By: Aryan Mehra (The University of Western Ontario), Charlie Solnik (Cal Poly SLO), Udhaav Jhunjhunwala (Singapore Management University), Chirag Gupta (New York University Stern)
Overview of the Deal
Sotera Health (SHC), a global leader of mission-critical end-to-end sterilization solutions and lab testing and advisory services for the healthcare industry, made its stock market debut in late November. The company raised approximately $1.1 billion (before deducting underwriting discounts, commissions, and offering expenses) through the sale of 46.6 million shares priced at $23 each. The IPO was priced towards the high end of the range with an initial proposal to sell shares between $20-$23. Furthermore, the company sold seven million additional shares as underwriters exercised their option to purchase additional shares bringing the total count to 53.6 million shares sold.
Sotera Health has stated that the proceeds from the offering will be used to redeem debt and for working capital requirements among other general purposes (including but not limited to acquisitions or investments in complementary products, services, technologies, or businesses).
Macroeconomic Trends
Despite a lag in IPO activity during the second quarter, the third and fourth quarters of 2020 have seen a resurgence of IPOs, breaking multiple records for deal numbers and proceeds. In the Americas, an 18% increase in IPOs activity and a 33% percent increase in proceeds over the previous YTD levels was observed. The APAC region continued its strong IPO activity and saw a 29% rise in the number of IPOs and 88% rise in proceeds. While the EMEIA region is still recovering from the IPO lag from earlier this year; IPO markets in the region showed a significant movement towards recovery with deal numbers increasing 34% and proceeds rising 49% compared with Q3 2019.
The COVID-19 pandemic has led to a dramatic increase in demand for personal protective equipment (PPE), with the industry expected to grow at a CAGR of 12.4% from 2020 to 2027. The growth and need for sanitisation of PPE is highlighted through, as cited in a report by Allied Market Research, the high revenue growth rate of 14.0% expected in the respiratory protection segment during the forecast period. Notably, the sterilization of these products is key to ensuring the safe use and distribution of many of these PPE materials.
Moreover, one of the main drivers behind the industry’s expected growth is the body of stringent regulation implemented by health ministries as it pertains to the adequate availability, allocation, usage, and disposal of PPEs. As well, both public and private groups are investing in new hospitals, in-home healthcare services, and primary healthcare centers, which has the potential to further increase demand for these PPE materials.
Company Details
Sotera Health (SHC) is a leading global provider of mission-critical sterilization and lab testing and advisory services to the medical device and pharmaceutical industries. The company was formed a few years ago as the parent company for Nelson Labs, Nordion, and Sterigenics, and has since inducted Toxikon Europe and Iotron Industries into its growing portfolio of subsidiaries. Sotera currently operates in 63 facilities across 13 different countries, working to ensure the safety and reliability of healthcare around the world.
IPO Details of Sotera Health
Sotera Health went public on November 20, 2020 through the sale of 53.6 million shares priced at $23 each. The lead book runners on the IPO include Goldman Sachs and Credit Suisse with a total of 16 financial institutions who served as underwriters on the issuance.
Sotera Health is backed by private equity firms Warburg Pincus and GTCR; this IPO comes after a failed attempt to sell the company previously in 2018. Lawsuits regarding one of the company’s factories prevented this 2018 sale from occurring. The private equity firms used this IPO as a way to put back some cash into their pockets.
Within this offering, the underwriters had the option to purchase additional shares in full which pushed the proceeds raised from the offering over the originally expected $1.1bn. Excluding these underwriter options, the float to outstanding shares ratio is estimated to be 16.8%.
Figure 1: SHC Share Price Chart (Source: Google Finance)
On November 20 2020, SHC started trading at $23 and closed on the day at a price of $25.10, and reached a high of $27 on its first day of trading. This reflects a well priced offering as well as higher demand than what was expected as original price estimates were in the range of $21-$23. Sotera stock is now trading at a steady price of around $27, well above the price at IPO.
Projections and Assumptions
Why was this deal done?
The primary reason for this IPO is to help pay off the massive amount of debt present on the company’s balance sheet. Sotera will be using a bulk of the proceeds to pay off all its outstanding principal amount of second lien notes which stand at $770 million. Additionally, the funds will be used for working capital and other corporate purposes. As mentioned above, Sotera will also be buying back 1.7 million of its shares from executive members - this would serve as a form of compensation. Sotera plans on using leftover funds for potential acquisitions, but they do not have specific targets in mind as of now. Pending approval, the leftover funds will be invested into short-term investment-grade securities. The company targeted a midpoint price of $21.50 but as they sold their shares for $23 the additional proceeds will be used to pay off more indebtedness.
Part of the proceeds will be used to repurchase approximately 1.7 million shares from executive officers at a price equal to that on the day of the IPO less any underwriting discounts. IPOs are a good way for private equity firms to exit out of their position in the company. Although Warburg Pincus and GTCR are not completely exiting their positions, this IPO serves as a way to get some cash back on the initial investment made.
Sotera has been growing very slowly and is plagued with debt. This issuance may be a way to stimulate the company back to life by cleaning up its balance sheet and allowing it to get a fresh start in the new year.
Short-term Analysis
Sotera operates in an industry with high barriers to entry and it has built a defensible competitive moat. In the short term, many of the largest pharmaceutical and medical companies will continue to need Sotera’s services such as lab testing. A key factor is that terminal sterilization is a government required step in the final packaging of healthcare products making Sotera an important part of the distribution process.
Sotera generates its revenue from two service lines: sterilization and lab services. Sotera is in a safe position given the race for a covid vaccine heating up and governments willing to spend big in order to have an adequate supply of vaccines. Pharmaceutical companies that are performing Covid trials to test a COVID-19 vaccine need to keep their labs clean and ensure a safe product reaches the market. Sotera will play a large part in ensuring sterilized medical equipment, PPE, and medical protective barriers get to where they are needed safely. This IPO is meant to de-risk the company’s balance sheet and is supposed to supplement Sotera’s decision to consolidate certain back office functions and sell off its Medical Isotopes business. These decisions have led to a 12.8% improvement in operating margins and have enabled Sotera to reduce the risk for investors. Sotera’s services are critical to the pharmaceuticals industry now more than ever which ensures the company should be able to perform well post IPO.
With rising health concerns and increased investment in developing healthcare products, Sotera’s stability and predictability will be key in garnering continued investor interest.
Long-term Analysis
The expected expansion of the healthcare industry, along with regulatory requirements, will necessitate the growth of the sterilization industry. Even before COVID-19, the US Bureau of Labor Statistics stated that the healthcare industry was projected to add more jobs than any of the other occupational groups, growing about 15% from 2019 to 2029. This growth puts Sotera Health in a comfortable long-term position as they continue to solidify their place within their market.
Within the past few years, Sotera Health has seen an increase in acquisition activity and added two new subsidiaries in the past two years. In fact, a large amount of the company’s expansion has been artificial. Freeing up room on the company’s balance sheet for further leverage opens up the possibility for further expansion via acquisitions in the coming years. Past acquisitions have expanded Sotera Health’s portfolio of sterilization technologies, with their most recent acquisition, Iotron Industries, allowing them to expand into Electronic Beam sterilization. Thus, with the acquisition of new subsidiaries, Sotera Health would be able to expand its product offerings, making them more competitive and allowing them to occupy a larger share of their market.
Risks and Uncertainties
The largest threat to Sotera Health’s long term success is its main competitor: Steris. Steris offers many of the same products and sterilization services as Sotera and is substantially larger. Steris earned $756 million of revenue in their most recent quarter, and Sotera Health earned $778 million of revenue in their most recent full year. Despite this competition, Sotera Health continues to grow, with their operating income increasing 11% so far this year. However, Steris still has a healthy lead and it does not appear that they will be overtaken anytime soon.
Sotera relies on a limited number of vendors to get certain medical equipment and other items needed in the operation of their business. With concern already spreading about how a Covid-19 vaccine would be distributed, medical supply chains are expected to be under a lot of strain. A prolonged bottleneck in the company’s supply chain would present major problems in serving their clients effectively.
A large risk for investors is if their investment will pay off. Sotera is primarily going to be using the IPO proceeds to pay off leverage limiting the usage of funds for growth through potential acquisitions or other investments. However, paying the company’s creditors off reduces the default risk for equity holders. The company in its prospectus has also noted that due to the company’s current covenants on its debt contracts, it does not expect to pay any dividends in the foreseeable future. This policy is common for companies that have just recently gone public.
Additionally, Sotera may be tempted to take advantage of a low interest rate environment in the near future after much of their old debt has been paid off from the IPO. However, this could cause the company to fall back into the issue of being too leveraged which will be something investors need to monitor.