Following General Electric's (NYSE:GE) third-quarter earnings report, it became clear that when Danaher (NYSE:DHR) completes its acquisition of GE's biopharma business in 2020, it will be getting the growth business of GE Healthcare. Moreover, the recent GE Healthcare investor day only served to reinforce the idea that Danaher is getting a great bargain in the deal.
Here's why, and what it means to both sets of investors.
Why the GE Biopharma deal is great for Danaher
There are three key reasons:
- The valuations on the deal are at a substantive discount to Danaher and peer-group valuations.
- Recent data and GE management's projections confirm that Biopharma is the growth business of GE Healthcare; the biopharma business may be outperforming expectations in 2019, while GE Healthcare ex Biopharma is probably underperforming.
- Biopharma is a complementary fit for Danaher's life-sciences businesses, and the fact that 75% of revenue comes from consumables will help Danaher with its aim of increasing its less cyclical recurring revenue.
The valuation looks very attractive
The value of the deal is $21.4 billion, but Danaher expects a tax benefit of $1.4 billion, so the net price is closer to $20 billion. But what is Danaher getting for its $20 billion?
GE's Biopharma unit manufactures resins and equipment that help biopharma companies research and produce blockbuster biopharmaceuticals used in immunology (for example, in rheumatoid arthritis). These include Johnson & Johnson's Remicade, Abbvie's Humira, and Roche Holding's Rituxan -- some of the best-selling drugs of all time.
GE's Biopharma unit operates in attractive markets, and the price being paid for it looks good too:
- According to GE's investor-day presentation, the Biopharma unit generated $1.1 billion in free cash flow (FCF) in 2018, compared to $1.9 billion for the rest of GE Healthcare -- implying a deal valuation of 18.2 times 2018 FCF.
- According to Danaher's projections, it will be buying the business at an enterprise value (EV) -- market cap plus net debt -- of 17 times EBITDA (estimated earnings before interest, tax, depreciation and amortization) for 2019.
Let's compare these figures -- 18.2 times FCF and 17 times EBITDA -- with the valuations of Danaher and its peers. Frankly, the GE Biopharma deal is at a lower valuation.
The deal was announced on Feb. 25; note in the chart below how Danaher's valuation has since risen compared to its peers. The market may have been merrily pricing in just how good a deal this is for Danaher:
Biopharma is the growth business of GE Healthcare
This argument has been strengthened recently. At the healthcare investor day, GE Healthcare CFO Monish Patolawala commented on his annual sales growth estimate that "around 3% is what we will end up [with] on an organic basis, in total." Frankly, this is disappointing guidance, considering the previous outlook was for growth in the mid-single digits. However, it appears that GE's Biopharma is not the laggard here; in fact, it looks like it's outperforming.
GE Healthcare has two subsegments -- healthcare systems ($14.9 billion worth of revenue in 2018) and life sciences ($4.9 billion). Biopharma sits in the life sciences subsegment, with pharmaceutical diagnostics being the other business. Biopharma generated around $3 billion in revenue in 2018, and the implied guidance given at the recent healthcare event was for $3.1 billion to $3.5 billion revenue in 2019, representing growth of 3% to 17%.
This tallies with what GE has reported so far in 2019. For example, in the third quarter, healthcare systems revenue grew by just 2% compared to 12% at life sciences; healthcare systems orders were flat organically, but life sciences' were up 10% organically.
Moreover, GE sees the global market for its healthcare business excluding Biopharma growing at 3%-4%, while Danaher sees the Biopharma unit's revenue growing at 6%-7% annually. There's little doubt about it. Life sciences is the growth business of GE Healthcare, and Biopharma is the growth business of GE's life sciences subsegment.
What it means to both sets of investors
For Danaher, it's clear that it's getting a business firing on all cylinders at a very attractive valuation -- consumables revenue in the Biopharma unit will drive FCF growth in the future, while Danaher expects to generate $100 million of cost savings by the third year. Add a billion dollars' worth of Biopharma FCF to Danaher's current FCF of $3.35 billion. At a price-to-FCF ratio of 30, that would give a market cap of $130.5 billion, compared to the current market cap of $106 billion.
For GE, the deal makes sense in the context of the company's debt-reduction plans, even if there's a sense the price could have been better. Moreover, the near-term guidance for GE Healthcare ex-Biopharma is disappointing, even if the longer-term outlook is OK.