Nuance Dictates an Acquisition

"It took a few minutes to sink in, but I realized yesterday that it's been an awfully long time since Motley Fool Hidden Gems recommendation Nuance Communications (Nasdaq: NUAN  ) bought another company." -- Dave Mock, Sept. 20, 2007

"Here you go, Dave. We've got you covered." -- Nuance, April 8, 2008 (paraphrased)

After spending much of last year beefing up its mobile-devices business -- providing voice-activated functionality to customers as diverse as Motorola (NYSE: MOT  ) , Nokia (NYSE: NOK  ) , Palm (Nasdaq: PALM  ) , Research In Motion (Nasdaq: RIMM  ) , and Garmin (Nasdaq: GRMN  ) -- Nuance refocused on medical transcription Tuesday, when it announced a $400 million deal to purchase eScription.

Nuance describes eScription as a "leading provider of computer aided medical transcription technology" -- a $7 billion-a-year industry in the U.S. alone. And while both Nuance and its Massachusetts neighbor eScription are mere guppies swimming in this great sea of cash, they're guppies with a voracious appetite for growth. Nuance says that its iChart "on-demand, hosted health care solution" is growing at 30% to 40% a year. Next year, it should dwarf that pace, as eScription's $65 million-ish 2009 revenue should swell Nuance's own on-demand medical transcription business by as much as 50% -- to perhaps $200 million in annual revenue.

At a cost
Investors liked the sound of that, bidding Nuance shares nearly 6% higher in the wake of Tuesday's news (before the markets turned red this morning). But beware -- this growth comes at a cost. Nuance predicts that buying eScription will subtract $0.08 or $0.09 from its GAAP profits this year, and $0.15 or $0.16 next year. Buying its neighbor will cost Nuance $340 million in cash, $23 million in Nuance stock, and $37 million in assumed stock options -- $400 million in all.

Is that a lot, or a little?
Personally, I think it's rather a lot. Nuance is valuing eScription at about 6.2 times next year's anticipated sales. If we assume the analysts have their revenue estimates right, Nuance's own stock sells for just 3.6 times next year's sales. Then again, it sounds like eScription is growing even faster than Nuance's own blistering 20%-per-year pace.

It's also worth pointing out that the $340 million cash portion of the purchase price is actually a bit more than Nuance has on hand. To finance the deal, and keep itself solvent, Nuance is therefore inviting Warburg Pincus to buy 5.8 million of its shares at a discount to today's share price, plus warrants to buy another 3.7 million shares at $20 apiece at any time in the next four years. Total cash infusion: $100 million.

Total potential dilution to current Nuance shareholders, from Warburg Pincus' helping hand, the paid-in-stock portion of the purchase price, and the assumed eScription stock options: A little more than 6%.