Look for Profits in This “Everyman’s IPO”

By Michael Brush
January 12, 2006

One of the most common questions I get as a market columnist is: “How can I participate in initial public offerings (IPO)?”

The allure of the IPO is understandable. Many IPO stocks grab headlines by rising dramatically right out of the gate (even if quite a few don’t work out so well).

Unfortunately, to join the IPO party you have to be a fairly high roller with a big brokerage account. Otherwise, you are out of luck.

There is one exception, and a solid pattern of insider purchasing points us to a promising example that looks like a solid buy right now.

The “Everyman’s IPO”

Here’s one way regular investors can break into the exclusive IPO club. Very small companies often come public by merging into shell companies that are already listed on an exchange. The beauty is that anyone can buy the shares of the shell company in advance – even without a big account at brokerage – to participate in this back door IPO. It’s a kind of “everyman’s IPO.”

This chain of events is about to play out next month at the Tampa, Florida-based CEA Acquisition Corp. (CEAC.OB) when a private biotech company called etrials Worldwide merges into CEA.

The result should be a publicly traded company that will likely be dramatically undervalued compared to a competitor. That – plus healthy growth -- should mean decent profits down the road for anyone who buys shares of CEA right now.

PDAs for guinea pigs

What does etrials Worldwide do? It sells software and electronic devices that human guinea pigs in drug trials use to keep track of things. Patients enter data into devices similar to personal digital assistants (PDAs), which transmit the information to labs.

Several giants of the pharmaceutical industry are etrials customers, including: Pfizer (PFE), Genzyme (GENZ) and Wyeth (WYE). The company’s equipment was used in the clinical studies on Viagra.

This electronic system of collecting data is faster, easier and more accurate than the traditional approach – patients using a pen and spiral notebook to keep diaries.

That’s why companies like etrials and DATATRAK International (DATA) – a public version of etrials – are growing so fast. And it looks like there is plenty of room for more growth. Right now, patients in about 75% of trials still use the spiral notebook approach. That should continue to fall. Meanwhile, the number of clinical trials is growing each year by about 15%.

Rapid growth

This helps explain why DATATRAK's revenue increased approximately 45% to $11.4 million for the first three quarters of 2005.

At etrials, revenue grew at between 50% and 72% a year for 2002 through 2004. These rates will slow down – since etrials has been growing off a small revenue base.

But investment bankers involved in the etrials deal – bankers who admittedly have a bias – use annual revenue growth projections of about 30% a year for the next four years, in their valuation models. If they are right, etrials revenue will grow to $45.6 million in 2009 from $15.8 million in 2005.

Undervalued shares

The way CEA shares are priced right now, at $5.40, it doesn’t look like the market sees what’s coming in the merger with etrials. Let’s walk through some numbers to see why.

DATATRAK trades for an enterprise value (market cap minus cash plus debt) of $86 million, or about 5.8 times its $14.8 million in sales.

But the new CEA, after etrials is folded in, looks like it will have an enterprise value of around $43 million, when all is said and done with the merger. That’s less than thee times sales, compared to the 5.8 at DATATRAK. And it’s half the enterprise value of DATATRACK, even though etrials has roughly the same amount of trailing revenue.

Good visibility

These companies also have solid backlogs. This isn’t surprising since clinical trials drag on for years. Still, the backlogs offer excellent revenue visibility. DATATRAK’s backlog of $17.4 million exceeds its trailing annual revenue of around $14 million. At etrials the difference is even greater. The company has about a $22 million backlog compared to about $15 million in revenue for last year.

The bottom line: It’s already a positive sign that CEA insiders – who already own a lot of stock – have purchased about $800,000 worth since mid-November, at prices near current levels, or $5.19 to $5.50. But insiders at CEA and etrials are also placing a simple and enticing bet which shows a lot of moxie. As part of the merger deal, they’ve agreed to put 1.4 million shares in an escrow account that will vanish unless the new CEA stock trades above $7 before February 2008. CEA should also get a boost right off the bat when it transfers to Nasdaq from the bulletin board later this year. I’d buy right here, while the market still hasn’t figure out all that’s about to happen.

Disclaimer

At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.

For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.