Merge Healthcare Bids Seen on Digital Records: Real M&A

Merge Healthcare Inc., a medical-software provider that put itself up for sale, is betting U.S. government incentives to digitize health records will draw buyers to the industry’s biggest bargain.

Merge Healthcare said last week that it is exploring a possible sale after losing more than half its market value in the past year as it moved to a subscription-based pricing model from one that allowed it to book more revenue up front. The $314 million company traded yesterday at 1.24 times analysts’ projected 2012 revenue, the lowest price-sales ratio among U.S. application-software providers involved in health-care equipment and services, according to data compiled by Bloomberg.

Robert W. Baird & Co. said the company could attract buyers with its technology that allows doctors to store and share medical images, helping health-care providers qualify for as much as $14.6 billion in federal grants for converting to electronic records. While Merge Healthcare has more debt relative to its market value than 91 percent of peers, Thornburg Investment Management Inc. said a private-equity firm also may be interested because it can refinance the company’s borrowings.

Merge Healthcare has “a depressed valuation,” Eric Coldwell, a Chicago-based analyst with Baird, said in a telephone interview. U.S. health care is “going through a major transition from paper and manual processes to digital technology. A long-term focused observer might look at them and say that this could provide an unusual buying opportunity.”

Founded in 1987, Merge Healthcare provides software and services that let doctors and health professionals digitize and share medical images such as X-rays, mammograms and CT scans.

Pricing Switch

Merge Healthcare’s shares tumbled 36 percent on May 8 after the company said it was moving to subscription-based pricing from traditional software licensing arrangements, a switch it said would result in less upfront revenue and more sales reported over the life of a contract instead. Because of the switch, Merge Healthcare withdrew its forecasts for 2012 sales and earnings before interest, taxes, depreciation and amortization.

Last week, Merge Healthcare said it hired Allen & Co. to help the company in “exploring and evaluating a broad range of strategic alternatives,” including a possible sale.

Steve Oreskovich, chief financial officer at Chicago-based Merge Healthcare, declined yesterday to comment beyond the statement.

‘Cheap’ Stock

Shares of Merge Healthcare are down 30 percent this year to $3.41 as of yesterday, valuing the company at 1.24 times this year’s projected sales, according to data and analysts’ estimates compiled by Bloomberg. That’s less than half the average 2.86 times multiple for U.S. application software companies focused on health care with a market capitalization of more than $100 million, the data show.

“The stock is cheap,” Douglas Dieter, a New York-based senior analyst at Imperial Capital LLC, said in a phone interview.

Today, Merge Healthcare was unchanged, holding at $3.41.

Buyers may be lured by Merge Healthcare’s depressed shares and medical-imaging systems that can help health-care providers meet criteria for receiving federal grants, said Baird’s Coldwell.

Providers are eligible for government money under a $14.6 billion program that incentivizes a shift towards electronic medical records. The program, enacted as part of the U.S. economic stimulus law in 2009, makes hospitals eligible for payments of as much as $11.5 million if they can demonstrate “meaningful use” of the technology. Doctors can apply for grants of $44,000 or $64,000, depending on whether they treat patients in Medicare, the federal health program for the elderly and disabled, or Medicaid, the program for the poor.

Imaging Expertise

There are “a number of menu items that providers are going to have to adopt and one of them is imaging and having images connected to and interoperable with the electronic health records,” Coldwell said. “Merge’s expertise in that area might be interesting” to potential acquirers, he said.

The company’s relatively high debt levels might keep a potential acquirer from offering much of a premium, Deepak Chaulagai, a Minneapolis-based analyst with Dougherty & Co., said in a note to clients dated Sept. 7.

Merge Healthcare’s about $250 million in total debt is the equivalent of 80 percent of its market value, data compiled by Bloomberg show. Among its closest peers, only MedAssets Inc. has a higher ratio at 0.93, the data show.

Still, a private-equity firm could buy Merge Healthcare and refinance the debt at a lower rate, according to Lon Erickson, a Santa Fe, New Mexico-based money manager at Thornburg who oversees about $6 billion of taxable fixed-income assets, including Merge Healthcare bonds.

More Cash

Refinancing the debt would “significantly reduce your interest costs and increase the cash flow,” Erickson said in a phone interview. For buyout firms, that’s “something they could factor into their overall return calculations.”

Imperial Capital’s Dieter said that while transitioning to a subscription model will affect the timing of Merge Healthcare’s revenue, it doesn’t affect actual sales or the company’s long-term growth prospects. Dieter has a 12-month share-price estimate of $5 and said a potential acquirer may have to pay a premium to that price.

Merge Healthcare’s sales are projected to rise in each of the next three years and approach $300 million by 2014, up 28 percent from 2011, according to analysts’ estimates compiled by Bloomberg.

With investors in Merge Healthcare focusing more on the disruptions caused by the switch to the subscription model and less on the company’s long-term appeal, it has become inexpensive, Dieter said.

Merge Healthcare has “an excellent suite of products in a high-growth market,” he said. For a private-equity buyer, “it makes sense.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE