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Merge to Merge

January 18

Milwaukee-based imaging software vendor Merge eFilm (Nasdaq: MRGE) has agreed to purchase for $393 million in stock another imaging software player, Cedara (Nasdaq: CDSW) located in Ontario.

The deal is a big step for Merge: it’s paying a substantially higher price than its own market cap of $257 million and the value is also a 25% premium over Cedara’s pre-announcement market cap.

Other metrics also demonstrate Cedera’s greater value. Its sales in the last 12 months were about $44 million with a profit margin of 33% versus Merge’s $35 million generating a margin of 20%. In addition, Cedera grew a robust 67% during this time while Merge saw a 38% expansion.

The deal makes strategic sense. While healthy, both players are rather small in the context of widely anticipated continuing software industry consolidation. In addition, the combination brings both marketshare gains and niche diversification: while both companies offer medical imaging applications, Merge focuses on radiology department operations while Cedera software runs the imaging devices themselves.

What’s less clear is why Merge is the buyer and Cedera the seller. Cedera certainly isn’t hurting for cash with $30 million on its balance sheet versus Merge’s $17 million. And both companies trade on a major US exchange so liquidity isn’t a factor.

But Merge’s trailing 12 month’s P/E is almost 39x versus Cedera’s 25x, so Merge has 59% greater stock buying power. Like GE used to do, Merge is buying low P/E assets with high P/E assets. That is, Merge is spending $393 million at a P/E of 27.4x to buy assets that – the theory goes – under Merge’s management will be worth about $560 million at Merge’s P/E of 39x.

Another benefit of the deal is moving the combined operation to an American headquarters, where the market is 10 times the size of Canada’s. But the real lesson of this deal is the power of stock market value perceptions.

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