Description

Synavant Inc. is a new spinoff from IMS Health that provides software and other products and services to help drug companies market their products. Basically they use information technology to help drug reps target the doctors most likely to prescribe and help get the word out about new drugs out to these doctors. They also have other associated businesses. This is a rapidly growing field with the increasing competition among pharmaceutical companies due to consolidation in the industry and the increasing use of out-sourcing to cut costs. Recently, Synavant formed an alliance with Siebel Systems (a leader in ebusiness applications) to create the next generation of their software so that it ties together all aspects of sales, marketing and service (and integrates the Internet).

Synavant appears to be losing money if you just take a cursory look but if you dig into the Form 10 you’ll see that, in fact, this is an extremely high quality company in terms of cash flow and is currently very cheap. What penalizes the earnings heavily is the amortization from an acquisition made in 1998 that added large amount of goodwill. A cash flow perspective is the right way to look at this company. It has a TEV and Market Cap of approximately $140 million (15.7 million shares outstanding at $9, no long term debt, leaving in the cash since the amount is small) and 1999 EBITDA of 29 million (adjusted by not counting Y2K costs). TEV/ EBITDA is thus approximately 4.8 times. Sales are $202 million for the year ending Dec. 1999 (all figures will be for that year unless otherwise noted) so the Price/Sales Ratio is about 0.70. Sales have grown from $74 million in 1995 to $202 million in 1999. Free Cash Flow is $14 million (this is subtracting all capex since I haven’t yet received a maintenance level from the company). TEV/FCF is thus 10 times and is thus lower when only maintenance capex is used to calculate FCF &-106; I’m guessing it’s around 7. Deducting Goodwill, assets are $100 million and Equity is $54 million and using FCF of $14 million the ROA is 14% and the ROE is 26%. The EBITDA margin on sales is 14.5%. Compare this to one of its main competitors Dendrite which has a market cap and TEV of $1.0 billion with sales of $192 million and EBITDA of $48.1 million (these numbers for Dendrite are from Yahoo but I verified that they are approximately correct by checking the 10K). Dendrite is growing rapidly had a great quarter. Dendrite sports a TEV/Sales of 5.6 times and a TEV/EBITDA of approximately 20 times with a ROA of 20% and a EBITDA margin of 25%. Clearly this is a good business to be in. The disparity between the valuations of these two companies is striking; Dendrite is better run judging by the financial ratios but Synavant isn’t too far off. If Synavant traded at Dendrite’s ratios it would have a TEV of between $500 million and $1.1 billion which would imply a share price of between $30 and $70. Just one more indication of how cheap Synavant is: the June 1998 acquisition of Walsh (the amortization of which runs about $13 million a year for the goodwill and $6.7 million for software) was for approximately $175 million in stock which is more than the current TEV and Market Cap of Synavant.

So why is such a rapidly growing, high quality software business so cheap? Well it’s a seemingly money-losing microcap just spun off from an S&P 500 company in a 1 for 20 distribution. And to think the post spinoff selling may not even have even really started yet and it's already very cheap. The only realistic possible negatives I see are: 1) Dendrite’s growth may be coming from Synavant. But, even if this is true and I have no evidence for it, as a independent company Synavant should be able to do a better job competing. 2) There is a chance that the transition to the next generation of software with Siebel could go wrong or be delayed. However at these prices that is a not a huge risk. 3) Top-line growth may be stalling but the Siebel deal should help revive it.

Insiders also have massive incentives to increase shareholder value. According to the Form 10 management has options (converted from IMS options) equivalent to 24% of the fully diluted common stock of Synavant at the time of the distribution and another 11% of outstanding shares have been reserved for new incentives after the distribution is completed. I have rarely if ever seen a management that had such large incentives.

Catalyst

The spinoff has set free a gem of a company that will eventually be recognized, most likely within the next 2 years. Management has huge incentives to get the story out and with the improved focus of being a stand-alone company margins and returns may get closer to Dendrite’s levels. The Siebel deal will also be a big opportunity to increase growth as many customers will upgrade to the new technology. If the stock languishes this company would very likely get acquired either by Dendrite or another competitor or by a management-led LBO.