The market is underestimating the financial benefits from big acquisition
Thursday 31 Oct 2019 Author: Martin Gamble

We think the benefits of CareTech’s (CTH:AIM) acquisition of its rival Cambian are not fully appreciated by the market and investors should get in now as they become more apparent.

Caretech is a national provider of care services for children and adults with complex needs, operating in the circa £15bn a year UK social care sector.

In October 2018 it purchased Cambian for £278m in a cash and share deal, receiving regulatory clearance in February this year. The acquisition further consolidates a fragmented market and brings more children’s care services to the combined group.

Management has identified £5m of pre-tax profit synergies by 2020, equivalent to a third of prior year profits, with £3m to be delivered by December 2019.

According to consensus estimates earnings per share will grow by 20% this year and a further 18% next year to 31 December, yet the price earnings ratio (PE) is a lowly 9.4 times while the dividend yield of 3% is covered three times.

It should be pointed out that the acquisition has increased net debt to £293m, which represents four times earnings before interest, tax, depreciation and amortisation (EBITDA), but strong cash conversion is expected to reduce leverage towards the target of three times.

The debt is more than covered by the value of the company’s property portfolio which was valued at £774m post the Cambian deal.

Over the last 25 years the company has grown from a single home to 550 facilities and 10,000 staff supporting 4,500 users.

CareTech came to the market 14 years ago in 2005 and in that time the UK market has grown from £2.1bn to its current size of £15bn, a blistering compound annual growth rate (CAGR) of 15%. The company has grown its revenues and earnings per share at an even faster rate with a CAGR of 20%, demonstrating its growth in market share.

Market growth is driven by a continuing trend to outsourcing from local councils and the underlying market growth of 5.5%.

The Cambian purchase has increased the proportion of children’s services that to the group provides. Adult services now represent a third of revenues, down from two thirds, while children’s services now represent around 60% of revenues, up from a third while foster care remains the smallest segment at 10%.

CareTech operates in a growing but fragmented market where the regulatory burdens are becoming more acute, putting pressure on smaller operators. Once the acquisition has ‘bedded down’ the company will have the scale and competitive advantage be continue to exploit future growth opportunities.

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