Desperately seeking Sigma

A merger of the two publicly listed pharmacy wholesalers, Australian Pharmaceutical Industries (API) and Sigma Healthcare, has been on the cards for almost two decades.

The relative strengths of the two wholesalers have reversed in that period, with an ascendant Sigma of the early 2000s now struggling and a genuine takeover target.
This time around there are two key questions: will API be the only suitor and will the Australian Competition and Consumer Commission allow an API-Sigma merger?

Market values eroded

API’s merger proposal values Sigma Healthcare at $700 million, calculated on a cash-and-scrip 68.6¢ per share offer, which was a significant premium on the market price when the bid was announced on December 13.

At first glance the API bid deserves consideration by the Sigma Healthcare board, however, after an eight-year struggle that has eroded investor value, the directors owe it to shareholders to explore the possibility of other suitors if they are of a mind to agree to a takeover.

Other suitors could potentially include private equity firms, healthcare firms with an eye on vertical growth opportunities or an international drug wholesaler and/or retailer keen to enter the Australian market.

It is not so long ago that grocery and hardware wholesaler Metcash was keen on acquiring Sigma.

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One of the key reasons that Sigma Healthcare is vulnerable to a takeover now is the loss of the Chemist Warehouse supply contract to Ebos. That shift, which brought Chemist Warehouse and TerryWhite Chemmart under the same wholesaler, is one of the key arguments API would put to the ACCC in seeking a merger approval.

Ebos’s two major customers will command a retail pharmacy market share of more than 33 per cent, with Chemist Warehouse around 23 per cent and TerryWhite Chemmart 10 per cent from June of this year.

Sigma is the wholesaler for five key brands – Amcal, Guardian, Chemist King, Discount Drug Stores and PharmaSave – and will have a market share of around 19 per cent when the Chemist Warehouse supply contract ends in June.

API’s major strength is its Priceline Pharmacy brand, which has a market share of more than 10 per cent, but is also the wholesaler for Soul Pattinson Chemist, Pharmacist Advice, Pharmacy Best Buys and independent pharmacies.

API’s enterprise value is around $786 million, while the merger proposal has lifted Sigma to around $594 million.

In the 2018 financial year, API posted net earnings of $48.1 million on annual sales of $785.6 million, while Sigma Healthcare generated net earnings of $55.1 million on revenues of $614.5 million.

Losing Chemist Warehouse

Sigma’s outlook will potentially be dented by the loss of the Chemist Warehouse business, although directors have indicated they are examining acquisition opportunities themselves to replace the lost revenues and earnings.

Playing down the Chemist Warehouse loss, Sigma CEO Mark Hooper said the decision provided a clearer future and “a runway to make the required changes to reshape the operating and fixed-cost base” of the wholesaler’s business.

“Over $300 million cash will be freed up at the conclusion of the contract, which will enable us to expedite the execution of our strategy to diversify and strengthen our business with a broader healthcare focus,” Hooper said at the time.

Sigma shareholders were not so bullish and virtually halved the value of the shares from the $1.02 price on January 4, 2018, before the Chemist Warehouse contract decision was announced.

While the share price rallied above 60¢ in October, it fell sharply to just 40.5¢ on December 13, triggering the API merger proposal.

Interestingly, Sigma’s October share price gains coincided with an indicative takeover offer lodged by API with the Sigma board but not reported to the Australian Securities Exchange until December 14.

The day before API acquired a near 13 per cent shareholding in Sigma.
API has already advised the ACCC of its proposal to merge the two pharmaceutical wholesalers despite the regulator’s previous reluctance to tick off such a plan.

Sigma Healthcare’s response to the API overtures last month indicated it would weigh up the offer against a review that it has been undertaking to identify cost savings, the business structure and growth opportunities as a result of the exit of its largest wholesale customer.

With the merger proposal now a live option within that review, Sigma’s directors should also be considering the value of attracting interest from other possible suitors.

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