Opto Circuits- Healthy top line growth :: Edelweiss

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Opto Circuits
􀂄 Healthy top line growth, but one-offs dent margin
Opto Circuits' (OPTC) Q2FY11 top line was broadly in line, but EBITDA and net profit
came below expectations, primarily owing to jump in SG&A and employee expenses
(owing to integration of its recent acquisitions) besides forex losses of INR 82 mn. Both
invasive and non-invasive segments grew at a healthy pace Y-o-Y (up 49% and 23%,
respectively) though the sequential decline in invasive revenues (-3%) was a tad
disappointing. EBITDA margin declined to 31.9% on account of higher staff costs (up
49% Q-o-Q, 45% Y-o-Y) and SG&A (up 37.7% Q-o-Q, 70.5% Y-o-Y). Rise in employee
costs was on account of integration of recent acquisitions of N.S. Remedies (India) and
Unetixs (US) besides fresh hires at OPTC’s new Malaysia facility. Jump in SG&A costs was
driven by higher promotional expenditure which the company pegged at ~INR 50 mn.
Excluding this expense, we estimate the EBITDA margin would have been ~33.4%. Tax
rate fell sharply to 2.9% from 10% in Q1FY11, led by scale up in operations in the Vizag
SEZ.


􀂄 Proposed acquisition of Cardiac Science
OPTC has announced that it intends to acquire NASDAQ-listed Cardiac Science (CSCX)
for USD 2.3/share and expects to spend a total of ~USD 85 mn on this acquisition. CSCX
had revenues of USD 156.8 mn and net loss of USD 76.9 mn in 2009. It develops,
manufactures and markets advanced diagnostic & therapeutic cardiology devices and
systems, which primarily include automated external defibrillators (AEDs). We believe
the acquisition is a strategic fit for OPTC’s non-invasive product portfolio and do not see
funding as a material concern given OPTC's negligible debt/equity of 0.1. However, CSCX
had initiated voluntary field correction for its key products, AEDs, in November 2009 and
post a warning from the USFDA in Feb 2010 it had replace ~24k AEDs in the US market.
To date, CSCX has set aside ~USD 32 mn for product recall/update. So far OPTC has not
clarified on its future liability, if any, for this product recall. We await further disclosures
from management on the acquisition and will thereafter revisit our numbers.

􀂄 Outlook and valuations: core business growth on track; maintain ‘BUY’
We believe OPTC’s core business growth remains on track and expect recent acquisitions
to enhance its product portfolio and drive revenue growth. OPTC’s new manufacturing
facility in Malaysia is expected to commence full-fledged operations Q3FY11 onwards and
will facilitate it to serve Asian markets faster, besides providing tax-exemption for 10
years. We await clarity from the management on its strategy for its proposed acquisition
CSCX, particularly details on the future product liability (if any) and the expected time to
turnaround the acquisition. Thus our current estimates do not incorporate CSCX. We
have lowered our FY11 and FY12 earnings estimates by 3.2% and 2.1% respectively
owing to higher SG&A costs. We maintain our ‘BUY’ recommendation.