Piramal Healthcare acquisition of Decision Resources Group - An attempt to value DRG

With Piramal Healthcare stock slowly and steadily marching northwards (Disclaimer: It has been my favorite stock for almost a year, so this post may be a little biased ) following a slew of acquisitions (and a Rs17.5 dividend per share coming up), I once again pause to take a look at the latest acquisition – Decision Resources Group for a sum of approximately $635 million. All the reasons given in their investor presentation indicate the attractiveness of holding this company in the portfolio. But again the question arises (as earlier with Vodafone India’s stake), have they paid an appropriate value for this? So, I make an attempt to value DRG, but the same being a privately held company a lot of assumptions need to be made.

As a start, let us consider the information available:

1)      Projected revenue of $160mn for 2012

2)      Revenue growth of 20% CAGR over past 5 years

3)      Industry EBITDA margins in the range of 15%-30%

For valuing the company, I need to make assumptions for the following factors:

1)      Growth Rate for next 4 years

Two cases have been considered: 20% and 17.5%

2)      Discount Rate

As the buyout would be in debt/equity ratio of 1:1, I have assumed that this would also be the final capital structure. The cost of debt is taken as 5.5% (based on Piramal‘s call transcript) and equity is taken as 13%, thereby coming to a discount rate of 9.25%

3)      EBITDA Margins

Various cases have been considered for the same.

4)      Net CapEx in future

For estimating the same, I have taken into consideration the ratio of Net CapEx required per unit increase in Sale. This has been taken from that of Cognizant, which also has an analytics practice (for lack of a better comparable). The average value for the past two years was found to be 0.475. This means, for a dollar increase in sale, $0.475 needs to be the net capex (New CapEx – Depreciation).

5)      Change in Net Working Capital (Non Cash)

For estimating the same, I have taken into consideration the ratio of change in Net Working Capital required per unit increase in Sale. This has been taken from that of Cognizant, as in the earlier case. The average value for the past two years was found to be 0.065. This means, for a dollar increase in sale, $0.065 needs to be added to the working capital.

6)      Effective Tax rate

I have taken a very conservative assumption of 30%.

7)      Terminal Growth Rate

Again two cases are taken – 3% and 5%

Result of the valuation exercise

Based on the EBITDA margin and terminal growth assumptions I have taken into consideration, we get six cases as shown in the tale below:

	Terminal Growth of 5%
	a	b	c
EBITDA Margin	Fixed 22.5%	Increasing from 18% to 26% in 9 yrs	Increasing from 20% to 26% in 9 yrs
Valuation ($mn)	$738.91	$960.76	$972.14
Discount on Deal	16.36%	51.30%	53.09%
	Terminal Growth of 3%
	a	b	c
EBITDA Margin	Fixed 22.5%	Increasing from 18% to 26% in 9 yrs	Increasing from 20% to 26% in 9 yrs
Valuation ($mn)	$561.50	$709.13	$720.46
Discount on Deal	-11.57%	11.67%	13.46%

On considering a terminal growth of 5%, all valuation show the deal gave Piramal a discount of at least 16.36%. But for a terminal growth rate of 3%, in case of a fixed EBITDA margin of 22.5%, the value comes 11.57% lower than the deal value, while for the rest it is above the deal size.

All in all, the deal seams to be very lucrative, as the analytics business generally has EBITDA margins in mid 20s. Moreover, my calculations have considered lower EBITDA margins during initial phase of 9 years and maturing to 26% (which seems attainable to me). I have also not considered the synergies between Piramal and DRG and the benefits of entering the global Analytics industry (which is growing faster than the IT/ITES industry).

Verdict: I still maintain a BUY on Piramal Healthcare and feel that the company is employing its cash well.

[You can refer to my valuation excel sheet at: https://sites.google.com/site/saumitraambegaokar/drg]