Maker Of Laboratory Gear Boils Out The Fat And Sees Profit Soar

Thermo Fisher Scientific has learned from past mistakes.

The supplier of laboratory gear was very aggressive and acquired dozens of small firms over the years. It built a far-flung empire of little technology pods, says analyst John Sullivan of Leerink Swann.

But by the late 1990s, Thermo TMO was standing on a sinking financial ship. It sold off most of its firms amid investors' concerns.

It closed half its plants around the world, got rid of duplicate overhead and merged divisions to turn itself around. It sold off the last remaining assets in early 2005.

Thermo trimmed the fat to focus on its core business. It supplies analytical instruments and lab gear to the life sciences tool industry.

It now runs two segments, Laboratory Products and Analytical Technologies. It makes instruments that analyze lab samples and tests, such as checking blood for disease. It also makes lab gear such as glass beakers and tubes, as well as chemical agents.

Rebound

Thermo has since rebounded. Its stock has more than doubled since April 2005. And through that span the company has posted strong quarterly gains.

It said second-quarter earnings surged 55% to 65 cents a share. Analysts were expecting 60 cents. This was the company's 12th straight quarter of double-digit profit growth.

Based on results so far this year, Thermo raised its full-year earnings outlook to $2.50 to $2.56 a share. The Street expects a profit of $2.50.

The question now is, can it maintain that growth?

After a few key acquisitions, new innovations and better execution, Thermo seems capable of doing just that.

"Thermo will still grow through acquisitions, but at a much slower pace," Sullivan said. "It will look for compelling technologies that will fit in or fill holes within its portfolio."

It more than tripled sales growth to $2.39 billion. But Sullivan says last year's second quarter did not include the acquisition of Fisher Scientific, which closed last November. Thus, it's not an equal comparison, he says.

Thermo Electron agreed to buy the larger Fisher for $10.6 billion in stock. The deal carved out a bigger share of the lab supplies business for Thermo. Today, the company enjoys a 15% to 20% share of the life sciences tool sector, Sullivan says.

The deal pairs Thermo's core business of making scientific instruments with Fisher's strengths in making single-use chemical agents and other lab gear.

"With complimentary product portfolios and strong distribution channels, Thermo Fisher will be the one big drug companies come to first," Sullivan said.

Its main clients include pharmaceutical firms, government research labs, hospitals and universities.

Innovation is critical to the life sciences sector, Sullivan says. And Thermo is an innovative leader within the space. For example, it unveiled a new kit that helps researchers understand how proteins act in our bodies.

The kit joins Fisher's unique Silac chemical with Thermo's mass spectrometry instrument. The outcome is a machine that can deliver quicker and better results.

"The new kit is cost-efficient and puts chemicals and instruments together," Sullivan said. "The optimization of the two is what separates Thermo from its competitors."

Its rivals include Agilent Technologies A, Waters WAT and PerkinElmer PKI, as well as chemicals maker Sigma-Aldrich SIAL.

Thermo has made more strategic acquisitions, proving it has learned from past mistakes. Two years ago it bought Kendro Laboratory Products for $850 million, to build on its portfolio of lab products.

In late July, Thermo agreed to buy Qualigens Fine Chemicals, a unit of drug giant GlaxoSmithKline GSK. Qualigens is India's largest lab chemical maker and supplier. The company had sales of $24 million last year.

"The well established and extensive channel network of Qualigens will make Thermo Fisher the leading supplier to India's research market, allowing us to accelerate our growth in a country where science and industry are moving forward at an exciting pace," CEO Marijn Dekkers said in a press release.

Analyst Peter McDonald of American Technology Research says that Qualigens is the start of Thermo moving into the wide-open Asian market, especially in China and India. Thermo generates about 7% of its sales from the two Asian countries.

"Asia is underrepresented and offers significant upside potential for Thermo, especially as Big Pharma moves its R&D and clinical research to China and India," said McDonald.

China is building a network of national and academic labs throughout the country for the first time, he says. The labs will need to be supplied with equipment and gear over the next few years. It's a wealth of opportunity for a global firm like Thermo.

China, India and other budding economies in Asia are spending billions to build an industrial infrastructure to support their fast-paced growth. But the buildup threatens to pollute the environment. Thermo makes equipment that can monitor the effects construction is having on the air and water.

Higher Standards

McDonald says China's recent pet food and lead paint scares may force the government to raise its standards. If that happens, he believes Thermo's equipment will be in high demand.

Stricter environmental policies here in the U.S. will also drive demand for Thermo's monitoring devices, McDonald says.

In 2005, the U.S. Clean Air Mercury Rule was passed. It will require continuous monitoring of gaseous mercury from coal-fired power plants. This will drive the uptake of monitoring systems, he says.

"The mercury regulations go into effect in early 2009, and power plants will need Thermo's instruments," McDonald said. "In the long term the systems contain a service component, providing a steady, recurring revenue stream."

Thermo has averaged about $1 billion of free cash flow each year. The industry is fragmented, with a bunch of mom-and-pop firms with $50 million or less in annual revenue. The space is ripe for the picking, McDonald says.

"With a war chest that size it has plenty of capital to make acquisitions," he said. "The small firms would be nice tuck-ins to fill voids in its portfolio. But it won't just buy for the sake of buying."