Colfax - Thoughts Ahead Of The Spin-Off
Summary
- Colfax surprised me when the company acquired the acquisition of DJO Medical in a $3.15 billion deal in 2018.
- That deal is now the trigger for a break-up of the business, as medtech and fabrication have little synergies.
- Colfax has prepared the business ahead of the spin-off as a re-rating could take place post the spin-off here.
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Colfax (CFX) has been a name which has seen struggles over the long run. In the spring of last year I looked at the prospects for the company, as I concluded that Colfax was better positioned, yet real execution was required to justify the valuation.
Nearly a year later, the company has seen modest growth and shares largely trade at similar values as early in 2021, yet with a full break-up of the business being upcoming, it is this event which could unleash some potential here.
Former Take
Colfax, a former spin-off from Danaher, has seen its business thrive quite early in its existence as shares peaked in their $70s in 2014 amidst the boom in shale natural gas and oil production in North America.
Ever since, shares have sold off quite aggressively, having traded in a $20-$40 range since 2016. The company has been quite aggressive to reposition the business, mostly driven by its $3.15 billion purchase of DJO Global in 2018, the provider of orthopedic devices and related software. The company generated some $1.2 billion in sales and $270 million in EBITDA at the time.
To finance this rather large acquisition, Colfax sold its Air & Gas business to KPS in a $1.8 billion deal a year later. In the year 2019, Colfax posted earnings of $2.01 per share, while net debt came in at $2.2 billion, as the numbers were a bit complicated as a result of the dealmaking efforts.
The company guided for 2020 earnings between $2.10 and $2.20 per share, as investors liked the improved positioning, including large exposure to medical technology. The company was hit hard amidst the outbreak of the pandemic with first quarter organic sales down 1% and change, with second quarter organic sales down 28%, and third quarter organic sales improving to minus 3%. In February 2021, the company posted its annual results with revenues down from $3.33 billion to $3.07 billion.
This decline in sales hurt profitability in a major way adjusted earnings fell from $2.01 per share to $1.40 per share, with GAAP earnings only reported at $0.44 per share. Nonetheless, the adjustments looked quite fair, mostly driven by amortization charges and restructuring charges, to a lesser extent.
Net debt came in at $2.10 billion a very steep ratio as EBITA for the year fell from $477 million in 2019 to $361 million in 2020. The 2021 guidance was comforting, with Colfax guiding for 15-18% revenue growth, yet full year adjusted earnings of $2.00-$2.15 per share look lackluster, largely in line with the 2019 results and in line with the original 2020 guidance. With shares trading at $40 in February 2021, I found the risk-reward not very compelling at a market multiple, while leverage was high and the company has a modest track record, including the 2021 guidance. After all, many names were set to post record results in 2021.
Existing News
Soon after the article was published in February, Colfax announced its intention to split up the business between its fabrication technology and specialty medical technology business. To cut net debt, the company issued 14 million shares at $46 per share just after the announcement, taking advantage of the move higher in response to the news.
The company started 2021 on a solid note, as Colfax hiked the full year guidance to $2.10-$2.20 per share after the first half of the year. The company furthermore announced the purchase of Mathys AG Bettlach, a Swiss orthopedics leader. The $285 million deal looked relatively cheap with sales reported at $150 million, yet EBITDA margins of just around 10% are quite modest, albeit that the deal looked solid. The deal was financed in an all-stock deal, with shares issued at $43.90 per share in July.
With 161 million shares trading at $45 here, equity of the company is valued at $7.2 billion, or $8.6 billion if we include net debt. Net debt is very modest with EBITA trending around half a billion here, for a 3 times leverage ratios as the company trades at just over 20 times earnings here.
What Now?
With the spin-off coming up soon in the current quarter, there is certainly potential in Colfax. Some recent M&A and deleveraging through the issuance of some shares over the past year, has made the business case a bit more compelling here.
The question is what the situation for both businesses ESAB (the fabrication business) and Enovis (the medtech business) will be. While the situation is highly uncertain here, as the reality is that the medtech business should probably warrant a premium valuation here, which leaves the sum of the part of both businesses perhaps with some upside from current levels. This is however on a combined basis, as the spin-off terms are not yet known of course.
Given the actionable event, the spin-off, I am quite upbeat here on Colfax, as the situation is still uncertain, with no spin-off terms announced. Nonetheless, I am leaning towards a small speculative long position in anticipation of a re-rating of the combined business post the spin-off.
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Source
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