By Tony Fong
NEW YORK (GenomeWeb News) – Flush with cash, firms in the life science tools and molecular diagnostics spaces have embarked on stock buyback programs, signaling an end to a hoarding of cash and improving optimism about the state of the economy and their businesses.
Since the start of the year a growing list of companies have announced share buyback programs. Just last week, Illumina said it spent $314.3 million in net proceeds from an offering of $800 million in convertible senior notes to repurchase about 4.9 million shares of its common stock.
Before that, Thermo Fisher Scientific announced a new $750 million share buyback program on top of an existing program for the same amount. Life Technologies also said it will repurchase up to $500 million in shares, and Waters announced a share repurchase program for $500 million.
Among other firms that have announced buybacks are Gen-Probe, which has launched a $150 million buyback, and Myriad Genetics, which plans to repurchase $100 million of its shares. And 2010 ended with Luminex announcing it would buy back up to $21 million of its stock, while Becton Dickinson announced a $2.1 billion buyback program.
While buybacks have long been a mechanism used by many companies to raise earnings per share, the timing of the recent programs announced suggests that after two years of conserving cash in the wake of the economic downturn, firms are focusing on increasing shareholder value and building business through the use of cash.
According to Peter Lawson, an analyst at Mizuho Securities, buybacks tend to ebb and flow with increased merger-and-acquisition activity and stock prices. Between 2001 and 2004, buyback activity in the life sciences and diagnostics space accelerated, and after a one-year slowdown, buyback programs again took off between 2005 and 2007.
A global economy downturn and weakened end markets subsequently forced companies into cash preservation mode. But with economic conditions improving, announced buyback programs in 2010 tripled over 2009 levels, Lawson told GenomeWeb Daily News, "so there's definitely been a rapid acceleration after a deceleration."
Mixing M&A and Buybacks
Even while companies were saving their cash leading into 2010, cash flows remained "robust" during the recession, resulting in healthy cash reserves and a willingness to use those funds. However, many firms are not yet prepared to risk spending it all on acquisitions, Lawson said.
"Now, you're seeing kind of a mixture of both," he said. "You went from investing nothing with cash, [and] just letting it mount up, to buybacks, and now it's kind of buybacks and M&A," he said.
In fact, 2010 was a year in which an improving economic picture resulted in more M&A activity among life science tools and genetic testing-related firms. Since the second half of last year, in particular, there have been several large deals, including Thermo Fisher's pending $2.1 billion purchase of Dionex, Life Tech's buy of Ion Torrent for up to $725 million, and Laboratory Corporation of America's $925 million acquisition of Genzyme's genetics testing business.
All three of those acquirers also recently announced buyback programs.
Lawson also said that for some firms, such as Myriad, Gen-Probe, Waters, and Illumina — which prior to last week's $314.3 million buyback, said in the summer it would be repurchasing $200 million of its common stock — using excess cash for M&A may not be easy because of their industry-high margins. Finding other similar sized firms with matching margins is a tough proposition, while buying one with weaker margins would dilute their earnings.
Using Waters as an example, Lawson said that "anything they buy is highly likely to dilute … their margins, so there are very few acquisitions they can really think about other than small tuck-in acquisitions," Lawson said. "It's very hard for them to get acquisitions that [offer] a significant return. They will typically dilute margins and then dilute earnings, and then therefore what do you do with the cash?"
Offering dividends to shareholders is one way of using excess cash to benefit shareholders and is a strategy that other types of life science firms, most notably large pharmaceutical firms, have employed. But many life science tools firms have typically not paid out dividends, and there are no signs that they plan to do so (though some of the more diversified firms, such as Beckman Coulter, Becton Dickinson, and Danaher, are exceptions).
One difference in the current round of buybacks is that this time it's not limited to just life science tools firms, but includes molecular diagnostics firms, as well.
According to Lawson, "there is a real drive to do them because there is a real fear of increased SG&A, increased wages … and any of the dilution related from other announced acquisitions."
In the case of Myriad, its buyback announced earlier this month is the third such program during the past 12 months.
A spokeswoman for the company said that the repurchase program is part of a larger capital deployment strategy that includes investing in R&D and acquisitions. With about $500 million on hand, "the buyback program really is to keep that cash balance around that level, not to sop up excess cash being generated," she said, noting that that figure is "quite a large amount for a company that's market capped around $1.7 billion, so it's trying to have a balanced approach to capital deployment."
Rather than doing buybacks for larger dollar amounts over longer periods, targeting smaller amounts over shorter periods also allows Myriad greater flexibility to use its cash for other purposes, she added.
A Goldman Sachs investment analyst took a harsh view of the company's share repurchase program, though, and said that it might be a way to artificially bolster its net earnings while masking softness in the company's business.
"Although EPS accretive, we believe this repurchase is reflective of slowing organic growth and increasing dependence on financial engineering to drive bottom-line growth," Isaac Ro of Goldman Sachs wrote in a recent research note.
The Myriad spokeswoman refuted that view but declined to comment further.
During BD's fourth quarter earnings conference call in November, company officials said its buyback was spurred on by several factors, including the "very, very low" cost of debt to help fund the repurchase, and a stock price that they felt was underpriced.
"[I]t really comes down to looking at our capital structure," David Elkins, BD's CFO, said on the call. "It's an opportune time … given … we're at historically low rates to maximize our capital structure without jeopardizing our ability to borrow into the future for strategic opportunities."
Saying that it is important to return cash to the company's shareholders, Elkins added that BD has $1 billion on its balance sheet, and money that it is borrowing is to "make us more efficient from a capital structure perspective."
He said that the $1.5 billion in buybacks targeted for 2011 and $600 million planned for 2012 are a "reasonable level."
Gen-Probe also cited the added flexibility a buyback program offers. The company did not respond to a request for an interview, but in a statement announcing its $150 million buyback program, CFO Herm Rosenman said in addition to increasing long-term shareholder value, the buyback will "offset dilution from employee option programs … while at the same time retaining the strategic and operational flexibility to invest appropriately in our business."
Looking ahead to the rest of the year, Mizuho's Lawson said that he expects firms to continue a strategy of buybacks mixed in with smaller M&A deals.
"There's nobody that's being excessive in their buybacks," he said. "It's just that [in] 2010 everybody kind of coalesced in when they were doing their buybacks."