SRI Surgical (STRC) reprocesses reusable surgical linens and instruments for healthcare providers through their ten regional facilities located across the US. STRC delivers both reusable and disposable surgical products to the healthcare provider, picks them up after use, reprocesses the reusable items, and then repeats the cycle. STRC aims to enable healthcare providers to reduce operating costs through outsourcing supply management and to reduce their environmental footprint through waste reduction.
As can be seen from the financials below, STRC has not been profitable for a number of years:
Revenues have grown steadily, but very slowly. Gross margins have held up around 30% and SG&A has come down slightly, but the business has not been able to scale enough to generate profitability. Depreciation has averaged around $9 million the last five years, while cash capex has averaged $6 million so the company has on average been minimally free cash flow positive.
At the current price of $3.75 a share STRC has a market cap of $24.4 million and an enterprise value of $35.4 million. STRC is trading at .6X book value of $38 million. Book value consists mainly of A/R, inventory, and the network of processing plants (and no intangibles or goodwill). STRC is also trading at at an EV/Sales ratio of .3 with stable gross margins. Of course, these discounts may be warranted given STRC’s sustained lack of profitability. But there would appear to be value in STRC to a larger company in the surgical products space who could dramatically reduce fixed SG&A expense and better utilize their plants. STRC has a unique position within the industry as the only reusable products processor with a national footprint. I would think even a purchase price at a substantial premium to the current share price would be below replacement cost to recreate the national network of plants and warehouse depots.
A strategic buyer could could sell STRC products through their existing larger sales force that has stronger relationships with hospital buyer groups and probably eliminate much of STRC’s substantial overhead. They could also better utilize STRC’s excess plant capacity by expanding into new markets such as higher margin single-use device reprocessing, which STRC has discussed for several years. For example, a natural buyer would be Cardinal Health, who already distribute their disposable products combined with STRC’s reusable products. If a strategic could eliminate at least half of STRC’s SG&A expense, or $8 million, they would be buying a company that right out of the chute would be making $10 million a year in EBITDA-capex before any gains from increased revenues through an expanded distribution network or new product lines. If a strategic paid even book value for the company of $5.85 a share ($50 million EV) that would represent a 56% gain for current shareholders.
In June 2010, activist shareholder David Callan sent a letter to the STRC board of directors expressing his frustration with the company’s ongoing poor results and pushing them to explore a sale of the company. The company responded in July 2010 by reiterating their “Strategic Transition” plan aimed to restore profitability (which has still not come to fruition). In November 2010, the board put in a poison pill in response to an unsolicited buyout offer from an unnamed “much larger direct competitor”. While STRC appeared adamant on remaining an independent company, they suddenly reversed course in September 2011 by hiring investment bank McColl Partners to explore strategic alternatives including a sale of the company. STRC has not provided any update on the process, other than to say it is still ongoing.
While there appears to be value in STRC’s assets in excess of the current share price, the sale process that has now dragged on for seven months makes me wonder if and when shareholders will realize that value. If there is interest on the part of a strategic buyer then surely it would have shown up by now. So either there isn’t buyer interest or the board/management of STRC do not want to sell the company. Either scenario is not good for shareholders. Management does not have particularly substantial personal holdings in the stock, so it is probably not in their best interest to push a sale. Given that there is a sale process at least officially in place, I do not see a further catalyst short of a shareholder launching a proxy battle to take over the board.