Ebos plans evolutionary growth in margin-stretched industry

By Nick Stride

Friday 11th October 2002

Ebos chief executive Mark Waller likes to recall a conversation with Peter Zuellig, scion of the multinational Zuellig Group.

"I don't know what's wrong with you Kiwis," Mr Zuellig told Mr Waller. "You just don't seem to want to make a dollar."

Mr Waller thinks the comment has something to it, in the medical supplies industry at least.

"Everyone's forgotten about margins and are trying to cut each other's throats," he says.

Mr Waller has margins close to his heart.

When he took over the top job in 1987 Ebos was a distributor reliant almost entirely on agencies. In former years that had been a great place to be margins were in the 30-40% range.

But the agency business was becoming fickle. In 1996, for example, Ebos suffered a major blow when British giant Johnson & Johnson decided to do its own marketing and distribution.

That and other changes were undermining Ebos' cosy position. In 1998, net profit was $2.8 million and the shares had fallen as low as $1.20.

Agency churn has increased since. Last year corporate upheavals overseas meant Ebos lost agencies for Germany's Beiersdorf (Nivea) and Britain's SSL Group (Durex).

Ironically Ebos' marketers had built up Durex into the national brand leader with an 85% market share the highest in the world. Now they'll have to try to undermine that position with the replacement agency brand.

The industry is also sensitive to changes in government policy.

Ebos' share price went into a steep climb in 1999 when the Labour Party, a traditional big health spender, won office.

But in the public health sector managers' squeeze on costs continues. And changes in public health sector buying policy can have a huge effect on individual companies.

Ebos has found that out a couple of times in Australia.

In orthopaedics a central authority formerly approved prices and reimbursed suppliers. A change of tack opened the market up to all insurers.

The influenza vaccine market, formerly almost entirely private, had been a good earner for Ebos. A move to state-by-state tenders took it almost completely public and Ebos, left without the scale to achieve worthwhile returns, pulled out.

The company found it had to adapt to the evolving landscape or face extinction.

Mr Waller identified two critical weaknesses: the vulnerability to agency "churn," and overreliance on the government sector.

The response has been threefold. Ebos has beefed up its presence in the non-agency wholesale business; spent cash buying brands in its own right, while working to retain and expand its agency portfolio; and relinquished the "suboptimal" brands owned by multinational clients.

It seems to have worked. Since 1998 annual revenue has climbed from $63.6 million to $206 million. June-year net profit was $6.1 million.

Now the company is on a charm offensive to lift its profile. This week it held a briefing for Auckland-based media and analysts ahead of a possible equity-raising next year.

It has grown in recent years through a steady stream of acquisitions and Mr Waller has gained a reputation as a shrewd player in the buying game.

"Mark's very competent in that area, and very strategic in his thinking," says John Cairns, head of research at Forsyth Barr Frater Williams.

Not that Ebos has stacks of cash to blow. Mr Waller says the company has copped criticism for its high dividend payout policy, an apparent anomaly for a "growth" stock.

That, he says, is largely down to 27% shareholder Peter Kraus, who believes in keeping management honest by relieving them of excess cash.

That's not Mr Waller's instinct he prefers to reinvest but he concedes Mr Kraus has been proved right over the years. "And as he points out, he's never denied me the cash for a good acquisition."

Acquisitions have to meet a range of criteria. Each must be a good strategic fit, must be earnings share positive, and must meet a hurdle rate of 12% to 15%.

The company's most significant recent acquisition has been Auckland region medical su pplies distributor Health Support (the old Auckland Government Stores Board).

Ebos sees government baseline health spending rising by $500 million a year as a huge opportunity. It has invested heavily in Health Support's state-of-the-art electronic logistics system, in-tegrating it with hospitals' own IT.

Other additions in the past six years have been Medic Corporation, Australia's Richard Thomson, Maygar Medical in Melbourne, natural health products business Nature's Kiss, and the Allesearch brand.

The scientific division has been merged with Global Science & Technology's local operation to take it to the No 2 market position and Mr Waller says it's now in a position to give the number one a run for its money.

Mr Waller says the buys have been small and low risk and "not the next step up in scale."

Management will spend the next three to six months "housekeeping" before any significant acquisition is considered.

"Own brand" acquisitions have included Anti Flamme, a herbal anti-inflamatory cream that competes with market leader Voltaren.

Mr Waller concedes Ebos is still too small to attract much attention from institutional investors but intends to keep its track record in front of private investors.

Forsyth Barr has produced research on Ebos for a year or so and assesses current fair value at $3.20 to $3.40.

Another sharebroker, ABN-Amro Craigs, intends to start coverage as soon as practicable.

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