Description

Quintiles is a compelling value idea due to its strong balance sheet and its low EV/Revenue multiple.

Here are the key stats:

Price $16
Shares 120mm
Eq Cap $1,920mm
Net Cash $379mm
Equity Investments $347mm
EV $1,194
LTM Revs $1,631 EV/Rev 0.73
Current Booking Rate $1,800 EV/Bookings 0.66

QTRN is a leading pharmaceutical outsourcing firm. 55% of LTM revs are from contract research (CRO) and 45% are from contract sales (CSO).

QTRN does not appear cheap on a P/E basis because 1) EBIT margins are depressed, and 2) the cash and equity investments on the balance sheet do not generate much income on the income statement.

QTRN did 10% EBIT margins every year from 1995 to 1999. QTRN's margins are currently running at 1.1% reported and 2.9% pro-forma (for restructuring and "one-time" internet expenses).

My research suggests that QTRN should be able to get back to at least 8% EBIT margins and would be worth 12x EV/EBIT based on the company's long-term 10%+ top-line revenue growth rate and high ROIC. This would give an EV/Revenue multiple of 0.96x.

Applying 0.96x to LTM revenues and adding the net cash and investments yields a fair value of $19 per share. If you apply this multiple to the current bookings rate of $1.8bn, you get a fair value of $20.50.

A more optimistic view of QTRN's prospects would say that 10% EBIT margins are possible and the stock could trade at 13x EV/EBIT. In this scenario, QTRN is worth $23.70 based on LTM revs and $25.55 based on the current bookings rate.

My research suggests that a return to 8%+ margins is possible. QTRN's current margins are distorted by the bad business that the company (and entire CRO industry) wrote in 1999 and early 2000. The industry has since become much more rational in its pricing. QTRN brough in a new CFO in 2000 and underwent a bunch of management changes itself. The net result of this is that QTRN has added a lot of controls that were missing in its business last year. I believe they have decent visibility into the business they are writing and current business is being written with an embedded margin that supports 8% EBIT margins.

Some investors are concerned about QTRN's CSO business. I agree that the CRO business is more attractive than the CSO business. However, a sum of the parts analysis shows that the current stock price more than compensates for the poor CSO business.

QTRN's LTM revs of $1.6bn are split $897mm CRO and $734mm CSO. The CRO can earn 10% EBIT margins and at 13x EV/EBIT would be worth 1.3x Revs. The CSO can earn 5% EBIT margins and at 11x EV/EBIT would be worth 0.55x EV/Revs. Using these two multipoles, I get a sum of the parts of $19.00. The value goes up to $21 if I take into account QTRN's current bookings rate.

There are many factors that can yield a price for QTRN above the "fair value" I have suggested above. First, QTRN is signing "gain sharing" deals with biotech and mid cap pharma companies. Three major deals have been announced so far and more are coming. These deals are complicated and only a few key details have been provided by QTRN. However, my analysis suggests that the deals are prudent and present substantial upside to 2003 profitability levels. Second, QTRN has developed a leading presence in Japan. The CRO and CSO busienss is not as well developed in Japan and thus is less competitive. QTRN was an early pioneer in the Japanese market and stands to benefit from the fact that CROs and CSOs are just now taking hold there.

The bottom line is that at $16, I think QTRN has excellent risk reward. I can justify a fair value of $20-26. I think the probability of QTRN going up $4 from $16 is much higher than the probability of it going down $4. If QTRN were to trade down to $12, I think it is more likely to come from a temporary fluctiontion than a permanent impairment of value.

Catalyst

Tomorrow, Pam Kirby, the new CEO of QTRN who was appointed several months ago, is going to outline her strategy for QTRN. I expect her to present a "back to basics" plan that will focus on execution (QTRN was lacking in this department under its previous CEO). Other catalysts include: 1) as margins return to 8%, profits and EPS will increase and show momentum; 2) as QTRN signs more "gain sharing" deals, it is possible that some of the deals will generate excitement and a higher stock price; 3) positive developments with QTRNs current partners on existing "gain sharing" deals could generate excitement. Lastly, low EV/Revenue valuation can often be its own catalyst.