Description

Overview:

Utah Medical Products(UTMD) makes medical devices used in critical care areas such as neonatal intensive care units, the labor and delivery department in hospitals as well as products sold to outpatient clinics and physicians offices. Major products include:

INTRAN PLUS: An intrauterine catheter that allows doctors to perform
tests on amniotic fluids.
VAD: Helps pull baby out during pregnancy.
AROM-COT: Finger cover designed to rupture maternal membranes.
DISPOSA HOOD: Hood used to deliver oxygen to babies.
DELTRAN PLUS: Takes blood pressure of babies.
GESCO: Silicone catheters for critically ill babies.
LETZ System: Used to excise cervical lesions.
EPITOME: Electrosurgical scalpel.
LIBERTY SYSTEM: Treatment for urinary incontinence in women.
PATHFINDER: Endoscopic irrigation device.
ENDOCURETTE: Tissue sampling for cancerous change in uterus.
LUMIN: Tool used for manipulating the uterus.

Sales are broken down into the following segments: Worldwide Obstetrics(46%), Worldwide Gynecology(18%), Worldwide Neonatal (14%) and Worldwide Blood Pressure (22%). UTMD does not provide very specific sales data by product but close to 100% of the Worldwide Obstetrics sales are related to its Intran product. As a result, close 50% of UTMD sales are tied to this product. There are three main players in this market: UTMD, Clinical Innovations (private company in Utah) and a division of Tyco. According to the CEO of Clinical Innovations UTMD has roughly 50% of the market, Clinical Innovations has 20% and Tyco has 30%.

Overall UTMD tries to market its products as the higher quality choice. As a result they are usually not the low cost providers.

Current Valuation:

Price: $17.20
FD Shares: 5.65 MM
Market Value: $97.3
Net Debt: ($2.4)
EV: $94.8

LTM FD EPS: $1.30
LTM EBIT: $10.0
LTM EBITDA: $12.1
LTM FCF: $8.0 (as of 6/02, info not in latest PR)*

P / LTM FD EPS: 13.2x
EV / LTM EBIT: 9.5x
EV / LTM EBITDA: 7.8x
MV / FCF: 12.2x*

Investment Thesis:

1)

While UTMD has not grown its top line much in the last five years its management team has shown a great ability to create shareholder value:

- Company has reduced basic share count form 9.4 MM in 1996 to 4.91 as of latest Q:
1996: 9.452
1997: 8.495
1998: 8.273
1999: 7.197
2000: 5.978
2001: 5.210
6/02: 4.905

- UTMD recently announced a self-tender for roughly 15% of its shares or
750,000.

- Operating margins have increased every year for the last 5 years, now
over 37%.

- CEO clearly discusses his strategy of focusing on return on capital and
creating per share value for his shareholders.

2)

Company generates strong FCF:

- Earnings are roughly equal to FCF.

- There has been minimal capex in recent times.

- Judiciously uses FCF to buy back stock and paydown debt.

- Has grown ROIC (EBIT/tangible invested capital) every year for the last 5 years and is currently over 70%:
1997: 28%
1998: 37%
1999: 55%
2000: 61%
2001: 72%

3)

Margin of Safety:

- While UTMD is not the cheapest company out there it is quite inexpensive
for characteristics it exhibits and the value it has created.

- Comparable medical device companies easily trade over 20x EPS.

- Company would make a very accretive acquisition for most larger players.

- Eventually I think there is the real potential for a management led
buyout down the road.

4)

Tyco lawsuit:

- One of the main reasons for UTMD’s stalled growth in the last 5 years
has been its lost Intran sales to Softran which is made by Tyco. UTMD
has claimed Softran infringed on their patents and UTMD has recently won
an injunction on the Softran product and a $23 MM judgment against them.

- As a result Tyco has been ordered to stop selling its competing Softran
product until the appeal is final. The appeal is expected to take up to
2 years, however, in the mean time Tyco cannot sell its product.

5)

Estimated Returns:

- Based on discussions with the company UTMD claims they have lost around
$7 MM in annual sales to Tyco. Based on its current margins and tax
rates I estimate this would equate to roughly $.34 in incremental EPS
after adjusting for new share count and interest expense. Adding this to
FD PF LTM EPS of $1.35 would equal about $1.69 in PF EPS.

- If UTMD wins it appeal they would get after tax proceeds of $13.8 or
roughly $2.8 per share on PF FD share count of 5.0 MM. The amount will
be larger if they win because they will get additional interest damages
during the time of the appeal.

- If we assume UTMD can trade at least 15x PF EPS of $1.69(in 2 years) or
$25.3 plus $2.8 from the case we can get to a price of $28.1 per share.

- This price would equate to a 63% gain on current prices and a 28% IRR
over 2 years.

- I think the traction could even be greater as the company has said that
the Intran product is the main avenue they use to get in front of the
doctors and sell their other products. As a result, it would not be
unreasonable to assume they could gain other sales through the increased
Intran exposure. I have tried to be fairly conservative in my estimates
and as a result have not included this in my analysis.


Main Risks:

1) Loss of appeal to Tyco.
2) Not capturing lost Intran sales.
3) Intran comes off patent in 2004, although I am not if this is a big
deal since it has already been copied for the last 5 years.
4) Low float may never allow it to get a peer level valuation.
5) Someone comes out with a better technology making Intran and other
products obsolete.
6) Group Purchasing Organizations have historical tried to squeeze small
companies out of their buying. If this trend continues it could hurt
small guys like UTMD.

Catalyst

- Winning appeals case.
- Evidence in upcoming financials that UTMD is winning back lost Tyco
sales.
- Successful completion of self-tender.