Acquiring Growth - Opto Circuits India

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There are very few companies listed on the bourses in India that have provided consistent topline and bottomline growth for a consecutive period of ten years. Opto Circuits India (Opto) which operates in the niche segments of the medicaldevices industry is one of them. Apart from its presence in the niche business segments and consistent performance, Opto has also been in the news on account of the acquisitions it has made in the past few years. The company has been very aggressive on the acquisition front having acquired 11 companies since 2000.Recently it has acquired a company in the US for USD 85 million, with 80 per cent of the acquisition cost financed through debt, resulting in questions like whether it will create growth opportunities for the company or will impact its earnings. What can be expected of the company going forward? How well does it stack up in the stakes of value creation for investors wanting to buy the stock? Here are the answers. But first, the business model.
The Business
Opto Circuits, that started its business as a supplier of sensors to large OEMs, has now developed into a full-fledged manufacturer of patient monitoring devices. It is now the largest medical devices maker from India.According to Valiveti Bhaskar Director Finance Opto Circuits, “When we acquire a company, we actually acquire technology. The acquisition provides us new products and new markets,but most importantly, new technology which is important in our field.” The company’s business can be broadly divided into non-invasive and invasive segments. The non-invasive segment which contributes around 72 per cent to the topline includes products like OEM sensors, pulse oximeters, etc. Initially the company had a presence only in the non-invasive segment, but it entered the invasive segment through the acquisition of Eurocor in the year 2006. The invasive segment includes stents which, according to the management, provides a higher growth opportunity. Opto has steadily expanded its presence in several geographies, including highly regulated markets like the US and Europe. Around 56 per cent of its business comes from North America, followed by 22 per cent from Europe, 15 per cent from the Asia Pacific region, and the rest from Middle America.
Growth Opportunities
Opto’s core business of non-invasive devices is getting stronger. We believe that the company will be able to sustain its current revenue growth of more than 20 per cent on[PAGE BREAK]

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the back of favourable market dynamics, cost competitiveness, diversified product offerings, expanding distribution reach, and high entry barriers. The global size of the market for the patient monitoring devices is estimated at USD 5.7 billion in 2011. This large market size offers Opto an immense opportunity to grow. We also feel that the entry barriers on account of the high technology base required for the business augers well for the company.The company’s cost competitiveness has helped it to sustain its margins over the years. One of the major reasons for its ability to grow rapidly is its cost competitive product offerings. Going ahead, Opto is setting up one manufacturing facility in Malaysia with an investment of Rs 150 crore. According to Bhaskar, this facility will go on stream from March 2011. The cost of manufacturing here will be slightly higher than that in India, butthe company will enjoy a ten-year tax holiday which will help reduce the production cost.
Invasive Business
In our opinion,Opto’s invasive business is its key long-term growth driver. This business consists of stents and catheters. The business has significant potential due to the large market opportunity and lower competition. Given its new product launches,increasing product awareness, and the opening up of a few regulated geographies, the company has good growth opportunities here. The size of the global coronary stent market is estimated at USD 7 billion. The US is a major market for coronary stents and contributes to around 37 per cent of the global market size. However, so far Opto does not have an approval to sell its stents in the USA.Further, Europe and Asia are also large markets and there is a significant opportunity for a niche player like Opto here too. “We are not supplying to the US and the Japanese markets which contribute to around 50 per cent of the demand. Still there is an opportunity of around USD 3.5 – 4 billion in the rest of the markets,” Bhaskar states.Inorganic Growth. The strong growth that Opto has been witnessing is partially driven by acquisitions. But of course there are certain issues that need to be noted here. It can be seen that the acquisitions have either resulted in higher debt or equity dilution. The FPO in 2006 followed by a preferential issue in 2007 and a QIP in 2009 are examples of the same.Recently,the company acquired Cardiac Science for USD 85 million. CSC manufactures advanced diagnostic and therapeutic cardiology devices and systems, including automated external defibrillators (AED).
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In 9MCY10, CSC posted a loss of USD 22 million at the EBIDTA level but the management believes that , CSC would turn EBITDA neutral in 4QFY11 and achieve EBITDA margins of 10-15 per cent over the next 12 months. But about 80 per cent of the consideration for this acquisition will be funded through debt, which will increase the interest cost for Opto.Historically, the cost of debt has been high (10-12 per cent) for the company owing to the nature of its business. Opto raised Rs 300 crore for the CSC acquisition, increasing the total debt to Rs 750 crore. In a scenario of rising interest cost, this factor will impact the bottomline. Further, Opto generates very little free cash flows because of high investment in working capital. Its working capital cycle is as long as 233 days. The management has stated that the reasons are higher inventory levels, competition with large established players, and long shipping time. The increased debt burden is likely to weigh heavily on the company’s financials in FY12. What really goes in favour of the company is its well-established presence in a niche technological segment. Moreover, the management’s composed aggression in acquiring companies and adding to its technological strength is sure to pay off in the medium to longer term.
Financials And Valuations.
As mentioned earlier, the financial performance of the company has been very good with continuous topline and bottomline growth. On a consolidated basis it posted a topline of Rs 1,041 crore and a bottomline of Rs 256.15 crore for 9MFY11. The figures are not comparable with 9MFY10 as it includes the acquisition of CSC. Going ahead we expect the company to close FY11 withnet sales of Rs 1,585 crore and bottomline of Rs 363 crore.This results in an EPS of Rs 18.10 and P/E of 14.70x. Further, with the growth in both the segments and new acquisitions we expect the company to post strong growth in the topline for FY12. But with the higher interest cost the bottomline is expected to witness some decline. However,despite the impact on the bottomline,we expect huge growth opportunities for the company, particularly over the longer term. For now we recommend that the investors should buy the scrip at its current levels with a target price DS of Rs 320 in one year.