiples around 5.5x EV/Ebitda, however they don’t have the same prospects as CREM3.

Cremer	Dez/2006	Dez/2007	Set/2007	Set/2008
Net Revenues	243	277	206	245
COGS	181	208	153	188
(-) Discounts on Purchases	-14	-20	-14	-18
Adjusted COGS	166	188	139	170
Gross Profit	76	89	67	75
(-) Sales Expenses	32	38	28	35
(-) G & A Expenses	28	29	20	23
Operating Income	17	22	18	18
(+) Depreciation	7	4	3	3
(+) Goodwill Amortization	18	18	12	12
EBITDA	42	44	34	33
EBITDA Margin	17%	16%	16%	13%
Capex	(5)	(8)	(11)	(5)
Working Capital	(21)	(11)	(11)	(25)
Free Cash Flow	17	25	12	3

Obs.: BRGAAP requires that discounts obtained by prepayment of goods purchased for resale to be included in the Financial Income line. However the company for disclosure purpose includes it as reduction of the COGS.

The Catalyst: An Undetected Control Group

Cremer's Main Shareholders	Qty (000)	Outstanding	File Date
Poland FIA	3290	9.8%	27-Nov-08
Guepardo Investimentos	1892	5.6%	6-Nov-08
Tarpon Group	3798	11.3%	3-Nov-08
CS Hedging-Griffo CV	5254	15.6%	31-Oct-08
a) Shares in Friendly Hands	14234	42.3%
Findlay Park L.A. Fund	1670	4.9%	11-Jan-08
Rio Bravo Investimentos	1430	4.2%	company
AIM Investments	1700	5.0%	19-Oct-07
b) Potential Friendly Hands	4800	14.1%
a+b) Total Shares could be Friendly	19034	56.4%
Note: Free-float of 94%.

Below, I explain why exist a group of related asset managers that are the major shareholder group in this company. However, there is no factual evidence that they have a formal agreement among them, if so they are obliged by CVM rules to disclose it. The key person is Mr. Luiz Alves Paes de Barros, who is a mentor for the Magalhães cousins.

- Luiz Alves Paes de Barros – portfolio manager / owner of Poland FIA (a mutual fund with only 3 investors and a NAV of around US$ 300 million); and head of Investment committee of Delos Asset Management;

- Octavio Ferreira de Magalhães – CIO - Guepardo Investimentos;

- Sergio Lisa Figueiredo –  Senior Analyst of Guepardo Investmentos / Member of the Board – Cremer;

- Rafael Ferreira de Magalhães – Managing Director of Delos Asset Management, and a former portfolio manager/analyst at Tarpon Investment Group;

- José Carlos Reis de Magalhães – CEO/CIO –Tarpon Investment Group, he is nephew of Mr. Luiz Alves Paes de Barros, who manages Poland FIA. Tarpon (ticker: TARP11 BZ) was written up by trev62 on December 3^rd-2008. Mr. Alexandre Borges represents Tarpon in the Board of Directors.

 - Luis Stuhlberger (CIO) from Hedging Griffo, helped to launch the Tarpon Investment Group., and a long time ago Mr. Luiz Alves Paes de Barros was a partner at Hedging-Griffo. Besides that, Hedging-Griffo distributes Tarpon and Guepardo funds.

 I didn’t find any evidence that Delos Asset Management has a stake in Cremer, however they manage investment clubs – Clube Delos de Ações - which has no obligation to disclose to CVM (the local SEC) the names of invested companies.

According info from company, another asset management company is represented in the Board of Directors – Rio Bravo Investimentos Ltda., which has 4,2% of the capital . The Board member is Mr. Mario Flack, who was the former CEO of Accenture Brasil and manages the RB Fundamental Equity Fund.

I would like to emphasize that this group have a value and long-term orientation for their investments.

Based on above, I am sure that the main group of hands-on asset managers will take care that Cremer executes successfully its growth strategy.

RISK

 The main risk is the execution risk of the planned strategy. However, I believe that it is mitigated by the presence of these experienced and long term investors.

Catalyst

1)Company can make very accretive acquisitions considering the credit crunch that affect more the small companies in the sector.
2)The informal controlling shareholder group may assure that the growth/consolidation plans will have a good execution. They have already two seats at the company’s board.
3)Operational and financial performance of the company will help to close the gap between price and value.