I'm Putting Real Money on Harvard Bioscience

Microcap Harvard Bioscience (NASDAQ: HBIO  ) is spinning off a high-potential, loss-making division, and the market isn't recognizing the value, leaving an attractive special situation. My Special Situations portfolio is buying $1,000 of the company on the next market day.

The business
Harvard Bioscience has two divisions: the Life Science Research Tools unit and the Regenerative Medicine unit. The latter business, called Harvard Apparatus Regenerative Technology, or HART, gets all the headlines for its regenerative medicine, which produces replacement organs using stem cells. The U.S. Department of Health and Human Services estimates a $100 billion market for regenerative medicine in the coming years.

Currently, HART's trachea product is in the clinical stage, and it foresees using its methods to grow organs such as hearts, livers, and kidneys for transplants. Initial work has been positive, with successful tracheal transplants reported in the peer-reviewed journal The Lancet, as well as mainstream papers such as the Wall Street Journal and New York Times. Commercialization won't begin until 2015, if the company receives EU approval for its first product. It's all exciting stuff, but I'm not interested.

What I am interested in is the remaining parent, the tools division, which is about as boring as the other division is exciting. It develops, manufactures, and markets specialized products for the life sciences, including syringe pumps, ventilators, and spectrophotometers, among 11,000 other products. Harvard focuses on this range of niche offerings in order to fly below the radar of the bigger players. It uses direct sales (58% of revenue) -- such as its salesforce, website, and 850-page catalog -- but also third-party distributors (42%) to sell to researchers at universities, government labs, and pharma companies.

To grow, the company uses a combination of in-house product development and tuck-in acquisitions (25 since 1996) that leverage its distribution network. Using this approach, Harvard Bioscience targets a 15%-20% annual growth in earnings per share.

The special situation
Harvard Bioscience is undertaking the quintessential Greenblattian special situation: a spinoff of a high-potential, loss-making division from a stable, cash-generating parent. Removing the loss-making division from Harvard's books, the transaction should double the parent's profitability, leaving a very cheap stub stock. And where does that losing division go? It becomes a clinical-stage company working in regenerative medicine. That spinoff has sex appeal to spare, but I'm interested only in the cheap parent.

Harvard intends to sell 20% of the subsidiary for $20 million in an IPO shortly, retain the remaining 80% for four months, and then spin that stake out to shareholders. Because the spinoff should comprise such a huge portion of Harvard's market cap, I want to own the stock before the transaction happens.

It's also great to see a management that wants to create value through a spinoff, instead of having its arm twisted by activist investors. But that makes a lot of sense, since management owns 14% of the stock outright and has another 14% via options.

For the year, Harvard Bioscience expects non-GAAP (ahem, "adjusted") earnings in its life science division of about $11.5 million, or $0.40 per share. Its HART unit expects to lose $6 million this year. So what could Harvard be worth as two separate businesses?

In the table below, I've chosen a range of earnings for the parent (in millions) and a range of multiples. For the valuation of HART, I've used a 40% haircut up to the full implied value of the IPO of $100 million.

Parent earnings

Multiple

Parent Valuation

Value of HART

Total Value

Upside

Price Per Share

$8

8

$64

$60

$124

(4%)

$4.32

$9

10

$90

$70

$160

24%

$5.58

$10

12

$120

$80

$200

55%

$6.97

$11

14

$154

$90

$244

89%

$8.50

$12

16

$192

$100

$292

127%

$10.18

With the spinoff providing a clear valuation on that side of the business, we have little downside on the remaining parent and the possibility of substantial gains -- low-cost optionality. As a rough guide, it looks like the parent is trading at three times earnings, netting out HART's full implied value of $100 million. And remember that the parent aims to grow earnings 15%-20%, something that should draw Wall Street's attention. I peg the downside at $4 and the upside at $10.

Risks
The most obvious risk is that the IPO of HART doesn't happen. The IPO market has been somewhat weak lately, and selling even $20 million of HART stock -- despite the potentially huge upside -- could be difficult. Even if the IPO does happen, execs may decide at any time to shelve the spinoff. But that seems unlikely, given management's buy-in and the strong economic rationale for the transaction.

Even if the spinoff happens, the small size of Harvard Bioscience may mean that it remains underfollowed. The market may not notice the high growth Harvard is aiming for, and would be unlikely to pay a high multiple for the stock, trimming the possible upside.

Harvard Bioscience relies a lot on acquisitions to grow its revenue, so the company needs to make smart buys. For serial acquirers, in particular, this is a big risk. In Harvard's case, it has $59 million in goodwill and intangibles of a total $131 million in assets -- relatively huge. This risk is mitigated by the fact that Harvard's purchases are largely "tuck-in," so that any one bad purchase is unlikely to hurt much. Also, the high executive stock ownership -- the CEO has 8.4% -- should help protect us against reckless empire building. But a series of bad buys could leave us questioning management's acumen.

Foolish bottom line
On the next market day, I'll be buying $1,000 of Harvard Bioscience in my Special Situations portfolio.

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Interested in Harvard Bioscience or have another stock to share? Join me on my discussion board and follow me on Twitter (@TMFRoyal).


Read/Post Comments (6) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 22, 2013, at 9:33 PM, MKArch wrote:

    Jim,

    You mention managment targeting 15%-20% earnings growth for the core tool business but what is it's historical growth rate? How realistic is the growth target for this segment?

  • Report this Comment On January 23, 2013, at 1:50 PM, TMFRoyal wrote:

    Hi, MKArch,

    The historical earnings issue is a bit difficult to tell on a stand-alone basis.

    For the future, they've broken this 15-20% projection down into several components:

    Organic growth -- 3-7%

    Acquisitions -- 10-15%

    Operational improvements -- 0-5%

    Without the investment needed in HART, they were losing $6 mn a year pre-tax there, that's a lot of extra cash.

    Jim

  • Report this Comment On January 26, 2013, at 3:06 PM, MKArch wrote:

    Thanks Jim,

    I lost track of your article and just now see your response. I did a little reading up and believe they only break out the core business last year. I think they only broke that out to the operating profit level. From what I can tell though it looks like they don't derive any revenues from the HART segment. So I looked at revenues and gross profit goinh back to 2005 as a proxy for how the core business grew and come up with and average of ~9% growth rate over the period for both revenues and gross profit.

    I figure 10% growth is a fair bet and at the $0.40 (non GAAP) earnings projected for 2012 and 15X multiple that gets the core business to ~$6.00/ share. Based on the operating income they reported for LSRT separately last year I get earnings of ~$0.30/ share and a fair value of ~$4.50/share. If the implied $100M value to the HART segment holds up after the spin off that's $3.50/ share for HART. To me it looks like you are getting the core LSRT business for about fair value right now and what ever HART ultimately fetches for free. Good enough for CAPS anyway. I might take a shot with real money after the next report.

  • Report this Comment On February 16, 2013, at 3:28 PM, HGolf92 wrote:

    Hey Jim,

    I was wondering how you got the expected earnings data on Harvard Life Science and Regenerative Technology divisions. It didn't seem to be on the 10k.

    Could you talk more about 10-15% projections you mentioned as well? Because revenue basically stopped growing in 2010 and 2011.

    Thanks!

  • Report this Comment On February 18, 2013, at 1:57 PM, TMFRoyal wrote:

    Hi, HGolf92,

    This figure was from the company's presentation late last year. I believe you can find that on the company's website.

    My apologies for the delay in response. I don't check back on the articles frequently, but you can always reach me on my message board.

    Jim

  • Report this Comment On April 10, 2013, at 11:06 AM, erblack4 wrote:

    JIm,

    Is it game off on the special situation now that the IPO has been postponed due to "market conditions"?

    Thanks, Bob

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11/21/2014 4:00 PM
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Harvard Bioscience… CAPS Rating: ****

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