Considering purchasing a business and would appreciate some advice

Shane732

I'm currently considering investing in an area that I'm not involved in on a day to day basis. I appreciate that this in itself brings it's own risks. However, I'll be working with someone who is involved in the industry and will be able to provide the expertise in the industry required.

I'm considering the possibility of purchasing a pharmacy. I provide taxation advice to a number of pharmacies but these pharmacies are not geared at all (i.e. long standing businesses that avoided expanding beyond their means) so I am not overly familiar with the current gearing that banks are willing to give in the area.

I'm aware that pharmacies purchased over the last 5 - 10 years have found it very tough due to the high financing costs associated with the premium that was paid by individuals to get into the industry. However, with these practices now in difficultly a potential opportunity arises for others.

IMO if you strip out the financing costs of pharmacies then they are profitable businesses. I appreciate that there have been significant changes in the industry with GMS income dropping over the last couple of years and with the likes of Boots and Tesco getting more involved in the industry it means the future may be tough for pharmacies.

Anyway back to the reason I've posted here - as anyone an idea of the types of personal finance input that would be required for a bank to play ball with an investment in a pharmacy? What type of gearing would a bank be looking at? I appreciate that a bank would be looking for personal guarantees etc...

I'm talking in general terms at the moment as this is at the early stages and I just want to get a feeler.

MidlandsM

I think you need to look closely at potential revenues going to be reduced in the future.

margins on drugs on the MC will be drastically cut in the future, and boots are in to take over the way tesco's did, be wary.

PCPhoto

I cant really help you on figures but a friend of mine took over a pharmacy a few years ago (he is a pharmacist) .... and he spent the first 2yrs working 60-70hours to keep costs down, he's still going but financially it may be more of a long-term thing if you are doing it - he still does over 50 hours every week as well as admin/payroll etc for 4 staff.

if you will have nothing to do with the business day-to-day its more than likely to continue to go in the same path it is on - you need to get involved in order to see the faults and find the holes where the money is disappearing - plugging them makes you more profitable.

Gloomtastic!

Doc Morris, the new branded pharmacy, is a franchise aimed at existing pharmacies wishing to switch to a high street brand but also people who have no experience in the pharmaceutical business. It's part of a huge European group but their Irish division is running this. Might be worth a talk.

http://www.docmorris.ie/en/Franchise/

Shane732

I totally appreciate that margins are only going to get tighter and that there is plenty of competition out there.

Ultimately, this may prove to be a stumbling block as I'll be taking this into account in any valuation and offer I'd be making.

In terms of me not being involved well I meant I wouldn't be on the floor working as a pharmacist - I'm clearly not a pharmacist and don't intend on retraining to be one. Of course, I'd be looking after the financial side of this such as accounts/budgets/payroll etc... with assistance from the person I'd be working with.

The way I'd see this working that initially put up the investment to purchase the pharmacy and that the other party (who most likely wouldn't have access to funding) would earn their shareholding in the company over a number of years.

Of course Boots and Tesco are pose major challenges even taking into account reduced margins etc... IMO pharmacies are still profitable when you strip out the financing costs.

I would see this as a long term investment and wouldn't be looking for a quick payback.

SGKM

I assume that you are aware of the current funding environment and without knowing specifics it’s hard to gauge but generally speaking banks would lend c. 3 – 3.5x EBITDA on acquisition debt with strict covenants and focus on cashflow.

I don’t know the pharmaceutical retail sector but I would imagine that there are strong fundamental headwinds facing the industry in the medium term; specifically the reduction in government drug payments, forthcoming competition from the UK multiples and consumer pricing pressure (in addition to the “general” issues facing many Irish retailers – over leverage, upward only rent and the Irish consumer environment). I could have it wrong but would that not point to serious margin pressure on pharmacies in the medium term? If you work in the industry you’d have a better idea of the trends and outlook.

It’s hard to comment without specific financials but it appears as if you’re looking at this in a strange way for two reasons; firstly I don’t understand what exactly you mean by “pharmacies are still profitable when you strip out the financing costs”. There are tons of businesses out there which are fundamentally profitable on an EBIT or EBITDA level but are strangled with debt repayments from acquisitions or boom time property plays so are loosing cash on an earnings basis so unless they have the debt written off they are unprofitable – Siteserve comes to mind as a good example.

Are you planning to buy a fundamentally profitable business (pre interest payments) that would not support acquisition debt repayments? It reads as if the way you’re thinking is to put up 100% equity and just take a dividend off the table every year? Bear in mind the cost of debt is always cheaper than the cost of equity so if a business cannot support debt repayments it will give you a crap earnings yield relative to what you could get elsewhere. Or are you intending to finance a mixture of debt and equity? In which case will that significantly reduce you’re return on equity?

Secondly if you are looking at this as a long term investment the only way you’ll create any value is by gaining the synergies of a few shops, thereby increasing margins and capital value over time. Investing in a static 1 shop which can’t service its interest payments will not give you an increase in your initial outlay.

So with regard to valuation a business is only worth what the market is willing to pay for it; obvious statement but 5 years ago valuation multiples based on high prospective earnings and funded by cheap credit now multiples are far lower. What’s your required return? If you’re cost of equity is 10% and the pharmacy is throwing off a solid €50k p.a. in earnings then it might be worth €500k to you. Or if it’s a medium term investment which you hope to sell in time then what’s you’re required IRR and how will you increase the capital value?