Description

While E-Z-EM (AMEX: EZM) appears to be trading at lofty multiples of EBITDA and earnings, a closer investigation of the company reveals a true value investment with significant catalysts on the horizon.

EZM consists of two main businesses plus what I will term an “option.” The first business is the imaging products division, which is the international leader in the design, manufacture and marketing of contrast media for diagnostic imaging of the gastrointestinal tract (e.g. contrast agents that allow technicians to see soft tissue details of CT scans, colonoscopies, etc.)

The second business, AngioDynamics makes products used primarily in the diagnosis and treatment of peripheral vascular disease. Interventional radiologists use these products during minimally invasive diagnostic and therapeutic surgical procedures. AngioDynamics is a very fast growing business (25%+ growth on the top line), but I will not spend much time on it because a portion of it (20%) was spun-off to the public on May 27, 2004 (NASDAQ:ANGO). The stock would not attract a typical value investor (>20x annualized EPS) and can be shorted out so as to create the imaging products stub. Shorting ANGO could be covered via the special stock dividend of 9.2 million shares of ANGO that EZM shareholders will receive on October 30, 2004 (record date: October 11, 2004).

After shorting out the ANGO piece (EZM owns 80%) we are left with an implied enterprise value for the core EZM imaging business of $63 million or about $5.91 per share — $18.35 current stock price less ANGO ownership of $10.19 per EZM share less another $2.25 in net cash (excluding ANGO’s cash on the EZM balance sheet and a recent special dividend). At this point in the analysis, the core imaging products business trades at 1.2x book value, 0.6x sales, and 14x EPS on May ’05 numbers [Note: EPS estimate assumes reported operating profit of $2.1 million in FY ‘04 grows to $6.8 million via a $1.8 million absence of restructuring charges, $0.4 million absence of spin-off expense, $1.9 million in cost savings and some modest internal growth -- annualizing the most recent quarter’s results would yield $6.5 million in operating profit and management guidance is for operating profit to double, which if you exclude a $2.8 million restructuring charge the company anticipates taking in 2005 gets you to $7 million).

I believe this is an attractive valuation at which to buy a stable, recession resistant business with a leading market share (Tyco is the nearest competitor) in an industry benefiting from demographic trends (older people need more diagnostic tests and the population >50 is projected to double by 2020), a secular push to lower healthcare costs by utilizing prevention or screening methods, and technological advances that may allow non-invasive colonoscopies (virtual colonoscopy).

If Medicare does indeed decide to provide reimbursement for virtual colonoscopies (cost of $400-$900 per procedure), it could mean that a lot more screens will be conducted as many people who should have colonoscopies do not have this procedure due to its uncomfortable nature. While there are approximately 85 million people over age 50 and doctors recommend patients have colonoscopies every 5-10 years, there are only 7-8 million procedures performed per year. The fact that a virtual colonoscopy does not entail the sedative, pain medication, and overall uncomfortable nature inherent in a traditional colonoscopy may drive the many people who are not scheduling these screenings to in fact do so. More procedures should mean more volumes for EZM as it has leading products for virtual colonoscopy, which it believes should achieve higher margins than its traditional products.

The option to which I referred earlier comes from EZM’s exclusive rights to manufacture Reactive Skin Decontamination Lotion (RSDL). RSDL (developed by O’Dell Engineering in Canada) is a decontamination lotion that neutralizes chemical warfare agents within a matter of seconds. The product is already in use with all service branches of the Canadian Armed Forces, as well as the armed forces of Australia, Ireland, and the Netherlands (there are also rumors that the U.S. secret service carries it). The U.S. Army has been extensively testing the product and requested that EZM repackage it. The company believes that orders will be placed in the U.S. Government’s FY ’06 (beg. Sept ’05), while first responder orders could come before that. At $13-22 million of revenue per year and 60% gross margins, the impact to EPS could be approximately $0.20.

Including the $2.2 million in annual cost savings from the second part of management’s plan to restructure its manufacturing operations (consolidation of its powder-based barium production to its manufacturing facility in Montreal – detailed in Note D in 10-K) and some modest orders from RSDL ($0.05), ’06 EPS could be around $0.64 implying a P/E, excluding the ANGO ownership and the net cash balance, of 9x. Another way of looking at the valuation is to value the RSDL business at $30 million or 15x a potential $2 million annual profit, as well as strip out the ANGO ownership and the net cash. In this case, the imaging business, with $100 million in revenue and a leading market share is trading at a very attractive valuation of $33 million in enterprise value or 4x EBITDA.

Other notes: Management owns a big piece of EZM as the company was founded by Dr. Stern and Dr. Meyer in 1961. Although family ownership sometimes receives a discount in the marketplace I do not view the family ownership as a negative. Management has shown that they are interested in unlocking shareholder value not only by the decision to spin-off ANGO but by returning capital to shareholders in the form of two recent special dividends (August 2003 and July 2004).

Catalyst

Completion of spin-off
Effective execution of restructuring
RSDL orders
Medicare reimbursement for virtual colonoscopy