Alere Makes a Takeover Bid for Axis Shield

Axis Shield's Daiabetes Franchise is the Key Attraction for Alere

Axis Shield was today made subject to a takeover proposal by Alere $ALR which you can read linked here and the subsequent response of the Axis Shield board was to reject the offer in a statement linked here

Alere was formerly known as Inverness Medical and has form for picking up UK diagnostics plays on the cheap. For example, over the last few years the co bought out UK co's BBI Holdings and Concateno. Both were a natural fit as Alere owns the patents for horizontal lateral flow strip diagnostic tests. BBI provided Alere with reagents and assays which could be used to develop tests and Concateno (primarily a drug and alcohol testing company) allowed them to naturally expand the product offerings.

With regards Axis Sheild, this company was covered at great length by EarningsView an article linked here and please read this for more background. I think the deal makes good sense but mainly for the Afinion point of care tests. It will allow Alere to accelerate sales of this system in the US as it competes with Siemens DCA Vantage system. Alere should be able to develop new tests for the system and also be able to expand sales of Nycocard (a cheap less accurate point of care system) mainly to emerging markets. The main attraction of Axis Sheild's point of care solutions is in its diabetes franchise and this is a good opportunity for Alere.


What's in it for Axis Shield Shareholders?

I think shareholders should accept this offer. ASD management has disappointed before with delivering unsatisfactory performance. I like Afinion and much of what the co is doing, but the distribution division clearly needs to be sold off and Nycocard's revenues are subject to the uncertainty of the flu season. In addition, Afinion US sales have missed targets last year-despite the co's tone- and I question whether CRP testing really is a useful way to differentiate between viral and bacterial infections.

The overwhelming majority of infections are viral and doctor's already know this. I've discussed this with a few doctors and opinion is divided as to the merits of CRP testing for this reason. However, CRP testing is widescale and Afinion is generating impressive-albeit lower than forecast- sales growth.

I think it is a good deal all round as I think that taking Axis Shield (and particularly Afinion) forward from here is better done by Alere. We shall see.

Fortinet A Fast Growing Network Security Play

Fortinet is an interesting stock to research because it is a good way to play the growing computer network security market. There are a few options to investing in stocks focused on network security, but I think Fortinet is one of the best options. Fortinet is the worldwide leader in Unified Threat Management (UTM), which is a grandiose way of saying that their network security solution covers all the core security requirements of an enterprise’s connection to the internet. As such, this encompasses firewalls, virtual private networks, intrusion detection and prevention and, anti malware.

The UTM market is primarily targeted at the small to medium size enterprise (SME) and Fortinet is the leading player in this market. Competitors like Cisco are focused on large enterprise solutions, whilst similarly for Check Point Software their UTM offering is only part of their product range. IBM is a competitor but has recently been seen as a potential purchaser of Fortinet due to their tardiness in establishing market share. Fortinet is attractive to IBM because they possess a proprietary technology. Fortinet do not resell other companies products.


Fortinet's Growth Prospects

 I think Fortinet has good growth prospects and I see their key share price drivers

• Growth in the economy seeing an expansion in SME market and a willingness to free up IT spending
• Growth in internet functionality of SME market
• Benefit of a UTM ‘One-Stop-Shop’ solution for SME’s in securing inbound and outbound traffic through one appliance
• Growth in cyber crime raising awareness of security needs
• Growth in Fortinet’s top line leading to operating margins that are closer to, say, Check Point Software
• Takeover potential. IBM are strongly rumored to be looking at them

I think the first point two points are contingent upon your view of the economy. However, should the economy grow next year I think that SME IT spending has the capacity to expand in excess of GDP growth due to the fact that companies have cash on their balance sheets. Moreover, most of the surveys are indicating a loosening of the purse strings in this regard.

The increasing importance of E-commerce and the utilization of internet portals to increase globalization of trade, should drive SME’s to increase their internet functionality. In addition, there will be more emphasis placed on monitoring internet (internal and external) based threats, given the inexorable rise in cyber crime. Similarly, corporations may seek to reduce energy and personnel cost by adopting a one-stop-shop solution with a UTM system. Whilst, this is not seen as an option for a larger enterprise, an SME will have different priorities.

However, I think the key driver for Fortinet’s share price will be top line growth and its effect on their key margin metrics. If we look at the last three years we see a nice trend developing in Fortinet's numbers. I've included Check Point's metrics to 2009 by way of comparison.

Fortinet 2008 2009 Rolling to Q3 2010 CheckPoint 2009 Revenue 211791 252115 301808 791,147 Gross Mgn 71.10% 74.93% 72.87% 85.58% SG&AMgn 49.27% 45.55% 43.02% 30.00% R & D Mgn 17.49% 16.74% 15.90% 9.71% Op Mgin 2.33% 10.05% 13.95% 44.89% FCF Mgn 16.47% 22.76% 28.14% 59.82%
source: fortinet,check point software, earnings view
The last column of Fortinet numbers are the rolling four quarters to the third quarter of 2010. The drop in gross margin is explained by the fact that Q4 is normally a large quarter. Indeed, analysts have revenue forecasts of $86.57m for 2010 Q4 vs. $70.71m last year. Gross Margins for Fortinet have increased every quarter this year.  I would also caution that Q4 2010 included a tax gain of $32m which somewhat flatters the free cash flow margins in the last two Fortinet columns. However, excluding that quarter-by calculating free cash flow margin for first three quarters of 2010- still shows they are translating 30% of revenue into free cash flow. Fortinet Margin Expansion Clearly, these numbers indicate that Fortinet has room to expand margins and cash flow generation as they grow their revenue numbers. I have included Check Point Software as a benchmark for Fortinet. However, I think it worth noting that Check Point is likely to have lower SG&A margins because they sell a lot of their product range into larger enterprises (fewer customers, bigger ticker values). In spite of this, I think there is plenty of potential for Fortinet to grow and for these catalysts to be realized in the share price. Fortinet Evaluation Fortinet trades at a price of $31.35 and a market cap of $2.31bn with $290m in net cash. On a back of envolope assumption of 30% FCFMargin and analyst forecasts of $370m in revenue for 2011 I would say that a forward FCFYield of 4.8% is cheap for a business growing revenues, earnings and cash flow at mid teens plus rate. You won't get this kind of growth by buying a 10 year note! I picked some up.