Allscripts Bought Its Way Into Trouble

In a recent Bloomberg interview, Allscripts Healthcare Solutions (NASDAQ: MDRX
) CEO Glen Tullman defended its $1.3 billion acquisition of Eclipsys Corp. last
September, suggesting the integration of the two companies will boost its stock
price because of increased sales. Up just 1.4% in the past 52 weeks, it
doesn't matter if the integration goes well. This is an overpriced stock with
several glaring problems. Value investors shouldn't waste their time. Eclipsys
Merger Tullman's rationale for making the deal is one of synergy. Combining
its focus on physicians' practices with Eclipsys' focus on hospital systems
creates a fully connected health care community that is benefiting from $27.4
billion in stimulus money. I'm not about to argue the validity of this
statement. It seems reasonable to assume that a fully digitized health care
system is better for patients. What I will question is the price the company
paid for Eclipsys. Revenues might grow, but it's debatable how much will flow
to the bottom line. Acquisitions tend to deliver far fewer synergies and cost
savings than anticipated. For proof of this, one only needs to observe what's
going on at Kraft (NYSE: KFT ) these days. Despite boasting about the synergies
of Kraft acquiring Cadbury in 2010, CEO Irene Rosenfeld has turned 180 degrees,
splitting its global snacks business from its U.S. grocery business. With this,
Kraft essentially will become the Cadbury and General Foods of old. It will have
gained no synergies from the acquisition. I'm not suggesting Allscripts will
split into two companies down the road, but the market has a reason to be
skeptical. Nothing it's done in the year since the acquisition would suggest
one plus one equals three. Return on Investment Allscripts issued 69.2 million
shares of its stock to pay for the Eclipsys acquisition. In addition, it issued
61.3 million shares to Misys, its controlling shareholder, who then sold 31.05
million shares in a secondary offering at $17.05 per share, and the company
repurchased another 24.4 million shares at $23.66. In addition, after the merger
was completed, it repurchased 5.3 million shares for $19.17 per share. All told,
it paid out $679 million to repurchase 29.7 million shares. Before the
acquisition, Allscripts had no debt. Afterward, it had $489 million in current
and long-term senior secured credit. Before the deal, it had 146 million shares
outstanding and 250.7 million after. The total effective cost, including taking
out its majority shareholder, came to $2.5 billion for a business that generated
$40.5 million in operating profits in the second quarter from $157.1 million in
revenue. That's an annualized return on investment of approximately 6.5%. That
wouldn't be so bad if it financed the deal with debt at interest rates of less
than 2% (what it pays currently), but it used stock instead, and that's
proving to be very costly. A quick calculation of its weighted average cost of
capital suggests its cost of equity is around 10.5%. Allscripts needs to find
synergies fast. As it stands today, it appears they overpaid by 40% or so.
Valuation Allscripts enterprise value is 18.3 times EBITDA. Cerner (NASDAQ: CERN
) and Quality Systems (NASDAQ: QSII ), its two publicly traded peers, trade at
22 times EBITDA. From this perspective, its stock isn't expensive. However,
these aren't the only stocks available for your purchase. There are about
5,000 other possible candidates, many earning far more than Allscripts ever
will. For example, Apple (NASDAQ: AAPL ) trades at 11 times EBITDA, yet the
iconic brand's cash position is eight times the market cap for all of
Allscripts and Apple is growing faster. With the exception of price-to-book and
price-to-sales, Apple is a much cheaper stock. As a value investor, I couldn't
possibly recommend investing in a company like Allscripts when I know I can own
Apple for less. Bottom Line Even if Allscripts successfully integrates Eclipsys,
the price it paid was too high. Eventually, this all-stock deal is going to come
back to haunt it. As of this writing, Will Ashworth did not own a position in
any of the stocks named here.