DPH – Acquisition and rights issue

Shares are up 8.4% today on Dechra Pharma’s announcement of an acquisition and rights issue. Dechra makes pharmaceuticals for animals.

It intends to buy Eurovet for £112.5m. Eurovet has sales of £64m, and EBIDTA of £10.7m. The acquisition will be part-funded by a rights issue to raise £60m on a 3 for 10 basis at 300p. Shares were at 464p propr to the announcement.

The market seems very happy with this, but I’m becoming increasingly doubtful about my investment in this company. I don’t think I’ve made a disasterous mistake. It just wasn’t a particularly good one. The company has shown good ROE, acceptable debt, and excellent EPS growth. But I think there’s a problem.

Share count has been rising at about 5% pa, which can be questionable. Compare that with a company like, say, industrial machinery company IMI, whose revenues have grown 20% over the last 2 years, and it actually reduced share count by 6%.

There are many ways of calculating returns on capital, but one way I’m favouring at the moment is to create my own "fudged" figure for NOPAT (Net Operating Profit After Tax) and divide by TIC (Total Invested Capital). My calcs of NOPAT throw all exceptionals and goodwill into the pot, as I want to be able to see exactly what junk directors are throwing in there. My calculations of TIC include intangibles. People are going to argue about the validity of this, but I like to include it because I argue that it was actual capital deployed in producing the earnings. It also provides a safeguard against highly-acquisitive companies, who can show enormous returns on capital if you strip out intangibles.

Anyway, if you calculate a ROIC my way, I think the returns for DPH are unimpressive. I get values of less than 10%. That’s not the kind of company I’m looking for. Compare that with another company I own, DNO, Domino Printing Sciences. That has a ROIC of over 20%, and operating margins over 15%. It has a decade of unbroken earnings increases. That’s the kind of company I want! DPH has had rather mediocre margins. Less than 10%. I want my companies to be killers. Nice solid ones, with great balance sheets, high returns on capital, and good organic growth opportunities.

So I’m distinctly back-pedalling on my decision on DPH. I wont be interested in the rights issue, despite market enthusiasm for it. Just give me the money. Next year I’ll review the situation, but I think DPH will be for the chop. I think there are more interesting opportunities available.

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About mcturra2000

Computer programmer living in Scotland.
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