Wednesday, April 12, 2006

Eye of the Storm
Bausch and Lomb (NYSE:BOL) ($45.6) the eyecare maker has been in a lot of news more so since the story of the fungal infection broke two weeks ago. The infection has afflicted 109 patients using its ReNu with MoistureLoc solution. However the company has been in trouble since a few months ago. Here is the chronology with closing prices

23 December 2005 - BOL moved to restate financial results back to 2000 because of accounting shenanigans at its Brazilian unit. Stock price falls from $79 to $72.

26 January 2006 - BOL says it will postpone its earnings filing to investigate improper booking of sales at its South Korean subsidiary. ($68.56)

2 March 2006 - declares dividend $0.13

31 March 2006 - First reports of fungal infections surface ($63.70)

10 April 2006 - BOL suspends shipments of ReNu ($57.44)

11 April 2006 - Company defends ReNu, says all tests are negative, Walgreen pulls entire line of ReNu, WalMart pulls the specific product. ($45.60)

These events usually qualify as one time opportunistic buys in my book, the previous call we made in a similar situation with Sherwin Williams on Feb 24 has paid us handsomely with a 25% gain in five weeks. However this is one is much harder to call. Here are the facts:

According to the 10Q filling dated 28 July 2005 (last filling on record). The six month revenues were broken out as follows:
Contact Lenses $359 M
Lens Care $269 M
Pharmaceuticals $ 278 M
Cataract & Vitreoretinal $ 185 M
Refractive $ 72 M
Total (6 months) $1163 M

Lens care generated about 23% of the company's revenue. 2005 Revenues from ReNu are estimated at $45 M about 2.25% of the total $2.3B. In the US there are reportedly 109 cases of "Fusarium" fungal infection reported by the CDC and according to a Business Week article about 36 million Americans wear contact lenses. Of the 30 cases investigated to date by the Food & Drug Administration, 28 wore contact lenses, and 26 of those patients used Bausch's popular ReNu products to clean and store their lenses. To date no direct link has been found to the usage of ReNu and the fungal infections. From the numbers and the facts it seems like this may not be a big deal.

The key here though is the statement from Walgreens released today -"There's a lot of customer confusion out there, which is why we decided to remove the entire ReNu line, - a Walgreen spokesman told Reuters." What is it that first comes to mind when you hear the words Baush & Lomb? Eyes, eyecare, contacts!!!! right. So calling this a Tylenol scare like situation that J&J was in is incorrect - afterall J&J is a very well diversified company selling Cordis heart stents, baby lotions and Band-Aids.

Although ReNu may be only 2% of revenue as the Walgreen statement implies Bausch &Lomb means eyecare to most customers and spillover effetcs are bound to affect sales in general. Moreover according to the 10Q "Growth for the first six months of 2005 was driven by share gains attributable to the Comapny's ReNu with MoistureLoc brand, the ReNu franchise gained 2% market share in Q2 05" So this was a major growth engine for the company.

Back to the fundamentals before the fungus story broke but after the accounting irregularities were uncovered the company traded around $65 a share - market cap of $3.5 B on sales of $2.3B a P/S ratio of 1.52

Lets look at the most pessimistic scenario for this company, assume that the company loses all of its share of lens care of about $ 500M and spillover into other areas, legal liabilities causes loss of another 15% of revenues $300M. This would imply a 2006 revenue number of about $1.5B (assuming no growth in other areas).

Now at today's price $45.6 (Market cap $2.45B) this gives the company a P/S of 1.63, still higher than the 1.52 it sported on March 30th. At $42.5 the stock should reflect its pre infection value.

So in conclusion, the company is in deep trouble has a great brand & franchise but its entire identity is associated with this franchise "eyecare" something people take very seriously. I believe that the company will recover and thrive but I want the classic "Margin of safety" before I play this one, I'll assign a 20% margin of safety and using $42.5 as my benchmark I would be a buyer at anything south of $34 a share. Speaking of J&J, once the air on this issue clears up they may just swoop in and buy BOL.


Blogger NO DooDahs said...

Well, you beat me to a BOL post. Darn.

4:10 PM  
Anonymous Anonymous said...

Assume BOL is a no-growth business, the past ten years cash flow averaged $4.73 according to ValueLine. Long term Price to Cash Flow 10.5 would assign a fair value of around $50. Now following your logic the reduced cash flow would be .625 * $4.73 = $2.95. Apply 10.5 to that would render $31 as fair value. BOL has been around $27 in 2001 and 2002. I'd back up the truck at $30. (Am I too aggressive?)

10:01 AM  
Blogger Lucas Brachish said...

Considering BOL had been hovering well above or near $70 for over a year prior to this, and all the news coverage it's now getting (putting the stock on the radar of every speculator on the planet), I'd offer this potential alternative scenario:

The stock will stay in the $30-$50 range for a while -- and depending on how things play out over the next couple of months, it may keep a solid bottom price in the low-to-mid 40s. The bad news/infection fears will calm down and B&L will finally get their marketing engine rolling full steam and get some decent PR going. Speculators will begin gobbling up the stock -- hoping it'll see $70 or $80 a again in less than a year -- driving the price up to at least $55-$65 in short order before everyone begins cashing in and the stock levels back down again.

Already we're seeing some speculators jumping into the fray, pulling the price back up by its bootstraps. If that trend continues and B&L's PR spin kicks in a bit sooner and more strongly than expected, then we'll be lucky to snap up B&L between $42-$48 over the next month... and we might be able to sell at $50-$60 within a few months or less. Very healthy gains and a relatively safe play. Even if things don't go as well as that, then we should still be able to sell for semi-decent profit in less than a year. If things go better than expected (lawsuits are dropped, etc.), then speculation could drive the stock back to $80 in no time flat, despite all the other problems the company may have. Buy BOL at $40 and sell at $80, doubling your money in less than a year and reaping dividends ... it's a stretch but it's not impossible.

But you lay out an intelligent scenario in terms of how important this scandal really is -- the fact that it's hitting one of B&L's strongest growth products -- and the fact that B&L's stock price was already on a slow-but-steady decline before this. So to be on the safe side, I'd have to agree that waiting for the stock to drop below $35 -- maybe even a bit under $28 -- would be the best bet. Prices may never actually go that low, but it's certainly the safer route ... and in this black period for B&L, it's easily believable.

We may even see a drop to low or mid 20s if things go really bad. But at that point speculation on the company being taken over by a rival should drive the price back up to $35 at least -- this is a massive company, after all -- so I'm hoping that buying anything under $35 should be golden. I guess what I'm saying is: figuring out the best buy-in price is a tough call right now...

I'll be looking to your blog for more views on this in the near future. Thanks!

4:06 PM  
Anonymous Asif (SINLetter) said...

Excellent analysis Ashish. Your post covered pretty much covered all the questions I had about BOL.

1:47 PM  

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