This article is authored by MOI Global instructor Samir Mohamed, manager of a private family fund, based in Switzerland. Samir is an instructor at Best Ideas 2018, the fully online conference featuring more than one hundred expert instructors from the MOI Global membership community.

Joel Greenblatt describes in his book “You can be a stock market genius…” how special situations can have attractive investment returns. Spin-offs are one such situation where management incentives to downplay the business outlook, investors getting shares they did not buy and a business free of a much larger organization often lead to an undervalued stock. Unrelated to spin-offs when a company has low organic sales growth and declining profit margins due to temporary factors investors tend to underestimate how fast that business can grow and how profitable it can be when those factors subside. Varex Imaging is a spin-off where organic sales have been declining in 2015-2016 and profit margins declined ever since hitting a high in 2014 likely due to temporary factors. The company was spun-off from Varian Medical Systems in January 2017 and has sales of about 780 Mio. USD when fully consolidating a recent acquisition. The company is a supplier of components and subsystems for X-ray imaging systems to OEMs like GE Healthcare.

A business with strong moats and long-term growth drivers at a fair price

Varex Imaging has the broadest portfolio of components and software packages in the industry; X-ray tubes and digital detectors (to detect X-rays and create images) comprise about 45% of sales each. 80% of its sales are in the X-ray medical imaging and 20% in the industrial and security X-ray imaging market. Applications range from CT (computed tomography) to scanners for airport security or non-destructive testing in industrial manufacturing. The company acquired a digital detector competitor in May 2017 with annual sales of 140 Mio. USD and complementary technology and customers. It has a good track record of integrating previous acquisitions and did not overpay.

The medical imaging market is an oligopoly: In digital detectors Varex has 30% market share, Trixell – a joint venture between Thales, Philips and Siemens – has 27% and the rest is split among smaller players and medical system OEMs that produce their own detectors. In X-ray tubes Varex has 20% of the market while the second largest player Toshiba Medical Systems (acquired by Canon) has 7%. The rest of the market are mostly OEMs that have not yet outsourced the development and manufacturing of X-ray tubes. Rather than competition these OEMs present a growth opportunity for Varex if they decide to outsource X-ray tubes. Varex management mentioned in webcasts that new OEMs (e.g. in China) consistently outsource X-ray tubes.

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