Developing Growth Strategy in Turbulent Economics Times
A Prescription for Identifying and Executing on Growth Opportunities in Healthcare

We are going through turbulent economic times. The Dow Jones Industrial Average has fallen 32% from its highs at the start of 2008 while the NASDAQ has fallen more than 40%. In this environment of gloom and doom, most corporate executives have taken prudent measures, by reducing operating costs and conserving cash, to ride out the storm. We have seen major layoffs from a wide array of sectors, including automobiles, consumer products, and even health care. Meanwhile, shareholders and board members of these companies are increasingly confronting the executive leadership with a key question: What does the company do next? Or, more specifically, what is the strategic direction necessary to best navigate the company through these tough times? Any bold strategic move in such a period of economic uncertainty is understandably perceived as being fraught with risks. In such an environment, how does a company make the right strategic move, while removing as much risk as possible? Scientia Advisors has designed a structured strategy process to do just that. It is targeted to developing growth strategy in a turbulent environment and facilitates the creation of a strategic direction grounded in hard data, on which all relevant stakeholders can gain consensus and alignment to move a company forward.

Questions concerning strategic direction become all the more important in the health care sector as it is likely to be the most resilient sector in the economy and consists of many segments that are likely to show sustained growth. In fact, the average health care stock fell "only" 14% in 2008 and of the top 10 NASDAQ performers in 2008, 6 were health care companies. Historically, health care has been the most defensive sector from a money management perspective. This is not only due to the commonly cited reason of "people will always get sick," but also to novel innovations making health care more efficient. In order to identify segments of health care that are likely to show sustained growth, it is critical to know how new technologies are likely to impact overall patient care and health economics as new technologies will reduce downstream procedures and therapies, lowering overall health care costs.

Uncertainty Creates Opportunities for Shareholder Value Creation:

Our review of the health care industry has shown that turbulent economic environments create new opportunities for growth and shareholder value creation. Previous periods of economic slow-down were the early and late 90s (post internet bubble) and 2001-2002(post 9-11), as shown in Figure 1. Some highly successful businesses were created in the medical technologies/diagnostics/life sciences areas in these periods through private equity activity. For example, Dade Corporation was acquired by Bain Capital in 1994 for $450M, eventually merged with Behring Corporation in 1997, and was sold to Siemens for $7Bn in 2007, thereby creating significant shareholder value for the original investors. Similarly, Waters Corporation (Ticker: WAT), one of the most profitable life sciences instrumentation companies, was spun off from Millipore (Ticker: MIL) in the early 90s for $360M and now trades at an enterprise value of $4Bn, despite a 40% decline in valuation since September 2008. The key lesson here for corporate executives is: Think like private equity investors; i.e. develop organizational consensus on emerging yet high growth segments of health care and identify undervalued companies that could serve as platform for growth in these segments. This requires that your strategy group or the operating entities have a strong understanding of various segments of the target market and a clear sense of the growth trajectory for the next 5-10 years. Such groups need to be on constant lookout for new technologies, IP, and assets that will allow them to participate in emerging, growth areas. Such growth activity as highlighted above is not limited to private equity deals. There are many examples of companies that exploit market uncertainty to create significant shareholder value over time. For example, Johnson and Johnson (Ticker: JNJ) acquired several assets from Inverness' Point of Care diabetes group in 2002 (post 911 slowdown) and successfully grew this business to become a leading over-the-counter diagnostics company. Johnson and Johnson has recently executed three mid-sized acquisitions across various health care segments, despite global economic slow-down. The key lesson here is that forward-looking companies do not let economic slow-down stall growth plans. On the contrary, they increase global growth activity. Philips (Ticker: PHG) has made three acquisitions over the past 3 months all in the area of patient monitoring in emerging economies including China, India, and Brazil.

Valuations have become very attractive - It's a buyer's market

Consider a recent acquisition of Advanced Medical Optics (Ticker: EYE) by Abbott Laboratories (Ticker: ABT), announced on January 12, 2009. As shown in Figure 2, Abbott agreed to pay $22/share for Advanced Medical Optics at a whopping 150% premium over its market cap, as reflected in the stock price of EYE. On the face of it, this seems like a very expensive acquisition. However, Abbott has acquired a leading company in the optometry segment of medical devices for a relatively discounted price. Looking at the historical EYE shares in Figure 2, Abbott paid almost the same as the market capitalization of EYE in October 2008 before the stock declined. If Abbott had attempted to acquire EYE then, it would have had to pay a premium of 20-50% over market cap, and could have paid $35/share instead of $22/share. Obviously, at such a high valuation, acquisitions become increasingly difficult to justify financially, which may explain why this deal did not happen until January 2009. Along with Abbott, forward looking and cash rich companies are increasingly viewing this economic slow-down as an opportunity to enter attractive health care segments. During Johnson and Johnson's recent Q408 earnings call, CEO Bill Weldon made it very clear that the company aims to take advantage of the myriad of acquisition opportunities available in the market.

Similar to Advanced Medical Optics, hundreds of segment leaders are now financially justifiable for possible acquisition. Cepheid Corporation is a case in point. Cepheid (Ticker: CPHD) has developed a breakthrough molecular diagnostics system that allows simple and rapid DNA diagnosis of hospital acquired infections (HAI). Over the past several years, numerous companies have evaluated this company as a potential acquisition candidate, given the attractiveness of the HAI market. However, Cepheid's high valuation (market cap of over $1.6Bn at its peak with only ~$129M in revenue in 2007) prevented many companies from considering it as a viable acquisition candidate. In the meantime, Cepheid's business has steadily grown to $170M in sales in 2008 with and is now trading at a market cap of $420M at a stock price of $8/share, as shown in Figure 3. Cepheid is expected to achieve profitability over the course of the next 12 months, which we think can be accelerated with the help of a larger player with expertise in microfluidics and molecular diagnostics. Significant shareholder value can be created as a result of a transaction between a large health care company and Cepheid, particularly with the growth of HAI, the overall molecular diagnostics market, and its impact on personalized medicine.

The Process

If indeed this is the right time to review opportunities for growth in health care, the question becomes, "what is the best process by which a company can develop a strategy that identifies areas for growth?" This task is challenging, not only because growth segments in health care tend to be small and below the radar, but also because it is very difficult to gain organizational consensus for a compelling business case. Gone are the days of high-level 'benchmarking' studies, strategic scenario planning, and audits. What are required in these times are deep sector insights, technological understanding, and intimate customer perceptions.

We at Scientia Advisors have a strategy process designed to do just that- a highly fact driven exercise that can help develop a compelling growth strategy and identify niche growth opportunities. Our systematic process walks members of the strategy team through key decision-making points and enables the development of consensus among key stakeholders of the team. By the time a final decision is needed, all key members of the team are on board and can agree on a decision, despite uncertainties and risks. Our process is divided into three fundamental phases - the What, the Why, and the How. Most companies tend to start their strategic thinking with the "How", i.e. they start reviewing possible acquisition candidates before developing an organizational understanding and consensus on market growth segmentation and underlying drivers. This mistake occurs time and again, as companies build a case for an acquisition without bringing key decision-makers on board on market growth projections and competitive activity and have limited appreciation of risks and uncertainties. It is only at the end of the process that the strategy teams realize that the business case is not solid or the valuation multiples to be paid for acquisition are not financially justifiable, leading to lack of decision-making which we call "corporate paralysis." Scientia Advisors' process is designed to overcome this.

The following are key elements of our process (See Figure 4 in pdf format and contact Scientia Advisors for further details)

Final Deliverable: We will synthesize all the information gathered thus far into a highly structured and board-ready presentation deck containing the following:

1. Clearly defined set of market opportunities in identified markets that could serve as sustainable and profitable growth platforms for your company for the next 5-10 years and that fit with your company's core competencies
2. Strategic plan and options for your company to build a world class business in identified segments with most attractive route to market
3. Overall recommendations

Such a process can last anywhere from 12-20 weeks, depending on the scope and level of detail needed. We have applied this process numerous times across a wide array of global corporations with a 100% success rate, i.e. in all cases, our clients were able achieve organizational consensus on a strategic direction. In some cases, we recommended an M&A transaction whereas in other cases, it involved JV or alliances coupled with internal R&D and sales efforts. We can also customize this process for the unique needs of our clients; the process is modular so some clients may choose to engage us on a just one of the phases or even a work-stream. Our process, while structured and robust, is also very flexible and is very much suited to assist you in your next growth move in health care. After all, no company can afford strategic paralysis in such challenging economic times.