The number of Initial Public Offerings (IPOs) certainly heated up in the second half of 2013, and it seems that the pipeline of floats could be just as voluminous in 2014.

Despite the extraordinary demand – on occasions we heard that it was six to 10 times the supply – the share prices of several IPOs are trading at or below their issue prices. This may present a favourable opportunity for investors wishing to enter selected companies they initially missed out on.

A medical opportunity

LifeHealthcare (ASX: LHC) is one float Montgomery Investment Management participated in. A microcap, it is currently trading at $1.96, a tiny discount to its $2.00 per share issue price. In recent weeks a number of institutions, including IOOF, Investors Mutual, Renaissance, AMP, Watermark and Northcape, have all announced a substantial shareholder position of greater than 5% of the 42.5 million shares on issue.

LifeHealthcare is a distributor of high-end medical devices in Australia and New Zealand, and we believe it is a high quality business with very solid prospects for growth. Half of the company’s revenues are derived from the distribution of implantable devices such as spine and joint prostheses. The remaining products in its portfolio include non-implantable devices such as surgical instruments, and capital equipment such as ultrasound machines.

LifeHealthcare (LHC)

Source: Bloomberg

The company services global medical device manufacturers without direct distribution in Australia. These suppliers either cannot achieve scale, or do not have access to Australia, and are willing to pay a margin for the local distribution. LifeHealthcare has done very well with this arrangement, with EBITDA to revenue margins approaching 20%, and an after tax return on equity that is forecast to hit 20%.

A strong sales force

Montgomery typically shies away from distribution businesses as they generally find it difficult to differentiate themselves from their competitors. But LifeHealthcare’s competitive advantage shines through in the form of its sales force.

The LifeHealthcare sales force must have an intimate knowledge of the prostheses and the devices they supply, while building lasting relationships with their surgeon customers. When a surgeon becomes comfortable with a piece of equipment, they are more likely to continue their relationship with the supplier – as any changes may require considerable training and adjustment time. This dynamic can translate into sticky revenues.

LifeHealthcare has grown the number of surgeons in its network from 52 in 2010 to 83 in 2013, and has increased the annual revenue per surgeon by 41% over this period.

Generally, we like businesses that receive a “higher share of wallet from a growing customer base”. LifeHealthcare’s forecast revenue for fiscal year 2014 of nearly $90 million is only a fraction of the addressable $6 billion Australian and New Zealand market, which is forecast to grow at 6% annually.

Acquisition plans

We understand that LifeHealthcare’s CEO, Daren McKennay, is on the lookout to acquire smaller distributors in Australia and possibly Asia. The successful introduction of new devices by LifeHealthcare’s suppliers could add further growth.

While the company has bright prospects, there are a number of risks that investors should consider. If the global manufacturers decide to market directly to hospitals, this will significantly impact the viability of LifeHealthcare’s distribution model. To mitigate this risk, LifeHealthcare signs exclusive long-dated agreements with suppliers. The contract with its largest supplier, which comprises 30% of its revenues, is set to expire in 2018.

LifeHealthcare must also continue to effectively manage its core asset – its salesforce. While management believe staff are adequately compensated and incentivised, any attrition could be a considerable drain on the company’s position.

We believe LifeHealthcare may earn 18 cents per share and pay out 13 cents per share in dividends in fiscal year 2014. At the recent share price of $1.96, this places the company on a prospective price to earnings multiple of 11 times with a dividend yield of 6.6%. While the company’s share price has generally traded at a small discount to its $2.00 issue price since its float in early December 2013, this may present an opportunity for investors who initially missed out.

Of course, we encourage all investors to conduct their own research and seek personal, professional advice before making any investment decisions.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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