Coag Divestiture Creates Huge Opportunity

We view the divestiture of the clinical lab coagulation business and the subsequent shift towards a greater focus on the higher-growth POC (point-of-care) segment both as major positive steps for Trinity Biotech (TRIB). The $90 million sale price for the stodgy coagulation business, which had been significantly underperforming the other major business segments in revenue growth and margin contribution, reflects over a 100% premium relative to our valuation.

And while the coagulation business accounted for 40% of total sales, we model EPADR (earnings per American Depositary Receipt) to actually grow by 3% in 2010 as the additional interest income generated from proceeds of the deal will offset the net contribution from clinical lab coagulation. The cash proceeds from the sale wipes the balance sheet clean of debt and reloads the company’s coffers, which, along with a steady stream of operating cash flow, will be incrementally pumped back into R&D and infrastructure as Trinity builds out its faster growth and higher margin POC business.

The company will also likely be looking to supplement organic growth with in-licensing arrangements, partnerships and possibly small acquisitions — all of which can now be funded with cash. The huge cash balance (~ $45 million), along with the elimination of debt maturities and loan covenants, substantially enhances Trinity’s flexibility and allows it to rapidly transition into products and areas that hold opportunities for significantly greater growth. Barring attractive opportunities to reinvest a substantial portion of the cash, we expect the company to instate a share buyback program.

We believe Trinity’s POC business offers opportunities for significant revenue and margin growth as the company shifts many of its successful clinical lab products and related technology over to POC, where it already holds a dominant and growing position in HIV testing. Ample opportunities should exist to exploit their existing distribution and marketing platforms and sell clinical lab products side-by-side with their new POC offerings.

Gross margin should significantly improve as the higher margin POC segment becomes a greater contributor to total revenue. Operating margins should dually benefit as the company sheds expenses related to the resource-intensive coagulation business. The overall rapid macro-shift away from central lab testing to the POC setting that is underway by healthcare providers should also benefit Trinity’s POC segment growth strategy.

While management’s main focus for growth will be on the POC business, clinical lab products will continue to provide a large and stable source of revenue and cash flow. The company has a number of high-potential products under development, some of which are expected to launch in the next 18 months, which, coupled with positive market fundamentals, the strategic shift to greater exposure to POC and Trinity’s proven ability to successfully compete against much larger competitors has us confident that the company can realize long-term double-digit annual revenue and EPADR growth.

The current stock price of $5.64 represents 9.7x our 2010 EPADR forecast of $0.583, and is up only slightly from the $5.47 it closed at on March 10, 2010, the day prior to the coagulation divestiture announcement. The current valuation completely discounts the enormously enhanced potential for significant long-term revenue and EPADR growth that has resulted from Trinity’s strategic shift away from the stodgy coagulation business and into a greater focus on the much greater potential POC segment.

We believe the shares are significantly undervalued and are initiating coverage of Trinity with an Outperform rating. Our price target is $8.16, representing 14.0x our 2010 EPADR estimate of $0.583.
   
First Quarter Financial Results…

Trinity reported earnings for the first quarter ending March 31, 2010 on May 11, 2010. Total revenue came in at $29.01 million, down 6.7% from the same period in 2009. Point-of-care revenue of $4.36 million was down 6.6%, which was attributed to the ongoing credit issues with an HIV customer in Africa. Management noted that the credit issues are still being resolved, and they expect a more normal level of sales to this customer to resume in future periods.

Clinical lab revenue fell 6.7%, but excluding the divested coagulation business, segment revenue decreased by 3.5% to $13.3 million. Lyme disease sales, which are seasonal, were noted as the cause of the decline in clinical lab sales.

Despite the almost 7% drop in revenue, EPADR grew 24.7% year-over-year to $0.15 as a result of a 60 basis point improvement in gross margin and a $1.58 million reduction in SG&A expenses, the latter a result of Trinity’s continued focus on cost control. The gross margin improvement and cost-control measures pushed operating margin up from 9.8% in the first quarter 2009 to 12.7% in the most recent period.

Trinity generated $4.91 million in cash from operations and was free-cash-flow positive by $2.58 million. The company exited the quarter with $6.22 million in cash, which does not include the $67.5 million received from Stago in early May.

Management revised its EPADR guidance for the 12-month period following the close of the Stago deal (~ Q2 2010 – Q1 2011) from their previous guidance of 90% – 100% of the $0.565 earned in 2009 to 100% – 110% of that level, which equates to $0.57 – $0.63.
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