CompuGroup Medical AG ("CompuGroup" or the "Company") is a German-listed provider of medical software solutions and IT services. The Company has high recurring revenue, strong margins, good ROEs, a high single digit rate of historical organic growth, and insider ownership approaching 50%. Despite these admirable qualities, you can purchase the Company today at roughly 9x its 2012E cash earnings: a sizable discount to both intrinsic value and the trading multiples of most competitors.
CompuGroup segments its business into two primary categories, Health Provider Services ("HPS") and Health Connectivity Services ("HCS"). The HPS segment, which generated 83% of 2011 revenues, provides modular software to roughly 250,000 end users (doctors, dentists, and laboratory technicians), encompassing a wide range of practice sizes from single practitioners to large hospitals and central labs. This software addresses a broad range of practice management needs, including personnel management, billing, electronic medical records, administrative support, and pharmacy management. The HCS segment, accounting for the remaining 17% of 2011 revenue, provides data solutions to roughly 135,000 medical industry professionals and service/product providers (pharmaceutical companies, medical equipment manufacturers, and insurance companies). These solutions include databases (covering clinical trials, market studies, and therapies), clinical decision support systems, and fraud prevention tools. Geographically, over 90% of the Company's revenue is generated in Europe, with the U.S. market accounting for the majority of the balance.
The healthcare IT market has strong underlying demand characteristics. As aging global populations and growing wealth drive increased demand for healthcare services, both providers and payors are constantly looking for ways to increase their cost efficiency. CompuGroup is a key player in this effort. By electronically linking the various service and product providers in the healthcare ecosystem, it facilitates better coordination of care, reduces duplication of testing, helps minimize diagnostic and medication errors, assists in fraud control, and improves reimbursement efficiency. A growing recognition of the inherent historical inefficiencies in the healthcare system is driving a growing number of governments to either mandate, or provide incentives for, more widespread use of digital patient records and electronic data interchange. This trend directly benefits CompuGroup.
CompuGroup's basic business model is very attractive. The Company sells licenses to customers up front, and then collects annual recurring maintenance fees for both continued use of its software and ongoing access to product updates. Typically, about 60% of HPS segment revenue is recurring in nature. Migrating customer data to CompuGroup systems, and training personnel in their use, requires a material initial customer investment of time and resources. As a result, switching costs become significant once CompuGroup has established a customer relationship. These high switching costs lead to annual customer churn rates below 2% and low customer sensitivity to price increases. After CompuGroup has installed its core system at a customer's premises, it then focuses on upselling additional functional modules to that customer. This upsell potential presents a major revenue opportunity for the Company, as the Company's current revenue level of roughly €1,500/doctor/annum is well below best-of-breed competitors whom are generating close to €10,000/doctor/annum. Historically, this upsell opportunity has helped the Company drive organic growth rates in the mid-to-high single digit range.
CompuGroup has used an active M&A program over the last decade to rapidly expand its geographic and product footprint. This has driven a transformation of the Company from a single product, German-centric concern to a far more diversified healthcare IT provider operating in over twenty countries. As CompuGroup moves into a new region and increases its market share over time, EBITDA margins typically improve substantially. CompuGroup currently generates EBITDA margins north of 30% in it more mature regions, where its market shares can approach 50%. Thus, the current consolidated corporate EBITDA margin of 20% should grow over time as newer regions mature, and the benefit of corporate overhead leverage is realized.
CompuGroup's Chairman and CEO, Frank Gotthardt, founded the Company in 1979. He and his direct family members control over 45% of the outstanding shares. Like many one-time entrepreneurs, he is intimately involved in the Company's operational details, but tends to shun the job responsibilities that involve being the public face of the Company. Those responsibilities are primarily borne by CompuGroup's CFO, Christian Tieg. Mr. Tieg, who came to CompuGroup as a result of its 2008 purchase of Profdoc (where he was CEO), is an outstanding financial executive. He has a strong focus on value creation, and has brought a high level of rigor to CompuGroup's day-to-day financial management, as well as its M&A process.
As you would expect for a company with such an attractive business model, CompuGroup's financial characteristics are impressive: EBITDA margins are roughly 20%, return on equity exceeds 25%, and cash flow generation is strong. For 2012, I am modeling €455mm of revenues and €100mm of EBITDA. This is squarely within management guidance, and represents a mid single-digit rate of organic revenue growth on top of a full year's annualization of 2011 acquisitions. €100mm of EBITDA implies about a 250bp increase in the Company's EBITDA margin, driven by a combination of operating leverage and the transition of the U.S. operations to operating profitability (EBITDA margins were actually at the full-year implied 2012 margin level for the back half of 2011). Moving down the income statement, €36mm in D&A, €12mm in net interest expense, and a 32% effective tax rate yield €0.68/shr in earnings. I am adding back the expected €26mm (€0.52/shr) in acquisition-related intangibles that will run through the P&L in 2012 to get to my €1.20/shr in cash EPS.
CompuGroup's attractive valuation results, in part, from stumbles that the Company experienced during 2011. A number of factors led to successive reductions in its 2011 financial guidance, thereby damaging investor confidence. In Austria, an important market for CompuGroup, a government-driven healthcare reform initiative (focused on hospitals) led to a temporary cessation of many IT projects. In addition, across a number of European countries, CompuGroup didn't see the benefit of the typical year-end budget flush. As a result, the typical high single digit organic growth rates dropped into the low single digits. The other primary problematic market for CompuGroup in 2011 was the U.S. The U.S. is a relatively new market for CompuGroup. The Company made three modest purchases in the U.S. market during 2009 and 2010, and initially put forward a relatively aggressive integration plan to bring these previously money-losing businesses to profitability during 2011. Integration snags slowed the process down, negatively impacting the region's expected EBITDA contribution. By year-end 2011, however, these one-off issues had been largely solved. Both 3rd and 4th quarter 2011 results were ahead of the previously reduced expectations, IT projects in Austria were back on track, pipelines were refilling nicely, and the U.S. market had been brought to profitability.
I believe that 9x cash EPS is far too cheap for a company of CompuGroup's caliber. This multiple does not accurately reflect CompuGroup's strong organic growth potential, accretive M&A program, likely margin upside, and highly invested management team. U.S.-based competitors (Allscripts, Cerner, athenahealth) trade in a range of 15-50x forward EPS without, on average, possessing superior financial characteristics to CompuGroup. From both an operational and financial standpoint, last year's stumbles have largely been rectified, and I expect renewed investor confidence to drive multiple expansion going forward. In the meantime, continued cash accretion and value-enhancing M&A should underpin the current valuation.