Sorin SpA offers investors a rare opportunity to invest in leading market share cardiac franchises, behind a new CEO and best-in-class operator, André-Michel Ballester, at a look-through / post-restructuring valuation of just 4X free cash flow.  Sorin shares are down more than 70% since their IPO in 2004, and the stock has been all but forgotten by the sell-side community.  Ballester is undertaking a radical turnaround to more than double margins over a 3-year period and shed unprofitable, non-core divisions by the end of this year, which should lead to a dramatic re-rating of the remaining core cardiac franchises once investors are able to appreciate the scope of pro forma earnings power.

Recently, market concerns surrounding forced liquidation by largest shareholder Hopa have pushed the shares down to historical lows, belying the material operational improvements and meaningful strategic progress that has been made by the new CEO since the beginning of the year. 

 

Sorin’s core franchise consists of 3 key businesses: (1) cardiac rhythm management (pacemakers, defibrillators); (2) cardiac surgery (blood circulation systems for cardiac bypass surgery); and (3) heart valves (both mechanical and biological heart valves).  Businesses have stable demand drivers (gdp+ or stable growth in most instances), leading regional market shares, very high barriers to entry (once products are proven to have high efficacy, customers are very reluctant to make a change), reasonable to good pricing power, and a healthy pipeline of exciting growth products, particularly in high-voltage defibrillators.

 

Sorin SpA, in its current incarnation as a medtech concern, has been a company in-flux, under different ownership and management for almost 20 years.  Originally, Sorin was a nuclear technology company borne out of a joint venture between two of Italy’s oldest industrial groups, Fiat SpA and MonteEdison.  When privatization of the nation’s energy companies left Sorin without business opportunity, the company re-invented itself through a series of acquisitions from large pharmaceutical and medtech companies divesting noncore assets over the past 20 years.   We became interested in Sorin in 2005 when a number of new managers entered the company, most notably, Mr. Ballester, who had excellent pedigree, having had responsibility for all of Edward Life Science’s European operations, and previously, headed Baxter’s European operations (we note that Baxter has been one of the more shareholder friendly corporates we have encountered, actively repurchasing shares and spinning off businesses when management felt valuation didn’t properly reflect intrinsic value).  We were encouraged by Ballester’s appointment to head the ‘gem’ business within Sorin – Cardiac Rhythm Management, and watched with interest hoping that the top ranks of management would soon turnover as well.  For reasons still not clear to the authors, succession took more than two years, but ultimately, Ballester was chosen for the CEO role.  We believe this appointment is a major upgrade, and the majority of Sorin’s operational problems were self-inflicted by the prior CEO, and current management, through their outlined plan to the market (discussed below) will restore the significant majority of value destruction witnessed over the past 4 years since Sorin’s IPO.

Ballester set forth in January an ambitious series of operational targets, the key features include obtaining EBITDA margins in excess of 20% (more than double the current level), disposing of loss-making stent and renal businesses this year (proceeds to pay down debt), and extracting improvements from working capital position intended to contribute to debt paydown.  Thus far in 2008, despite indications of 200 basis points of margin improvements, he has delivered 250 basis points of margin improvement in the first half of the year (largely SG&A driven), despite challenging currency headwinds (cost base is largely euro denominated while roughly 40% of sales are outside of the euro zone).  If Ballester is successful in completing an operational turnaround in his core businesses, disposing of non-core assets at a modest valuation, and utilizing his plentiful tax-loss carryforwards to offset future income, Sorin will transform from a highly-levered, loss-making conglomerate to a refocused cardiac franchise with strong profitability, with modest leverage, trading at just 4.7X EBITDA and 4X free cash flow. 

 

 

Additionally, it appears that large shareholder Hopa’s stake will not come to the market (as reported by the press), since Italian private equity firms Equinox and Mittel have entered into an agreement to acquire Hopa’s industrial holdings (the largest of which is Sorin).  Mittel and Equinox have stated publicly their perspective that there is significant value in Hopa’s Sorin stake, which gives us comfort that the shareholder base has been stabilized, and as such, market concerns of a significant overhang risk are without merit.

As an interesting aside, in the summer of 2007, the company attracted the interest of private equity (as reported by the press) with potential valuations ascribed to the business of roughly 3X the current level, or at E2.05 per share.  We understand that the board preferred to run the business and extract value itself before considering options of this nature, but wouldn’t rule out the company’s willingness to maximize value in this vein once it has delivered upon its operational commitments and separated out the core businesses.

Cardiac Surgery (CS) – 50% of sales - world leader in its businesses, including:

·         Extracorporeal blood circulation systems that are used during stopped-heart surgery. The main products are heart-lung machines, oxygenators, arterial filters and tubes.

·         Autologous transfusion systems, which include devices and disposables used to collect and purify blood

·         Business is ex-growth but a stable cash generator

The Sorin Group distributes these products under the Dideco, Cobe Cardiovascular, CarboMedics, Mitroflow, Sorin Biomedica and Stöckert brands.

 

Heart Valves – 16% of Sales - Strong competitive position in EU, just entered US tissue segment.  Business lines include:

·         Artificial cardiac valves (mechanical and tissue valves) and annuloplasty rings

 

Cardiac Rhythm Management (CRM) – 37% of Sales - Strong European presence, with product range consisting of:

·         Pacemakers

·         Implantable defibrillators

·         Holter monitors

·         Electrophysiology products

·         Telecardiology products

·         Interventional cardiology: drug-eluting and bare-metal coronary stents

Renal Care (RC) (non-core / discontinued)
Strong local market share in southern Europe, in the areas of :

·         Hemodialysis systems

·         Dialyzers (disposable filters)

·         Hematic lines, concentrates and fluids for the preparation of dialysis solutions

Valuation (assuming E40mm of future proceeds for non-core asset sales)

 

Previous management’s decision to invest significant amounts of capital in trying to diversify toward the ‘wave of the future’ -  stent-development, and similarly poor capital allocation in acquisition of a structurally flawed renal business, has radically impaired investors  ability to value the underlying core franchise.   Additionally, when Sorin was listed in 2004, JP Morgan and other analysts that covered the stock were focused almost entirely on the company’s speculative exploits in stent development.  Shortly after the company failed to be awarded the necessary regulatory approvals to sell stents, the analyst community dropped coverage.  Since then, the stock has fallen dramatically (down nearly 70% from its IPO levels), and no medtech sell-side coverage focusing on the core mature businesses has resumed.

Divisional level profitability isn’t disclosed at this time, but we estimate broadly that the core business two years out are capable of earning normalized free cash flow of between 60-80mm (once disposal proceeds and modest free cash flow are used to paydown debt).  We realize this is a wide range, but coming off of a low base with such significant scope for improvement makes choosing a more precise figure almost impossible to predict.  With a market capitalization of just 362mm euros at today’s levels, the magnitude of share price appreciation could be as much as 300%+ upside.  The below benchmarking exercise attempts to show Sorin’s potential future value if capable of achieving peer average operating performance and/or management’s targets (all equity prices and metrics converted to USD):

Valuation