Description

Thesis Summary (NOTE: all numbers adjusted to per IMS shares, but deal will close in Q shares)

The recent merger of IMS - the world’s leading provider of healthcare data and insights to the life sciences industry and Quintiles (Q) - the world’s largest Clinical Research Organization (CRO) has, in our view, created a world class asset that will enjoy a dominant position across Healthcare Information, Clinical Research and Healthcare Analytics & Consulting.

We believe that IMS + Q is a case of 1+1 >2.  The complete suite of a) the most comprehensive database spanning sales, prescription and promotional data, medical claims, electronic medical records and social media, b) a smarter CRO that leverages the data to speed up and reduce the cost of clinical trials and c) an end-to-end Real World Evidence platform that spans retrospective and prospective analysis of drug effectiveness, would make IMS-Q the largest outsourced provider to the Life Sciences industry, with several offerings that are mission critical to both the commercial and the R&D functions of their customers. We believe the merger positions the combined company to gain market share as well as increase its share of wallet of its life sciences customers. 

We think that no other company in this highly fragmented field can compete with the breadth and depth of the new IMS-Q and the upside from accelerating growth could be significant.  We believe there is some precedent that gives us comfort that the combination could be powerful.  In 2015 LabCorp (LH) combined with Covance (CVD).  LabCorp’s data which is rather limited by comparison to IMS and consists of a database with US-only diagnostic data, accounting for only 30% of the potential patient population available for trial recruitment (70% is outside the US), is on track to deliver $300M of revenue synergy or ~350bps of cumulative incremental growth over 2016-2018. IMS data is global and more robust as it draws from several sources including drug manufacturers, wholesalers, pharmacies, physicians, hospitals, laboratories, health plans and other payers, governments, services organizations, information technology vendors, patients and social media. The far more complete and richer data should allow IMS-Q to achieve much better growth than LH-CVD, which is not adequately reflected in management’s $450-800M or revenue synergy guidance.

What makes the stock particularly compelling is that the combined company is trading at ~13x forward EPS with limited synergies which would be an attractive multiple for either IMS or Q on a standalone basis.  We believe this entry point has been created by a dislocation and lack of understanding in the respective shareholder bases that were either more business service oriented in the case of IMS or healthcare focused as in the case of Q – but with little overlap.  In addition, people were unhappy with the Q quarter as the book to bill was lower than expected as management blamed some timing issues, but IMS had a chance to see the run rate of the business after the quarter ended and felt very comfortable with the growth rate for Q.

If the business develops along the lines we anticipate in our base case, EPS (accruing to the IMS shareholder) would grow to $2.64 in 2020 from $1.52 in 2015, driven by 6.5% organic revenue growth, $450M of cumulative revenue synergies and $100M of cost synergies. Assuming leverage is maintained at 4x Net Debt/EBITDA, which seems likely, and excess capital is used to repurchase shares, IMS-Q can buy back 54% of the outstanding shares over 2017-2020 and grow EPS to the area of $4 by 2020. Valued at 17-20x IMS shares could be worth $68-$80 by 2020. To add some context around the valuation multiple, 17-20x seems like a fair multiple given the 20%+ ROIC, an EPS CAGR of 26% in this case, and close 100% net income to FCF conversion. Also, historically Q and other CROs have traded at ~18-20x and IMS has traded at 16-20x.  In our upside case we assume$150-250M of cost synergies, $800M–$1Bn of cumulative revenue synergies (representing 200-250bps of incremental revenue growth per annum) and keeping leverage at 4.0x Net Debt/EBITDA yields an EPS range of $4.68 -$5.55.  Applying a multiple of 20-25x which seems reasonable in light of an EPS CAGR of 38-46% this would represent would yield a stock price of $94-$139.

The following table outlines the pro forma EPS for existing IMS shareholders before and after the Q merger:

The primary sources of synergies and earnings growth for IMS-Q are:

Cost synergies:

Management has guided $100M of cost synergies. To put this in perspective, it is ~6% of the combined SG&A expense of IMS-Q.   We view this as conservative, which makes sense given the CEO of IMS is going to be taking over the combined company but likely views the transaction as more of a “merger” than “purchase” from the board level and therefore feels  the need to be more judicious in his initial description and characterization of the amount of ultimate cost reduction.  In addition to duplicative public company costs and other corporate costs, combining the Real World Evidence businesses of IMS and Q is expected to be a meaningful source of cost synergy, which we think is not fully baked into the $100M guidance. Illustratively- IMS revenue per employee is $195K. Recognizing that 50% of IMS’ revenue comes from selling data which is not people intensive, say Q’s revenue per employee in its commercial business increases to 75% of IMS’ level or $146K from $119K today. Assuming cost per employee of $50K per annum, this would amount to a headcount reduction of 1,729 employees, only 18% of Q’s workforce and yield cost savings of $86M. So we make the point that the $100M guidance seems low and has the potential to be exceeded over time. Every $25M of additional cost synergy adds $0.04 to EPS.  Our upside case assumes total cost synergies of $150-250M.

Leverage:

Given the recurring nature of IMS-standalone, the leverage target was 4-5x EBITDA before the merger with Q. The combined IMS-Q also has high FCF conversion and can support leverage of around 4x EBITDA in management’s opinion. The additional capital can be used to repurchase shares or accretive acquisitions, consistent with Ari Bousbib’s historical track record and preferred balance sheet structure. This is not something that the street is focused on and can be significant source of earnings growth. Based on our estimates, IMS-Q can buy back 54% of the outstanding shares over 2017-2020 propelling EPS CAGR to 28%, compared to 20% without share repurchases.

Revenue Synergies:

Management has guided 100-200bps of revenue growth acceleration over 2017-2020 which translates to ~$450-800M of cumulative revenue synergies over 2017-2020. Every $50M of revenue synergy adds $0.04-$0.05 to EPS. Broadly, following are the sources of revenue synergies as a combined company:

·         CRO business: IMS-Q hopes to improve the win rate (and hence market share) of the CRO business by designing better trials, increase speed of recruitment and speed of trial execution by leveraging IMS's ~530M anonymized patient data. This is not dissimilar from what LH-CVD is attempting to do. While it could mean a tougher competitive environment for CROs going forward, the deal wins achieved by the LH-CVD combination is encouraging. We also believe that IMS data is significantly richer and broader compared to LH’s US-only diagnostic data because 70% of the clinical trials are done outside the US. IMS also has more sources of data compared to labs and hence has more robust and complete information. Lastly, the Q-DGX JV will always remain an avenue Q can tap if diagnostic data becomes imperative for any reason.

·         Real World Evidence business: While both IMS and Q each have their own RWE offerings, they complement each other. So they hope to create a full cycle evidence generation platform to improve their competitive position. This is a high growth area driven by the gradual shift towards value and outcome based pricing models within healthcare. IMS-Q hopes to "productize" what is today an ad-hoc consulting/solution based model for performing market studies to drive better ROIs for the commercial organizations of Pharma companies.

Bundling/Cross-selling/ gaining wallet share:

We believe that being the largest outsourced provider of mission critical services to the life sciences industry, IMS-Q will enjoy an enhanced position of power and will be able to sell more services to their customers over time, effectively leveraging their large size and monopoly position in the Information business. This is a win-win strategy because clients would end up saving money by buying services from one scale player at an attractive total cost rather than several disparate vendors who logically would be unable to offer competitive prices compared to IMS-Q’s bundled end-to-end offerings. We don’t incorporate this into our model and believe the effective bundling could propel revenue growth towards or above the higher end of management’s guidance of $800M.

2020 EPS Sensitivity to cost and revenue synergies are shown below:

 Business Description:

Q:

Q is the largest CRO in the world, with a market share of ~15%. The total CRO market is ~$100Bn, of which ~$50Bn is the maximum that can be outsourced, of which $25Bn is currently outsourced. The outsourcing trend is expected to continue because the CROs bring scale, specialized skills and faster patient recruitment times, thus offering life sciences customers cost savings and faster time to market. The CRO market is growing at 6-8% which approximates standalone Q’s long term growth expectation.

Q operates in 2 segments- Product Development (75% of Q standalone revenue and 90% of operating income) and Integrated Healthcare services (HIS, 25% of Q standalone revenue and 10% of operating income).  Its Product Development segment is the CRO business providing clinical research services for mid-late stage drug development. Its Integrated Healthcare Services segments provide commercial services, communications and engagement services, real-world and late phase research, and other healthcare solutions.

IMS:

At the core of IMS, it collects data from drug manufacturers, wholesalers, pharmacies, physicians, hospitals, laboratories, health plans and other payers, governments, services organizations, information technology vendors, patients and others on a global basis and distributes it to life sciences companies (pharma and biotech). Around this core, IMS is now expanding its markets by leveraging its monopoly-like position in its Information business to capture and grow its market share by cross selling related technology services to its existing life sciences clients.

IMS is a high quality business with a deep moat in the form of its monopoly-like position as a healthcare information/data provider. The average tenure of its top 25 clients is >25 years and retention rate for top 1,000 clients is 99%. IMS scale is a significant competitive advantage and barrier to entry because it has been collecting and selling information for 60 years. Its unparalleled depth and breadth of data is difficult to replicate by competitors that are, consequently, largely regional.  The largest competitor- Symphony is ~10% the size of IMS’ Information business and has been unable to really create a dent in IMS market share. Also, the long history implies that IMS’ data is entrenched in its clients’ workflow, and the company consequently enjoys highly recurring revenues, high incremental margins, and generates significant free cash flows. It has a capital light model with Capex ~5% of revenue and little to no working capital requirements.

Before IMS was taken private in 2010 (by TPG, CPP Investment board and Leonard Green), previous management routinely exercised its monopoly position by increasing prices to drive revenue growth, which frustrated clients. While this was effective in growing FCF it led to low growth because volume stagnated once IMS saturated the life sciences market. Current CEO Ari Bousbib, appointed by the private equity owners, changed the company’s strategy to focus on a larger related TAM and growth. He leveraged IMS’ entrenched information offerings to sell related technology services to the existing client base rather than take annual price increases. This strategy is advantageous to clients because IMS data interacts better with IMS software as opposed to molding the data for third-party software and analytics platforms (E.g. IBM). This was a win-win proposition because clients save on integration costs when they choose IMS for both Information and Services. Given the high fixed-cost nature of its data, IMS can scale its technology solutions quickly and at low marginal cost, while propelling growth. 

 IMS operates in two segments:

Information (51% of IMS standalone revenue, 54% of gross profit)

This is the backbone of IMS. In this segment, IMS collects information from a wide variety of data suppliers (manufacturers, wholesalers, pharmacies, physicians, hospitals, laboratories, health plans and other payers, governments, services organizations, information technology vendors, patients and others) on a global basis. IMS has the most comprehensive data base which can be narrowed down to a zip code in certain developed markets It has 500 million comprehensive, longitudinal, anonymous patient records (i.e., records that are linked over time for each anonymous individual across healthcare settings).

The data is standardized organized, structured and integrated into useful market insights and sells it primarily to life sciences companies (pharmaceuticals, Biotech etc.). The TAM for information is ~$3Bn, of which IMS has 50% market share. IMS has 5000 clients, with the top client contributing ~5% of revenue. Life Sciences clients use IMS data to address fundamental operational questions such as:

90% of Information revenue is from subscription or license-based contracts and has historically been recurring and predictable.  10% is ad-hoc and depends on pharma spend. Majority of the costs in this segment are fixed and relate to data acquisition. This segment has normalized gross margin in the high 50s and grows 1-2% with all of the growth coming from emerging markets.

Risks

·         This segment can be a little lumpy on a quarterly basis due to the 10% ad-hoc portion of the business, as witnessed in 3Q2015 when clients exhibited tentative buying behavior, which revered in 4Q2015

·         Drug price regulation could also be an immediate headwind if clients responded to drug price cuts by cutting costs as kneejerk reaction. However IMS data is not a significant portion of pharma marketing and R&D budgets to warrant such a reaction in our view. Conversely, the data and/or analytics could help clients justify drug prices by measuring efficacy ( Real World Evidence)

·         Within the information segment all of the growth comes from EMs while DMs are largely flat. Any macro weakness in the emerging markets (which tend to be predominantly patient pay markets) could result in drug companies realigning their spend levels to match underlying market growth and hence result in a lackluster growth in the information segment

Technology Services (49% of IMS standalone revenue, 46% of gross profit)

The Technology segment consists of a mix of projects, large-scale engagements, multi-year outsourcing contracts and multi-year Software-as-a-Service (“SaaS”) licenses. It has 4 sub-segments elaborated in the following section.

The TAM for these services is $42Bn and IMS has the opportunity to capture market share by increasing penetration of its tech services within its base of 5000 information clients.

The technology services segment is highly competitive with a high level of interest and investments from Technology consulting companies (IBM, Accenture, Deloitte, Cognizant Technology Solutions, Infosys etc.), Consulting and Analytics companies (McKinsey, Nielsen, The Advisory Board, ZS Associates, Verisk etc.) and CROs and healthcare focused companies (Quintiles, Covance, Parexel, RTI Health Solutions, Symphony Health Solutions, Synovate Healthcare, Trizetto, Veeva, etc.).

Majority of the costs in this segment relate to personnel cost because IMS leverages its database and does not have to spend much additionally for data acquisition, which is a significant competitive advantage. Also, because IMS data and software are inherently inoperable, bundling them together eliminates integration cost and effort for clients.

This segment has normalized gross margin in the high 40s and grows high single digit organically. Acquisitions are expected to add ~2% to growth annually.

The following table outlines the growth and margin profiles of the sub-segments of Technology Services:

A: Tech & Apps: an extensive range of cloud-based applications and associated implementation services. SaaS solutions support a wide range of commercial and regulatory processes, including multi-channel marketing, CRM, performance management, incentive compensation, territory alignment, roster management, call planning, compliance reporting and Master Data Management. These solutions are used by healthcare companies to manage, optimize and execute their commercial strategies in an orchestrated manner while meeting their regulatory obligations. IMS uses proprietary algorithms, to combine country-level data, healthcare expertise and therapeutic knowledge in over 100 countries to create Global Market Insight family of offerings such as MIDAS, Analytics Link and Disease Insights, which provides a leading source of insight into international market dynamics and are used by most large pharmaceutical companies. Tech & Apps is growing at mid-teens with gross margins higher than segment average.

B: Cegedim: In April 2015 IMS acquired French company Cegedim for ~$445M This acquisition was transformational and expanded total revenue by ~20% and filling key gaps in IMS’ portfolio through its CRM software and a physician database (OneKey) which is reported under the Information Segment. Cegedim has 15% EBITDA margins which over time should expand to 20%+ by achieving run-rate cost synergies of $60M by 2017. Note that over the course of 2015, management has both raised synergy estimates and accelerated the timeline for realizing them. The following table shows the allocation of Cegedim within IMS’ segments.

C: Workflow Analytics & Consulting Services: IMS provides a broad set of strategic, analytic and support services to help the commercial operations of life sciences companies successfully transform their commercial models, engage more effectively with the healthcare stakeholders and reduce their operating costs. Global teams leverage local market knowledge, therapeutic area expertise and global information resources to assist clients with portfolio, brand and commercial strategy, as well as pricing and market access. Workflow Analytics is growing at high single digits with gross margins higher than segment average. Consulting is growing at mid-single digits with gross margins lower than segment average.

D: Real World Evidence: These solutions enable clients to use anonymous patient-level data to understand treatments, outcomes, and costs to inform and advance healthcare decision making. With patient privacy and security safeguards, IMS offers data assets that integrate medical claims, prescriptions, electronic medical records, biomarkers and government statistics as needed for research requirements.  IMS’ propriety technologies and advanced analytic skills help clients manage and use this information to understand the effectiveness and economic efficiency of drugs in real-world use. IMS also helps biopharmaceutical companies engage more productively with health plans, providers and government agencies. RWE is growing at mid-teens with gross margins around segment average.

E: Gross Margin: Tech & Apps have the highest gross margin followed by Workflow Analytics, RWE and consulting in descending order. While the exact margins are not disclosed, our assumptions shown above triangulate well with reported financials and seem reasonable.

The following table outlines IMS-Q’s earnings profile:

The following table outlines the pro forma EPS for existing IMS shareholders before and after the Q merger:

The following table outlines IMS-Q’ free cash flow profile:

The following tables outline IMS-Q’ balance sheet before share repurchases:

The following tables outline use of cash for share repurchases:

Risks:

·         Consolidation within life sciences clients

·         A shift towards specialty drugs infused in doctor’s offices away from drugs sold in pharmacies is a tail risk. However, IMS is probably the best positioned data provider to enhance its physician database. Note that this trend would emerge over time and the shift will not occur overnight.

Catalyst

Closing deal