Quick Take

Sotera Health Company (SHC) has filed to raise $1 billion from the sale of its common stock in an IPO, according to an amended registration statement.

The company provides sterilization and lab testing services to medical device and pharmaceutical companies.

SHC is growing slowly, has significant debt and the IPO appears excessively priced, so I’ll pass on it.

Company & Technology

Broadview Heights, Ohio-based Sotera was founded to provide end-to-end sterilization, microbiological and analytical testing services.

Management is headed by Chairman and CEO Michael Petras, Jr., who has been with the firm since 2016 and was previously CEO of Post-Acute Solutions at Cardinal Health.

Below is a brief overview video of Sotera Health:

Source: Sotera Health

In addition, the firm provides advisory services for pharmaceutical and food processors worldwide.

The company counts ‘more than 40 of the top 50 medical device companies and eight of the top ten global pharmaceutical companies (based on revenue)’ as customers.

It has a total of more than 5,800 customers in over 50 countries.

Sotera has received investment from investors including private equity firms Warburg Pincus and GTCR.

Customer Acquisition

Sotera operates several brands. For sterilization services, it operates under the Sterigenics and Nordion brands.

For its laboratory testing services, it operates under the Nelson Labs brand.

Nordion and Nelson Labs were acquired by the firm in separate transactions and management has acquired a number of other firms in what it calls a disciplined approach to M&A.

The company has 50 sterilization facilities and 13 testing labs, which are located strategically near their major healthcare provider customers.

Selling, G&A expenses as a percentage of total revenue have been rising as revenues have increased, as the figures below indicate:

Selling, G&A

Expenses vs. Revenue

Period

Percentage

Nine Mos. Ended Sept. 30, 2020

20.8%

2019

18.9%

2018

17.9%

Source: Company registration statement

The Selling, G&A efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Selling, G&A spend, dropped to 0.1x in the most recent reporting period, as shown in the table below:

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Selling, G&A

Efficiency Rate

Period

Multiple

Nine Mos. Ended Sept. 30, 2020

0.1

2019

0.2

Source: Company registration statement

Market & Competition

According to a 2020 market research report, the global market for sterilization services was an estimated $2.7 billion in 2019 and is forecast to reach $4.4 billion by 2027.

This represents a forecast CAGR of 6.3% from 2020 to 2027.

The main drivers for this expected growth are a continued rise in the number of elderly people along with chronic illnesses and development opportunities in emerging countries.

Also, further growth is expected to come from the medical device industry, which is seeing stringent regulatory requirements driving sterilization service demand.

Major competitive or other industry participants include:

  • Applied Sterilization Technologies (STERIS) (STE)

  • Regional/smaller outsourced sterilization service firms

Financial Performance

Sotera’s recent financial results can be summarized as follows:

  • Increased topline revenue, at a low and decelerating rate of growth

  • Growing gross profit and gross margin

  • Increasing operating profit and margin

  • A swing to net income

  • Significant but uneven cash flow from operations

Below are relevant financial results derived from the firm’s registration statement:

Total Revenue

Period

Total Revenue

% Variance vs. Prior

Nine Mos. Ended Sept. 30, 2020

$ 601,313,000

2.8%

2019

$ 778,327,000

4.3%

2018

$ 746,149,000

Gross Profit (Loss)

Period

Gross Profit (Loss)

% Variance vs. Prior

Nine Mos. Ended Sept. 30, 2020

$ 322,995,000

8.3%

2019

$ 395,431,000

10.7%

2018

$ 357,252,000

Gross Margin

Period

Gross Margin

Nine Mos. Ended Sept. 30, 2020

53.71%

2019

50.81%

2018

47.88%

Operating Profit (Loss)

Period

Operating Profit (Loss)

Operating Margin

Nine Mos. Ended Sept. 30, 2020

$ 153,637,000

25.6%

2019

$ 183,597,000

23.6%

2018

$ 80,847,000

10.8%

Net Income (Loss)

Period

Net Income (Loss)

Nine Mos. Ended Sept. 30, 2020

$ 5,063,000

2019

$ (20,850,000)

2018

$ (5,870,000)

Cash Flow From Operations

Period

Cash Flow From Operations

Nine Mos. Ended Sept. 30, 2020

$ 98,740,000

2019

$ 149,041,000

2018

$ 119,563,000

(Glossary Of Terms)

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Source: Company registration statement

As of Sept. 30, 2020, Sotera had $108.3 million in cash and $3.4 billion in total liabilities. Debt was $2.9 billion.

Free cash flow during the twelve months ended Sept. 30, 2020, was $54.5 million.

IPO Details

Sotera intends to sell 46.6 million shares of common stock at a midpoint price of $21.50 per share for gross proceeds of approximately $1.0 billion, not including the sale of customary underwriter options.

Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $8.76 billion.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 16.8%.

Per the firm’s most recent regulatory filing, the firm plans to use the net proceeds as follows:

[i] redeem all of the outstanding aggregate principal amount of the Second Lien Notes at the applicable redemption premium, plus accrued and unpaid interest to, but excluding, the date of redemption and

[ii] repurchase 1,669,122 shares of our common stock (based on an assumed initial public offering price of $21.50, the midpoint of the estimated offering price range set forth on the cover page of this prospectus) from certain of our executive officers at a purchase price per share equal to the initial public offering price per share of our common stock less the underwriting discounts and commissions payable thereon (the “repurchase”).

We plan to use the balance of the net proceeds of this offering to repay a portion of the outstanding indebtedness under our Term Loan.

Management’s presentation of the company roadshow isn’t available.

Listed underwriters of the IPO are J.P. Morgan, Credit Suisse, Goldman Sachs, Jefferies, Barclays, Citigroup, RBC Capital Markets, BNP Paribas, KeyBanc Capital Markets, Citizens Capital Markets, ING, Academy Securities, Loop Capital Markets, Penserra Securities, Siebert Williams Shank and Tigress Financial Partners.

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Commentary

Sotera is going public to use the proceeds to pay down its significant debt load and buy shares from certain of its executive team.

The company’s financials show slow and decelerating topline revenue growth and gross profit growth, while turning a small profit and generating meaningful free cash flow.

Sales and marketing expenses as a percentage of total revenue have been rising while its sales and marketing efficiency rate has been cut in half so far in 2020 as the Covid-19 pandemic has disrupted the firm’s operations.

However, management believes the pandemic will increase customer awareness of the need for sterilization and ultimately add to its business prospects.

The market opportunity for sterilization services is expected to grow at a CAGR of 6.3% through 2027, so it is interesting that the firm’s revenue growth has been materially lower than this expected growth rate, indicating Sotera may be losing market share.

As a comparable-based valuation, management is asking IPO investors to pay a significant premium over direct competitor STERIS’ current public valuation multiples.

STERIS is a larger firm with less debt, faster revenue growth and much higher free cash flow than Sotera.

So, given the comparison, while Sotera may be a fine company, the IPO is excessively priced, so I’ll watch it from the sidelines.

Expected IPO Pricing Date: November 19, 2020.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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