Sydney, May 23, 2007 AEST (ABN Newswire) - The following transcript is an "Open Briefing" by IBA Health (ASX: IBA) regarding the recently announced agreement with iSoft Group PLC.
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IBA recently announced it has entered an agreement with iSOFT Group plc for a A$333 million all-share acquisition of iSOFT by Scheme of Arrangement. The Scheme is recommended by the iSOFT board. What's the rationale for the acquisition and its structure as a Scheme of Arrangement?
Executive Chairman Gary Cohen
Our rationale is that by taking two leading, internationally based health information system companies with complementary footprints, products and management, we'll create one of the largest companies in the industry globally and certainly the largest in the socialised healthcare world. We believe our acquisition of iSOFT will create the company able to deliver systems to governments and major healthcare organisations from the UK, Ireland, continental Europe, Africa, and the Middle East, right through to Asia and the Asia Pacific region.
CEO Steve Garrington
In the health IT market, there's no doubt that, whilst the UK National Health Service (NHS) program is the largest in the world, there's a growing number of increasingly large procurements. To achieve the scale and capability to service the kind of procurements that are on the increase is an important strategic aspect of the transaction.
Executive Chairman Gary Cohen
We believe we're creating a very profitable, strong balance sheet company that will provide earnings accretion for our shareholders and deliver a lot of shareholder value over the course of the next 12 months and beyond.
By structuring the deal as a Scheme of Arrangement we're able to minimise the cost of acquiring the shares, and at the same time, if we manage to get approval from the majority of iSOFT shareholders voting at the Scheme Meeting, and representing 75 percent or more of the value of the shares voted, then we can acquire 100 percent of the shares without having to go through the compulsory acquisition process.
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What's the basis of your A$333 million valuation of iSOFT?
Executive Chairman Gary Cohen
We know the iSOFT business very well. Steve Garrington was CEO of one of its major business units and our CFO Gordon McKay was Finance Director of that same unit, which iSOFT acquired. Gordon worked for iSOFT for a period of time. We have a clear view of the historical operational performance of the business and the future performance it would be capable of delivering to shareholders.
Stripping out the extraordinary costs iSOFT has incurred over the last 12 months, and including the cost savings the business is currently achieving, which have reached a run-rate of GBP35 million (over A$100 million) per annum, there's a very clear and direct path to strong margins more in keeping with a software product company.
We believe the valuation of A$333 million is a fair one, particularly taking into account the cost of assuming iSOFT's debt, which gives rise to an enterprise value of about A$515 million, and the additional equity funding we needed to support iSOFT's working capital requirements.
Most importantly, the A$333 valuation gives both sets of shareholders an opportunity to see value accretion. From our shareholders' perspective, it's a straight accretion exercise. For iSOFT shareholders, it's an opportunity to participate in a go-forward situation rather than cash out given the company's unusual circumstances over the past 12 months.
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In light of iSOFT's recent financial difficulties, what level of formal due diligence have you been able to conduct and are you comfortable with the level of risk inherent in the acquisition?
CEO Steve Garrington
Firstly, there was an extensive vendor's due diligence report prepared by a major accounting firm that was made available to prospective purchasers when iSOFT commenced its sale process. That report, given the financial background of iSOFT, focussed heavily on the key areas of risk.
Secondly, we had our detailed knowledge of big areas of the existing iSOFT business that people in our team, including me, used to manage, plus the advisory work done for us by ABN AMRO.
Thirdly, because of the sale process, we had much more access than in a normal public company takeover situation. We were able to interview all iSOFT's key managers and spend an enormous amount of time, in particular with the technical team, looking at the software development program that's underpinning the delivery of LORENZO to NPfIT, the UK NHS IT program. I don't think we could have done any more to satisfy ourselves that we have a thorough understanding of where the iSOFT business stands today.
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The acquisition is expected to be "significantly" EPS enhancing in the financial year ending June 2008, excluding restructuring costs and amortisation of acquisition and related intangibles. IBA's shares on issue will more than double to over 800 million with the issue of over 275 million shares to iSOFT shareholders and about 190 million shares through the placement and rights issue. Given iSOFT had a break-even result in the six months to October 2006, what do you base this forecast on?
Executive Chairman Gary Cohen
We've been able to work up a detailed model of the merged entity, however UK takeover regulations preclude us from giving forecasts. What I can say is that we're very clear about our own earnings position for the June 2007 year and iSOFT has provided a trading update for the April 2007 financial year. Our combined revenue for 2006 is $537 million.
If you consider the annual growth in the health IT market of 11 percent, and look at our historical EBIT margin of 33 percent versus iSOFT's current EBIT margin of around 10 percent, then take into account the cost synergies being realised by iSOFT pre-merger and the A$27 million in potential cost synergies we've identified, you can see why we can confidently say the acquisition will be substantially earnings enhancing in the 2008 financial year, even with the additional shares.
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You expect the full benefits of the expected cost synergies of A$27 million per annum to be realised in the 2009 financial year. The savings are expected to result primarily from the elimination of duplicated infrastructure and premises. What scope is there for further cost efficiencies and for revenue synergies, for example through product cross-selling?
CEO Steve Garrington
The synergies we've identified come from three areas: head office moving to Sydney; savings on premises (particularly in Australia and New Zealand and to a lesser degree SE Asia); and a small amount of savings related to overheads in India.
The savings are predominantly about infrastructure rather than people. We're conscious that when you buy a business like iSOFT that's fallen into a bit of disrepair, you need to retain people to reenergise it, re-brand it and build it up again.
It's too early for us to say whether we can realise further savings, but there are a few areas where there's the potential for cross-selling products. For example, iSOFT has a small sales team in Southeast Asia, which will be able to support and underpin the existing efforts of our own team and help drive additional sales.
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Can you comment on the structure of iSoft's revenue model and how it compares with IBA's in terms of the percentage of recurring income and its degree of stickiness?
CEO Steve Garrington
The percentage of recurring and contracted income within the iSOFT business is high compared with ours - it's in the range of 60 to 70 percent. Even through the recent period of turmoil, iSOFT's customer base has been extremely sticky, as is the case generally in the healthcare IT market. To our knowledge, there's only one client worldwide in the market looking for a new system. However, because of iSOFT's financial uncertainty, it hasn't been very well placed in recent new tenders.
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One of iSOFT's major issues has been around its revenue recognition methodology, which was recently changed in line with International Accounting Standards (IAS) guidelines. How does iSOFT's current revenue recognition methodology compare with IBA's?
CEO Steve Garrington
We're a software product company and our revenue recognition is consistent with IAS. We book revenue from licenses at the time the software is delivered to the client and the client is obliged to pay for the software. The services we provide fall into two categories: implementation, where revenue is booked over the project delivery period, and maintenance, where revenue is booked on a calendarised basis over the life of the contract.
A number of the larger contracts within the iSOFT business include product development and previously iSOFT had been booking license revenue relating to some of its longer-term development projects while the products were still in development. In that way revenue was recognised earlier than was perhaps appropriate.
Now iSOFT recognises revenue from development projects over the life of the contract on a percentage completion basis, which is conservative and we believe appropriate, particularly in some of the larger contracts. Indeed it's consistent with what we do in the rare cases when we undertake small development projects. iSOFT also booked revenue from its long-term contracts with the NHS ahead of delivery of the services for which it was being paid.
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After the well publicised delays in iSOFT's delivery of product to NPfIT, what level of confidence do you have that iSOFT can meet the revised NPfIT delivery schedule? What are the implementation risks?
CEO Steve Garrington
NPfIT is a very demanding program and from the information that's available in the public domain, it's clear that all suppliers have suffered delays - not just iSOFT. It's also worth pointing out that iSOFT isn't responsible for the implementation program - that's the work of Computer Sciences Corporation (CSC). iSOFT's role is to deliver the LORENZO software product to CSC.
In August of last year, iSOFT renegotiated its contract with CSC so that payment for about 50 percent of the contract value is made against incremental delivery milestones. From a commercial perspective, iSOFT has de-risked the development project. So far, delivery has been broadly in line with the agreed milestones.
The schedule isn't without risk, but we're confident that with our involvement and the recapitalisation of the business the enlarged company will be better able to focus on the project with less staff attrition, and we believe we can meet the delivery schedule.
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LORENZO is iSOFT's flagship software product but its development has suffered a number of delays. What's been the problem with LORENZO and why has development been delayed? Where is it now in the development time line?
CEO Steve Garrington
Originally, iSOFT was working for two prime contractors to NPfIT, CSC and Accenture, which caused some complications. With one prime contractor, CSC, taking over in January 2007, delivery has been simplified. Also, in the early part of the program, iSOFT was required to adapt earlier versions of its software to meet the urgent needs of hospitals that had failing, non-iSOFT systems, and that work turned out to be greater than expected.
LORENZO is a new design-and-build solution for the NHS and it has to meet very demanding specifications. iSOFT has done a very good job of designing the core architecture and infrastructure of the product, which is largely complete. The iSOFT development team is now going through the process of adding the application modules and functionality to the core of LORENZO and delivering this software through a rigorous testing process to CSC.
There are some key milestones to be delivered over the next few months which should see the delivery of LORENZO 3.5 ready for deployment by mid 2008. There are also some additional smaller components that will be delivered over the following 12 months.
It's also worth mentioning that clinical modules of LORENZO are currently being rolled out at two early-adopter sites and are due to be installed at a further two sites later this year. This roll-out underpins our confidence about the delivery schedule.
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To what extent does the future of iSOFT depend on the success of LORENZO and what are the risks at this stage of the product's development?
Executive Chairman Gary Cohen
The first point is that the NPfIT programme of work accounts for only 16 percent of iSOFT's total revenue - although it gets 100 percent of the media coverage! The second point is that revenue from the UK market, which is about 50 percent of total revenue, comes from a variety of areas. iSOFT has over 60 percent market share across the UK and Ireland health information systems market. In continental Europe it has a majority of the major hospitals in the Netherlands and is the leading provider of laboratory and radiology software in Germany. In Australia-New Zealand, iSOFT has a strong position in the public sector in patient management systems.
Overall, if the NPfIT program were to slow down, iSOFT's position is protected through its installed base - its future certainly doesn't depend on LORENZO.
Having said that, LORENZO is an important product for tomorrow. In the health care market you need to have reference sites, and once LORENZO reaches a proven state over the next few years, we'd expect it to have a long life cycle. By contrast, the vast majority of the flagship products of the major US healthcare IT companies are over 10 years old and we have an opportunity to lead the global market in the next generation of systems.
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Is there any evidence that iSOFT customers will be sensitive to a change in ownership? How will you seek to handle the change of ownership in terms of client relationships?
CEO Steve Garrington
The financial strength and longevity of the provider is an important aspect of any buying decision in the healthcare market, particularly where government funds are involved. Our plan to restore the balance sheet will immediately address any issues in this regard.
It's pretty clear to us that most of iSOFT's customers would see a strengthened and enlarged group, where the employees don't fear for their jobs and where there's money to invest in R&D, as a very strong positive. And that's been the overwhelming feedback iSOFT has received.
We've also worked very closely with CSC, iSOFT's biggest customer, to ensure CSC is comfortable with the financial position, management structure and technical capability of the group and our commitment to LORENZO and the NPfIT program itself.
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Can you comment on iSOFT's working capital requirements and how they compare with IBA's? Do you see scope for working capital reductions going forward?
CEO Steve Garrington
In a normalised situation, iSOFT's working capital requirements aren't particularly different from ours, with one exception - the product development investment in the LORENZO project. However, as I said earlier, the revised deal with CSC means the LORENZO development is underwritten in that CSC will be paying for the delivery of increments of the product.
Nevertheless, there is a working capital hole of about GBP70 million, or approximately A$170 million, because iSOFT's former management brought forward a lot of the cash associated with many of its current contracts either through prepayments or by way of contract financing arrangements. As a result, the company won't receive any cash as the balance of those contracts is delivered. iSOFT therefore requires additional working capital in the interim. The bulk of this liability winds down over the course of the next two years, with a tail over the third year.
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What's the outlook for the group's cash flow over the initial period post acquisition?
Executive Chairman Gary Cohen
We can't be specific about the outlook. However, we've made sure we've got adequate headroom in our refinancing of the business. When we acquire iSOFT, there should be no net debt in the group. We've also been very conservative in our modelling, and put in place a four-year banking facility, even though the contract financing largely unwinds over two years.
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As at the end of October 2006, iSOFT had total borrowings equivalent to A$110 million and including contract financing, total debt stood at A$248 million. Can you comment on the intended use of IBA's new debt facilities of A$309 million and the A$200 million of equity you'll be raising?
Executive Chairman Gary Cohen
We've raised A$55 million from our conditional placement, which was many times oversubscribed by about 40 international and domestic institutions. That cash, together with the funds from the planned rights issue, which is underwritten by ABN AMRO Rothschild, will be used to retire iSOFT's existing loan facilities. On completion, the group will have surplus cash and the only liabilities will be the A$180 million of contract financing and deferred revenue.
The A$144 million long-term loan and A$60 million revolving facility we've arranged will be available for working capital requirements and won't be used to retire any other debt. Our A$107 million bank guarantee facility will be used to replace iSOFT's existing bank guarantees, which are expected to wind down over the next 12 months.
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Under its new debt covenants, IBA expects to be restricted in paying dividends to shareholders in the current financial year ending June 2007 and next financial year. Can you comment on the outlook for dividends over the medium term?
Executive Chairman Gary Cohen
We want to revert to a dividend paying position as soon as possible. One of our key objectives will be to restructure our bank debt as the group returns to a more normal cash positive position.
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Thank you Gary and Steve.
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Contact
Gary Cohen or Steve Garrington
TEL:(+61 2) 8251 6700
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