Life Technologies (Life Tech), a leading global life sciences firm, had rewarded its shareholders by almost doubling the firm’s share price from its 2009 low of \($26\) per share to \($51\) by mid-2012.

Despite this stellar performance, Gregory T. Lucier, Life Tech’s Chairman of the Board and Chief Executive Officer since 2008, felt uneasy about the firm’s future financial performance.

The life sciences industry is facing major challenges. Foremost is the increasing pressure on profit margins stemming from the escalating cost of health care due to the growth in chronic diseases, an aging population, and new medical therapies. Efforts to control healthcare costs are resulting in a reduction in the reimbursement rate for healthcare providers such as hospitals, testing laboratories, and physicians. Furthermore, pressure to reduce runaway government deficits is reducing the funding of scientific research.

These developments are driving consolidation among Life Tech’s customers. Such consolidation reduces the number of potential new accounts and enables customers to increase their negotiating leverage with vendors such as Life Tech. There is also a growing trend for customers to reduce the total number of vendors they use. Customer consolidation is driving consolidation among life science companies in an effort to realize economies of scale, scope, and purchasing. Underway for several years, consolidation among Life Tech’s competitors is expected to continue as companies attempt to strengthen or hold their market positions. Increased concentration within the life sciences industry is expected to result in stronger competitors that are better able to compete as sole-source vendors for customers.

The combination of customer and competitor consolidation could put significant downward pressure on Life Tech’s profit margins. Mr. Lucier and the Life Tech board faced a dilemma: whether to continue to pursue the firm’s strategy of growing market share through customer-focused innovation or to consider alternative ways to maximize shareholder value such as selling the firm or aggressively growing the firm.

Founded in 1987, Life Tech had established itself as a leading innovator of life science products and services that improve the effectiveness and efficiency of professionals in the pharmaceutical, biotechnology, agricultural, clinical, government, and academic scientific communities. The company’s products also are used in forensics, food and water safety, animal health testing, and other industrial applications. Life Tech produces lab analytical and testing instruments; robotic systems to automate labor intensive research, research consumables including glassware, plastic ware, vials, tubes, and syringes; equipment from centrifuges to microscopes; lab furniture; and lab information management and testing systems.

On January 18, 2013, Life Tech announced that it had hired several investment banks Deutsche Bank and Moelis & Co. to explore strategic options for the firm as part of the board’s annual strategic review. Mr. Lucier offered additional details in a subsequent earnings-related telephone conference call to investors and Wall Street analysts saying that the review has begun in the summer of 2012 and that “all ideas were on the table.” Sensing the possibility of a sale, investors drove the share price up by 10% to \($58\) by the end of February.

Mr. Lucier and the board’s decision would be based on a continued analysis of current and expected industry trends and the firm’s overall competitive position. Mr. Lucier directed his accounting and finance department to assess the impact of the results of this analysis on the value of the firm under different sets of assumptions. What follows is a discussion of these considerations....

Discussion Questions:

1. N ote the enterprise and equity valuations for Life Technology in the Excel spreadsheet model entitled Life Tech Undertakes Strategic Review Financial Model on the companion website accompanying this book. View this as the base case. The CEO Greg Lucier asks his chief financial officer (CFO) to determine the impact of plausible assumption changes on the firm’s valuation. The CFO asks you as a financial analyst to estimate the impact of a change in the firm’s revenue growth rate and cost of sales as a percent of sales. On the Target Assumptions Worksheet, make the following changes and note their impact on Life Tech’s enterprise and equity values on the Valuation Worksheet:

a. Increase the sales growth rate in 2014 by 2 percentage points.

R etaining the assumption change made in (a), decrease the cost of sales as a percent of sales by 2 percentage points in 2014.
What is Life Tech’s enterprise and equity value resulting from these changes? How do they compare to the base case? Briefly explain why each of these changes affects firm value. Do not undo the results of your changes to the model’s base case.
2. U sing the model results from question 1, the CFO believes that in addition to an increase in the sales growth rate and an improving cost position, Life Tech could employ its assets more effectively by better managing its receivables and inventory. Specifically, the CFO directs you as a financial analyst to make the following changes to days’ sales in receivables and days in inventory. On the Target Assumptions Worksheet, make the following changes and note their impact on Life Tech’s enterprise and equity values on the Valuation Worksheet:

a. R educe receivables days by 10 days starting in 2014.

b. R educe inventory days by 10 days starting in 2014.
What is Life Tech’s enterprise and equity value resulting from these changes? How do they compare to the results in question 1? Briefly explain why each of these changes affects firm value. Do not undo the changes to the model you have made.
3. G iven the results of the model from questions 1 and 2, assume Mr. Lucier and the Life Tech board raised their target debt to equity ratio from 30 to 60% to reduce their WACC. Such a reduction would make projects that would not have been undertaken at a higher cost of capital attractive. Recalculate the firm’s WACC assuming that none of the assumptions about the cost of capital made in the base case have changed, with the exception of the levered β. (Hint: The levered β needs to be unlevered and then relevered to reflect the new debt to equity ratio.)
Without undoing the assumption changes made in questions 1 and 2, use your new estimate of the firm’s WACC during the planning period to calculate Life Tech’s enterprise and equity values given on the Valuation Worksheet. Briefly explain why the change in the debt to equity ratio affected firm value.
4. Based on your answers to questions 1–3, what do you believe are the most important value drivers for Life Tech based on their impact on the firm’s enterprise and equity values? Which are the least important?
5. T he base case valuation reflects a constant 57% gross margin throughout the planning period.
Based on the information given in the case study, do you believe that this is realistic? Why?
Why not? How might this assumption have biased the estimates of enterprise and equity valuation in your answers to questions 1–4? If they were biased, what would be the direction of the bias?