Description

Thermo Fisher Scientific, Inc. may not be a company that most value investors have on their “watch lists.”  But it should be.

TMO was created when Thermo Electron and Fisher Scientific merged in a stock-for-stock transaction on November 9, 2006.  The combined enterprise has the goal of being the “world leader in serving science” by providing analytical instruments, equipment, reagents and consumables, software and services for research, manufacturing, analysis, discovery and diagnostics.  The results that the company has delivered since the merger indicate that it is well on its way toward satisfying that objective.

What’s to like about TMO? 

For starters, it is very big and very profitable: TMO will generate approximately $9.6 billion of revenues and over $1.1 billion of net income in 2007.  With a market cap of over $25 billion, TMO is large enough for virtually any investor.  TMO earns 45% pretax returns on tangible capital, has high margins (41% gross margins and 17% adjusted operating income margins) and has favorable cash conversion characteristics (free cash flow equates to 85-90% of net income). 

With size come scale advantages: TMO possesses the broadest portfolio of technologies, products and services in the industry as well as extensive customer reach.  And TMO has strong brands: 70% of revenues come from products that carry TMO’s own brands (the two key brands are Thermo Scientific – a technology brand focused on sciences – and Fisher Scientific – a brand targeted toward procurement and laboratory managers, representing convenience).

TMO views itself as a consolidator of the industry.  Its own merger integration is going well, and it expects to make more acquisitions, some significant, in the future.  TMO currently represents roughly 1/8 of the industry (end market is between $70 and $80 billion).  It is comprised of Life Science (46%); Industrial, Environmental & Safety (34%); and Healthcare (20%). 

With size also come diversification advantages.  TMO deals with a customer base that is fragmented.  There are over 300,000 customers in 150 countries.  No single customer accounts for more than 10% of TMO’s business.  And the product mix is extensive: 54% consumables, 30% instrumentation and 16% software & science.  Finally, TMO does significant business in international markets, with North America accounting for 66% of sales, Europe 24% and Asia/Rest of world 10%.  This broad customer, product and geographic range help create a stable business.

TMO is securely capitalized: the balance sheet is solid with only $1.4 billion of net debt.  The Total Debt/Capital ratio is only 14% and Debt/EBITDA is 1.5x.  Of course, there is capacity to take on much more leverage when the time is right.

For investors who prefer less guidance rather than more: TMO provides only annual guidance, not quarterly.  This is a step in the right direction toward attracting real owners.

All of these favorable characteristics add up to a big company that can grow at well above average rates for a long time.  Specifically, over the next 3 years it would be reasonable to expect revenue growth of 7% compounded (6-7% organic) and earnings per share growth of 20-22% compounded.  How do we get there?

TMO reports in two segments: (1) Analytical Technologies and (2) Laboratory Products and Services. 

The Analytical Technologies segment serves the pharmaceutical, biotechnology, academic, government and other research and industrial markets, as well as the clinical laboratory and healthcare industries.  This segment has six principal product groupings - Scientific Instruments, Biosciences, Integrative Technologies, Diagnostics, Environmental Instruments and Process Instruments - and provides a broad range of instruments, bioscience reagents, software and services to address various scientific challenges in laboratories, in manufacturing and out in the field.  Analytical Technologies will do in excess of $4 billion in revenues this year and nearly $800 million in operating income.  This performance represents 11% revenue growth and close to 20% margins.  Management anticipates that revenues will grow at a 7-9% organic rate and that margins will increase to 22-23% by 2009.

The Laboratory Products and Services segment offers a combination of products and services that allows customers to engage in their core business functions of research, development, manufacturing, clinical diagnosis and drug discovery more accurately, rapidly and cost effectively. It serves the pharmaceutical, biotechnology, academic, government and other research and industrial markets, as well as the clinical laboratory and healthcare industries. This segment has six principal product groupings - Laboratory Equipment, Laboratory Consumables, Research Market, Healthcare Market, Safety Market and BioPharma Services - and provides products and integrated solutions for various scientific challenges that support many facets of life science research, clinical diagnosis and workplace safety.  Laboratory Products and Services will do nearly $5.7 - 6 billion in revenue and over $770 million in operating income.  This performance represents 6% revenue growth and over 13% margins.  Management anticipates that revenues will grow at a 5-6% organic rate and that margins will increase to 15-16% by 2009.

Since the merger took effect, management has delivered more than it has promised.  The consolidated company now produces nearly $10 billion in revenues and over $1.5 billion in operating income.  Management is working toward a consolidated operating income margin goal of 19-20% (compared to the current 16-17%) and FCF to Net Income conversion of 100%.  If these goals are achieved, the company would be earning cash profits of $3.50-4.00 per share in 2009 and would have ample room for continued above average growth.  The shares are probably worth in the high $60s today – and can be owned for a long time without having to worry about finding the next cigar butt.

Catalyst