#5 Recent addition (4/1): RX

The other addition we made in the healthcare field is IMS Health. Here is how the investment came about:

I like cheap stocks (i admit there are many metrics but the two i most commonly use are p/e or ev/ebitda and book/replacement value). In the case of p/e ratios, I prefer to own companies with low p/e's but high operating margins. I figure why should I pay up to own a company with low margins? If I can own a company at 8x p/e and it has 30% ebit margins, shouldn't that be preferable to buying a company at a 15 p/e with 20, 30 or even 40% ebit margins? I have decided to call this idea a PEBIT (pee-bit) ratio. It is kind of like PEG (in which you conceptually are willing to pay a higher p/e in exchange for growth), except here you are willing to want to buy the stock that gives you the best operating margin bang for your valuation buck.

I ran a quick screen for US companies with p/e<20,>20% ebit mgn and EV>1000. Three hundred companies fit the bill and the top 1/3 had PEBITs of <0.3. A lot of these were financial names, commodity oriented names, or levered radio/broadcasting companies. However a few stood out (I was happy to see MSFT which we already owned came out on the list at a 0.25 PEBIT--8x p/e and 32%+ ebit margin), one of which was IMS Health. For a frame of reference, less than 1/3 of the companies in the S&P have a PEBIT of <0.5.

IMS is a medical sells market research for otc and prescrpition pharmaceutical products. Basically they sell prescription data. I was familiar with IMS Health from a previous investment project. In 2005 IMS Health had tried to merge with VNU, a Dutch company that also was in the measurement/data business--it owned Nielsen (the Nielsen ratings). The deal was blocked after shareholders of VNU argued they could gain a better return if the company were more efficiently run. It was a big Event driven idea in 05-06 (as arbs tried to reverse the deal and load up on VNU stock. The company was eventually sold to a consortium of private equity investors). During that time i was lucky enough to meet with IMS's management. Although I knew VNU shareholders weren't crazy about the deal with IMS, it was mostly because of their dislike for VNU management more than anything wrong with IMS. In fact i actually thought the IMS management seemed pretty good. I have to admit i didnt follow IMS much after 2006, but when i came across it a few weeks ago, the name did ring a bell. Plus, I figured good data helps companies make better decisions, so there may be something to their business. The stock was trading at $12.50, on eps estimate of $1.70 for 2009, or 7x p/e. I read the most recent earnings transcript for RX and the $1.70 seemed doable. Even more attractive was the company's 12mo trailing operating margin of 20-25%. paying 7x for 20% ebit margins in a business that I hope is not cyclical (like commodities) and should have a good macro trend seemed reasonable.