Monday, December 8, 1997

Horizon Pharmacies, Inc.
Phone: 972-736-2424
Price (12/5/97): $11 7/8


The sun never sets on this Horizon without the stock price rising. Or so it seems. Shares of this drug store chain have quadrupled since its initial public offering at a split-adjusted $3.33 a share in July.

Horizon is actually executing its stated strategy of gobbling up independently owned stores and improving profits partly by changing their sales mix. Third quarter results reported Nov. 14 showed sales up 93% while same-store sales increased 13.2%. Backing out one-time charges, profits tripled and earnings per share jumped 50% to $0.04 (split adjusted).

Investors have piled on for part of the action. After raising $5.5 million in July, Horizon hustled up another $4.3 million in a private placement in October that went at twice the IPO price. Follow-up stock offerings often worry investors. In this case, the offering increased shareholders' confidence since it provided cash for even more deal making.


Based in Princeton, Texas, Horizon was founded in 1994 as a vehicle for acquiring and consolidating a chain of retail pharmacies primarily located in towns with populations of fewer than 50,000. The company has grown rapidly to 23 stores, mainly in the West and Midwest, with nine pharmacies purchased since its July IPO. The firm plans to purchase eight to twelve pharmacies annually.

Horizon's strategy is to maintain the individualized feel and customer service features of the pharmacies it buys while enhancing profitability through greater use of technology and access to more competitively priced inventories.

The company also hopes to expand its higher-margin home healthcare and non-pharmaceutical sales and services while becoming less dependent on prescription drugs, which account for 80% of sales. A model for the future is its Farmington, New Mexico store, which sells and leases medical equipment and offers home healthcare services such as IV infusion and home oxygen therapy.

Insiders own about 25% of the company. The stock recently split 3-for-2.


Income Statement*
9-month sales: $24.5 million
9-month income: $0.43 million
9-month EPS: $0.19
Profit Margin: 1.8%
Market Cap: $52.6 million (Based on 4.43 million shares)
(*Pro forma for first nine months of FY97 as adjusted for the split and acquisitions. EPS excludes one-time tax charge of 4 cents per share.)

Balance Sheet*
Cash: $1.3 million
Current Assets: $10.9 million
Current Liabilities: $3.6 million
Long-term Debt: $2.6 million
(*As of Sept. 30, 1997. Does not account for $4.3 million raised in an October private placement or recent acquisitions.)

Price-to-earnings: N/A
Price-to-sales: N/A


When investors think an industry consolidator has the wherewithal to make the businesses it buys more profitable, they may bid up the consolidator's stock, allowing it to use its pricey shares to acquire other companies on the cheap. For this magic to occur, investors must believe the story.

Horizon didn't appear to inspire that willing suspension of disbelief. It was small. Plus, lead underwriter Capital West lacked experience. Even after the stock's strong start, the company seemed constrained by its small acquisition war chest. Then one had to wonder about valuation. This double would have been hard to predict.


The lone earnings estimate offered by First Call doesn't make any sense aside from the aggressive 75% growth projected for next year. So we're on our own.

Horizon is a moving target, but its pro forma income shows 1.8% profit margins. That compares to projected margins for this year of about 2.5% to 2.8% for drug store giants like CVS (NYSE: CVS) and Rite-Aid (NYSE: RAD). Each is far less dependent on prescription drugs sales than is Horizon.

Both of these behemoths have also adopted a consolidation strategy that has sent their own stock prices soaring so that they now trade at an enterprise value slightly below this year's sales. Even assuming a gangbuster fourth quarter gets added to the three new acquisitions already announced (good for $5.7 million in annual sales), Horizon is far more richly valued, likely sporting an enterprise value well over this year's pro forma sales.

Chair/CEO Rick McCord has said the company likes doing deals that are about 50% seller-financed (at 8% to 8.5% interest), with the difference split between cash and stock. The company has $5.3 million in available cash, or $7.8 million if all options and warrants are exercised. So Horizon will likely see its shopping constrained by debt well before it runs low on cash.

The key is the price of its acquisitions. In four recent deals, Horizon added about $7.2 million in annual sales for just $1.3 million in cash, debt, and stock. That means Horizon paid 0.18 times sales for these pharmacies while its own stock sells for maybe 6 times that amount. On this basis, this drug store chain would appear to have a better chance of becoming a Trouble than a Double in the next year unless it can markedly improve profits.

Yet, the stock is trading on the assumption that Horizon can buy more sales over the next year, making this enterprise value-to-sales disparity less outrageous. As long as investors believe that story (and thus keep the stock price high enough to do another offering and then another), this Horizon might just keep expanding.

Still, even if financing doesn't get in the way, the industry titans might. Then there's Wal-Mart (NYSE: WMT), which is making its own drive to claim a bigger chunk of small-town America's pharmaceutical sales.

-- Louis Corrigan

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