Like Jeremy Grantham (https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIDcqoAT4ld7GKOHZUG9JWP9W5DQj1S%2fKmc5I%2bGUtYqbld%2bgoxFi%2bzMxE5NIA5TqSh4m7rb%2ftlzv8S5igV%2fiBd%2fq%2fxcADvA%2f0tZWAiFYaz4zzw%3d%3d), I see quite a few high-quality, fairly acyclical, decent-growth companies trading at cheap multiples. These opportunities have no hard catalysts, but many are attractive takeout candidates and priced at attractive levels on both an absolute and relative basis. 

Thermo Fisher Scientific (TMO) is one of my favorite such opportunities.  

TMO develops and manufactures scientific instruments and agents used in scientific and medical processes. It serves several sectors: biotech/pharma, hospitals and medical labs, universities, and government agencies. It has been written up on VIC previously and it is a fairly simple company to understand.   

The idea highlights are: 

- Valuation is 13x Unlevered FCF

- Organic growth in the mid-to-high single digits (6+%)

- Extremely high ROIC, 50+%

- Simple business that has only mild cyclicality

- Strong competitive advantage that gets stronger over time due to scale, brand and customer switching costs, and breadth of product line

- Unlevered balance sheet with net debt 0.4 x EBITDA

- High quality management that has made smart acquisitions and has not wasted capital

- Ideal private equity opportunity; however, management has not indicated any willingness to sell and its size would make it a deal as large as First Data and ClearChannel

- Recent selloff (from $50 to 42) sparked by 50bp adjustment to revenue forecast that was fully explained by strengthening dollar. It is difficult for me to see how market did not have its revenue adjusted automatically as dollar moves around, and it is difficult for me to understand how the "news" affects the valuation more than a percent or two. Anyhow, I do believe it has provided an opportunity. 

Valuation (I used $45 price although I realize it jumped closer to $46 halfway through writing up the idea) 

417mm shrs * $45.00 = $18,770mm mkt cap

Net Debt = $2,139mm - 1,317mm = $822mm

TEV = $19,592mm  

Revenue 2010 = $10.7bn

EBITDA '10 = $2075mm 

Here, we need to get into a little complexity regarding TMO's amortization and taxation. Using GAAP accounting, TMO has a very high D&A of $780mm. However, this number is meaningless because it includes $585mm of amortization related to acquisitions. And 75% of this amortization has no tax effect because it is the result of a stock-for-stock merger (namely, the Thermo Electron and Fisher Scientific merger). For tax purposes, we should only use a $145mm tax shield and disregard the $440mm of amortization related to non-taxable mergers. If you use the entire amortization amount as a tax shield, your free cash flow number will be much too high and your cash taxes paid will not match reality. 

Adjusted EBIT = $2075mm - $195mm (depreciation) - $145mm (amortization that affects taxes) = $1,735mm 

Due to foreign tax rates and R&D tax credits, TMO's normalized tax rate is about 20% (as indicated by company and as borne out by cash taxes paid). 

So, NOPLAT is $1,388mm. But, all-in capex (required for organic growth) is about $200mm versus adjusted D&A of $340mm. 

So, FCF to Unlevered TEV is $1,528mm (12.8x); This translates to "Cash" EPS of $3.50/shr ((1528 - 66 (interest))/417). 

To reconcile the company's Adjusted EPS forecast of $3.45/shr --> $1,439mm to Unlevered FCF of $1,516mm,  we need to make three adjustments. First, we need to add net interest (tax adjusted) of $66mm to Adjusted EPS. Second, we need to add the amortization tax shield (20% * $145mm = $29mm). And finally, we need to subtract the amount by which all-in capex exceeds Depreciation ($5mm).     

Note that my EBITDA and the company's adjusted EPS only adjusts for restructuring, tax rates, and amortization. Non-cash compensation and other expenses are included. This should be a true cash number.

Even in this market, I think that a company of TMO's quality and growth should be trading at 17-18x, which gives us $63 (+40%). 

----- 

The company has three major sources of long-term secular growth: (1) Increased market share, (2) Secular growth of customer base, and (3) Expansion into Asia.  

TMO's target market (laboratory equipment and consumables) is enormous and it has at most 20% market share, even though it is the largest player in the field.  

The medical, environmental, and chemical fields that TMO sells into, like most scientific fields, should grow as fast or faster than GDP. 

TMO is a global footprint with a global brand. Foreign sales now account for a third of revenue, and growing. And due to international training of scientists, the brand should translate well across the globe. Much better than a consumer product brand. 

Based on prior performance and managment comments, I expect organic growth of 5-7%. As well, management has fairly wisely deployed capital in acquisitions to add complementary products to their offering. 

----- 

The competitive advantage of TMO is based on four factors:

- scale: TMO has 10,000 sales and service people in the field and is the largest player in the fragmented field. Think Sysco and Ecolab. This scale and number of contact points enables TMO is expand into marginal areas either organically or via acquisitions. 

- brand and switching costs: the scientists and technicians in the field do not want to switch reagents. Consistency is important and once they become familiar with a product, they do not want to switch brands. They are not price sensitive. Admittedly, the procurement department is going to push back on this issue and argue that some of these reagents are commodities. I am sure this user/procurement dynamic differs from customer to customer. 

- breadth of products: management has argued that becoming a one-stop-shop is a tremendous advantage as procurement departments try to slim down the numbers of vendors.  

The scale and breadth of product moats certainly get stronger over time as they benefit from the fortuitous positive feedback loop that increased stregth begets more strength.