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Robert M. Johnson LBS REF: CS-09-002

Date: February 2009

ProMed

Abstract
For Sid Worley, it was decision time. He had spent the last two years courting the
management and the family owners of his largest competitor, and finally (and
unexpectedly) they had indicated that they would be receptive to ‘a serious offer’ to buy the
company. Worley was excited and determined to buy the company, but now he faced the
reality of having to come up with an offer that would work.

The case was developed by Robert M. Johnson, Lecturer in Entrepreneurship at London Business School. It has been
prepared as a basis for class discussion rather than to illustrate either the effective or ineffective handling of an
administrative situation.

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Background
Sid Worley, aged 35, was the managing director and largest shareholder of ProMed
Limited, a supplier of specialised medical equipment and services to UK National Health
Service (‘NHS’) hospitals. ProMed was a relatively young company (founded in the
Midlands region in England in 1994 by two health care specialists), and Worley had
purchased ProMed from its founder in 2002 with backing from a group of private investors.

When Worley bought it, the company had been growing steadily but cautiously, a reflection
of the founders’ focus on patient care as well as their lack of real commercial experience.
Worley immediately set out to strengthen the commercial management of the company
while trying to preserve its well-deserved reputation for focusing on ‘caring for patients’.

After the first year the company was already recognised as a much stronger marketer and
was beginning to pick up new service contracts from the NHS (see Exhibit 1). Worley
realised early on, however, that the only way the company would be able to grow
significantly was to make one or two strategic acquisitions and then expand its services
from a larger base. Thus in late 2003 Worley began to study carefully the competitors in
ProMed’s market niche.

J. Healy Limited
There were only three companies of significant size that interested Worley, and J. Healy
Limited was clearly the one with the most potential. Still owned by the family whose
ancestors had started the company 72 years earlier, J. Healy was a well-known and highly
regarded name in its industry worldwide. Recently, however, the company had slipped
substantially in the marketplace and was rumoured to be in serious decline. While still
owned by the family, the company was no longer run by a family member, and no one in
the family was close to the business, relying instead on the management team to run the
company and deliver the annual dividends.

Worley approached the non-executive (and non-family) chairman of the company prior to
buying ProMed, but at the time there was no interest in selling the company. Now,
however, there were signs that the company was not able to adjust to recent competitive
changes in the marketplace, and it was losing business to competitors, including ProMed.
Worley had also heard rumours that the company had built up substantial bank borrowings
and was under increasing pressure from the bank to straighten out its financial situation.

The opportunity
Worley had made a point of staying in regular contact with J. Healy’s chairman, and when
it became apparent that he was no longer closing the door on a possible sale, Worley
pursued him relentlessly (though sensitively). His persistence paid off – and in late 2004
Worley was invited to make ‘a serious offer’. J. Healy’s chairman emphasised, “The family
had an unsolicited offer three years ago from a French company, that was very attractive,
but were not interested in selling. The business has changed since then and two of the
older families have suffered illnesses, but they remember that offer and would expect you

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to recognise the value inherent in the company and its worldwide reputation. They know I
have spoken with you and have said they will consider an offer from you, but they’re not
going to be interested in anything that is silly.”

Worley knew that he had the inside track – that the family would prefer not to sell to one of
the other two major competitors because of long-standing bad feelings – but he took the
chairman’s caution at face value. He would have to make an offer that would make sense
to the family, or they might seek competitive offers.

ProMed’s investors had already indicated their willingness to fund any reasonable
acquisition, but Worley also recognised that the price paid would have to make sense in
order to count on that support.

Information problems
Worley suspected that the company was in worse shape than anyone had indicated, and
this was confirmed when he received the management accounts from the company (see
Exhibit 2). First, the latest accounts available were four months old (and apparently were
produced more quickly than usual). Then Worley’s questions revealed a weak
understanding of the numbers on the part of J. Healy’s management.

Over the next few weeks of analysis and questioning, it became apparent that only when
the audit was performed each year was it truly clear. Yet despite the obvious shortfall year-
to-date and a recent announcement that the company had lost another large service
contract, J. Healy’s managing directors insisted that the company would achieve its
forecast profit for the year of £580,000.

There was also a big question about whether some items in the balance sheet were
accurate. For example, when Worley asked about the company’s high-level stocks, the
answer was that the company had to continue to carry parts for all older products that it
had manufactured because of the specific medical nature of those products. While he
understood the argument – indeed ProMed faced a similar, though less significant issue
with its stocks – Worley was surprised that there seemingly had been no ‘cleaning out’ at
all, and he wondered if the company had even conducted a proper stock take.

While he saw this as one of many opportunities to improve the company, at the moment
Worley was only concerned about coming up with a realistic value for the company.

Preparing to make an offer

At this stage, J. Healy’s management was reluctant to provide Worley with much
information until it saw a serious offer. The view was that Worley knew the industry, he
knew J. Healy’s reputation, he had their financial information (sketchy though it was), and
he should be able to decide what to pay for the company. Detailed due diligence could
take place later, once a ‘serious offer’ had been agreed.

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Indeed Worley did know the industry well, so he took J. Healy’s financial information and
began to develop a model for the business. Much of the first year involved taking
substantial duplicate costs, as well as excessive Healy overheads, out of the company.
Aside from the stocks issue, he didn’t expect any changes in working capital.

After several iterations, Worley had a forecast, which, though simple, he felt reasonably
comfortable with (see Exhibit 3). He also collected as much information as he could about
comparable values in the field (see Exhibit 4). Finally, he remembered what one of his
business school professors, a seasoned acquisitions person, once told him: “After years of
dealing in unquoted companies, I’ve learned one simple rule: when you’re the seller, you
sell at eight times EBIT 1 ; when you’re the buyer, you pay six times EBIT.”

Although his concerns about J. Healy’s condition had not subsided, Worley knew that he
now had to come up with a price.

1
Earnings before interest and taxes.

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Exhibit 1: ProMed results

P & L (£000) Forecast

2003 2004 2005 2006

Turnover 4,176 6,146 7,306 8,204

Cost of sales 2,991 4,914 5,982 6,828
Gross profit 1,185 1,232 1,324 1,376
Overheads 656 547 535 528
Operating profit 529 685 789 848

Balance sheet 31 December 2004

Net fixed assets 350

Debtors 663
Stocks 758
Work in progress 163
Cash 455
Current liabilities (1,072)
Net current assets 967

Long-term debt 1,070

Net assets 247

Shareholders’ funds 1,260

Goodwill on acquisition (1,013)
247

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Exhibit 2: J. Healy financial statements provided to Sid Worley

Statement of results
2000 2001 2002 2003 10 mo.
2004
Turnover 16,770 17,846 18,947 19,110 14,444
Cost of sales 8,834 9,472 10,543 10,591 7,815
Gross profit 7,936 8,374 8,494 8,519 6,629
Overheads 7,477 7,514 7,676 7,964 6,366
Operating profit 459 860 818 555 263

Balance sheet 31 August 2004

Property 202
Equipment 737
Automobiles 302
Intangible assets 9
Net fixed assets 1,250

Raw materials 1,215

Work in progress 835
Misc. stocks 73
Purchased goods 1,075
Finished goods 2,174
Total stocks 5,372

Debtors 2,557
Cash 67
Total debtors and cash 2,624

Trade creditors 1,554

Other creditors 624
Total creditors 2,178
CAPITAL EMPLOYED 7,068

Capital and reserves 3,962

Current year profit after tax 36
Shareholder funds 3,998

Overdraft 1,621
Lease / hire purchase 696
Associated company funding (157)
Long-term loans 750
Short-term loans 160
Total borrowings 3,070
TOTAL FINANCE 7,068

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Exhibit 3: Sid Worley’s forecast for the combined businesses

2005 2006 2007 2008 2009

Turnover 21,500 21,600 22,600 23,500 24,400

Cost of sales 15,000 15,000 16,000 16,700 17,400
Gross profit 6,500 6,600 6,600 6,800 7,000
Overheads 4,000* 3,900 3,900 4,000 4,100
Operating profit• 2,500* 2,700 2,700 2,800 2,900

*
Excludes extraordinary restructuring costs.
•
Capital expenditures and depreciation were offsetting.

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Exhibit 4: Financial data collected by Sid Worley

Corporate tax rate 35%

Base lending rate 4.75%

UK 10-year government bond yield 4.53%

London Stock Exchange:

FTSE All-Share average P/E 22.03
FTSE Small Cap average P/E 25.50
Health Care sector average P/E 26.85

Comparable Public Companies: (large companies with comparable divisions)

Novacare (U.S. company)

P/E 11
Beta 1.16
Debt: Equity 89%
Unlevered Beta 0.61

Smith & Nephew (UK co.)

P/E 14.9
Beta 0.56
Debt: Equity 22%
Unlevered Beta 0.46

Recent trade sale of company in similar area of the industry:

(based on discussion with venture capitalists)
P/E 18
Multiple of sales 1.5

BDO Stoy Hayward Private Company Price Index ∗ 39% discount ∗

ProMed investors’ desired IRR 30%

∗
BDO Stoy Hayward publishes a monthly report on unquoted company trade sales, comparing the
valuations achieved with valuations in the quoted sector and thus showing the resulting discount at
which unquoted companies are sold.

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