A 4-Minute Look at Medpace Holdings
If Walmart (NYSE:WMT) wrapped up its fiscal year with strong comps in the U.S., why did the stock fall 6%? What should you do when the company you own shares of is bought by another company? In this episode of MarketFoolery, host Chris Hill and analyst Jim Gillies analyze those questions and introduce Medpace Holdings (NASDAQ:MEDP), a clinical research business more investors should know about.
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This video was recorded on February 18, 2021.
Chris Hill: It’s Thursday, February 18th. Welcome to MarketFoolery. I’m Chris Hill. Joining me today, Mr. Jim Gillies. Good to see you, my friend.
Jim Gillies: Good to be seeing you, Chris.
Hill: We have a universal dilemma facing investors that we’re going to talk about. We’ve got a company I’ve never heard of before today, but Jim is very excited to tell investors about it, so we’ll talk about that. We’re going to start with the biggest retailer in America. Walmart’s fourth quarter was highlighted by same store sales in the U.S., up more than 8.5%, e-commerce sales were up nearly 70%, CEO Doug McMillon talked on the call about the investments that Walmart is planning to make in 2021, and I am assuming those comments are why shares of Walmart are down 6% this morning.
Gillies: I think it’s still they’re down 6% this morning. You are taking a company the size and breadth and strength of Walmart, one of the few companies left essentially unscathed. In fact, customers have been driven to them during the pandemic by the closure of practically everyone else. You’re going to take down this behemoth retailer by 6% in a day. If you believe that your portfolio should have what I’ll call “bedrock positions” on which you can layer growth for your more exciting positions as Walmart, whatever it is, I’m not sure if it’s exciting, what a great day to add a share to Walmart. It’s a decline of 6%. That’s just my humble opinion.
Look, they missed earnings, guidance, whatever your expectation, big deal. They blew away revenue during the pandemic or total revenues up about 7%, their operating profit is up about 10% this full year. You mentioned e-commerce is up about 70% across the company. In the U.S., it’s up nearly 80%. They made a lot of cash last year. They used it to boost the cash on the balance sheet. They took down a bunch of their debt. They’re investing, I found this interesting. They’re investing in what they call U.S. wages, so they’re going to bring the average associate’s hourly rate to above $15 per hour. I know that’s been a debate of some magnitude in your fine country. Walmart is saying, “Well, we’re just going to do it before we get legislative to do it.” I say, good on them. Certainly, competitors like Costco had been doing that for a while, so I think it’s good that Walmart relatively is following suit. They increased their dividend for the 48th year in a row, Chris. They approved a new $20 billion buyback plan. They made $26 billion last year, and they paid out, I think, about $6 billion in dividends, and just shy at rebuying […] . This is to channel my inner Ron Gross. This is a company hitting on all cylinders. I […] 20 times earnings until I get this. Down 6% today, cool. That’s the way.
Hill: The only thing I’ll add is, the longer Doug McMillon is CEO of Walmart, the more impressive his track record becomes. As you said, for people who are building a portfolio and saying, I want to have this chunk over here that’s dedicated toward growth, some high fliers, some Rule Breakers. I’m going to take some chunk over here and it’s going to be bedrock positions that I’m not going to worry about. Doug McMillon is a CEO that nobody should be worried about.
Gillies: 100%, yeah. No, this is absolutely a bedrock position, and I already called that today’s 6% fell off silly a couple of times, so I’ll call it silly again and move on.
Hill: Earlier this week, we got fourth quarter earnings from the aforementioned company I’ve never heard of before; Medpace Holdings, ticker is MEDP. Medpace is in the business of clinical research trials. Tell me why you’re a fan of this company.
Gillies: I’m going to try to channel —
Hill: Let me cut you off right now. In less than four minutes, tell me why you’re a fan of this company.
Gillies: [laughs] Good luck. Yeah, they are a contract research organization, but around The Fool, we praise companies rightly, by the way. We praise companies, and we invest in companies, and we recommend repeatedly companies where we have founder management, management that think like owners because they are owners, with meaningful stakes in the gain. Companies that are, to rattle of a few, I own a few of these and admire all of them: Shopify, Appian, The Trade Desk, Starbucks for a time, under Howard Schultz, Costco for a time, and we still love Costco and Starbucks, but the founder and management aged out. Costco with Jim Sinegal, Square, and I think I’m the only Fool that’s ever even noticed Medpace. Here’s Medpace; it was founded in 1992 by Dr. August Troendle, who came from the FDA. He saw what was needed, left the FDA where he was a reviewer, and founded this contract research organization. CRO is contract research; they basically allow entities that are pursuing new treatments and drugs and medical devices, and allows them to reduce their cost for outsourcings in the CRO. That’s, in a nutshell, what it is. […] review through phase one through four trials, and that sort of thing. He launched this company in ’92. He’s still CEO today, Chris. This is 30 years on the job almost. I think he’s probably pretty decent in what he does. It kicked around in private equity. He had it personally for a while, and then private equity pro. It IPO’d in 2016. He still owns somewhere between 20% and 23% of the shares at this company. I’m not sure what the recent buybacks are, what he’s up to now. He put up $20 million on cash at the IPO to buy shares in his own IPO. That’s neat.
Once it was taken public, he used the company’s copious cash flows to buy back all of the debt that he was left with at the IPO of the company. He’s debt-free today. He bought back a bunch of stock from his former private equity sponsors, so he’s free and clear. Today, the company has a debt-free balance sheet, $278 million in cash on the books. It’s had free cash flow production since IPOing, like I said, since 2016. In 2015 to 2020, free cash flow has compounded at an annualized 23.4%, and at $277 million last year.
No place to put it, except for buying back shares and buying on the balance sheet really. Even at the conference call this week, Medpace CEO, August Troendle, basically says, “Yeah, 20% growth is what we’re comfortable with. We’re not really straining above that. This is our sweet spot.” He’s only done it since coming public, and like I said, he’s run the business for 30 years. This is a company that you can buy today for five times this year’s expected revenue, and about 25 times this year’s expected EBITDA. It is a high quality business that I’ve never heard another Fool mention. Like I said, I pulled out Shopify, which we all know and love, Appian, The Trade Desk, etc. Smaller company, $6 billion, but I think, Fools, this is a company that again, we talked about bedrock company. Now, maybe, you get some growthy names in there as well. This isn’t as sexy as a SaaS business, and that’s fair enough, but you need some of these mid-tier, can grow with high think, low 20s rates for almost as long as they want. When will Wall Street notice Medpace? Maybe when it hits $10 billion, $20 billion. I don’t know, but you could say you were in now.
Hill: When you look at the valuation of the business, it’s down a little bit from its high, it’s still up more than 60% over the past year. It sounds like it doesn’t look overly expensive to you.
Gillies: Well, I believe you will tell me you have to pay up for quality. This is not a rock-bottom price; Ironically, Walmart is more of the rock-bottom price, but it is a fair price for a great business run by a very Foolish founder management team with skin in the game, and he’s built it as a fortress, so even through the pandemic, they did what everyone else did, they pulled their guidance and they talked down expectations, and then the full year results, they’d smash them. That’s what they do in bad times; and in good times, they do better.
Hill: Quick programming note; this weekend on Motley Fool Money, it’s our 12th anniversary.
Hill: 12 years ago this week, we started Motley Fool Money. Just for some context, the S&P 500 was at $770 today, at just under $3,900. The Nasdaq was at $1,440. Right now, the Nasdaq is at, let’s just call it $13,700 and change, so you’re welcome. That’s right. I’m claiming all the credit.
Gillies: [laughs] Taking all the credit. Well, I don’t get any credit because I think I’ve been on exactly one Motley Fool Money show in 12 years.
Hill: Look, I can’t do anything about the laws that the leadership in your government has set up with respect to cross-border. Look, I’m not going to cross the Canadian Mounties. That’s suicide.
Gillies: They’ll tell you to stop it again, right?
Hill: Exactly. Our email address is [email protected] Got a great question from Charlie in San Francisco. He says, “As a relative newcomer to The Motley Fool, I love the insight. It’s definitely helped me navigate the crazy year with a cooler investing head. My question is about Electronic Arts‘ acquisition of Glu Mobile. As a Glu Mobile shareholder, how do I weigh up whether to sell my Glu shares or hold for the sale and take the shares of Electronic Arts? I’m in it for the long-term, no need to sell. I’m just unsure what is the best response as an investor in the acquired company.” I love this question because this is a situation that a lot of investors find themselves in. If you’re an investor for a long enough period of time, it’s “I bought shares at this company. I’ve got my bull case for company X, and they got bought by company Y. I don’t know that I want to be a shareholder of company Y.” What are a couple of things that investors should do to answer that question for themselves?
Gillies: Charlie, it is a great question, as Chris says. I will say, I feel your pain. This has happened to me twice this month, and because I don’t really know anything about Glu Mobile and not much more about Electronic Arts, I’m going to speak in generalities and also talk to you about how I’d approach this with the two companies that have gotten this happen with me. First off, it can be great when your company is acquired for a fat premium or it can be awful because you had multibagger hopes for them. I had one of each of those this last month.
The good news is you’re getting a 36% premium. The bad news is you don’t really have — or not really bad news, but you don’t have the choice to take EA stock here. Or if you do have the choice, you’re going to have to do it because they are paying $12.50 in cash for every share of Glu Mobile. For you to roll that into EA, you’re going to have to either wait for the cash to be received and then buy shares of EA at that point or you could sell Glu today and buy EA. Of course, that necessitates a bunch of questions. This happens every time you go through those. The first question is, how excited are you to own the acquiring business? You have to start, what made you buy Glu Mobile? Those reasons may indeed survive in the combined company. But Electronic Arts is a $42 billion company and Glu is about a $2 billion company. Glu is going to be less than 10% of the combined company’s total revenue. I’m going to predict that the culture that survives intact is probably going to be Electronic Arts. Probably the thing that you like about Glu is probably going to be absorbed into. A lot of people from Glu will probably be exiting the company within a couple of years. That’s just what happens. Peter Lynch talked about this phenomenon a little bit in One Up on Wall Street, I believe. Might’ve been Beating the Street. There might be a company or product that you love, but if it’s trapped within a bigger company where it doesn’t contribute much or can’t contribute much, you get played out, so that’s not great.
One thing I like to do as well is I consider the valuation arguments. EA, for example, closed yesterday about 6.5 times sales and is trading for about 16 times next year’s EBITDA, which is our rough first glance at cash flow. I look at Glu and Glu is trading at about 3.5 times sales, which I was surprised by. It’s actually a lower multiple and it’s trading at about 19 times next year’s EBITDA. So 16 for EA,19 for Glu. That actually doesn’t look that bad, frankly. In fact, it looks like EA’s got a bit of a bargain depending on how you want to look at valuation-wise. But EA is growing slower, so even though the forward valuation is a little more favorable for EA, the slow growth where they’re going to dominate whatever Glu puts up gives me a little bit of pause.
That’s my thing, and I’ll tell you the story. Like I said, I’ve had this happen to me twice this month. The 1st company, it’s a company called CRH Medical. CRH Medical, it’s a company I like, a company I still own. It always had something, Chris. There was always something like they did well, but they tripped over their own feet a few times. Outcomes, this other company called WELL Health that’s buying them with an 80% premium. It’s done and dusted. Let’s go. Because as I look at the acquiring company, it is a much higher growth, growth through acquisition, it’s a cash burning company, it’s trading at well over 10 times revenue. If we grant them all of their acquisitions together, it’s still trading over 10 times revenue going forward versus my CRH company, which is trading at less than four times revenue. They’re clearly buying CRH to use that cash, to slate the cash, burn over it, well, not willing to go up on the valuation chain. So goodbye to those assets and we’re good as my camera turns off on me.
The other one is a company called NIC, which goes by the ticker EGOV on Nasdaq. It is a great company, really well-run. Government processes online, so if you need a permit for a camping site, you have to pay a parking ticket, chances are NIC developed the app for it. It is a fantastic company that I had great hopes for. I’m sad to see it being taken out by Tyler Technologies, which is another great company. I’m enthused about both companies here. I think Tyler is an excellent company; I think NIC is an excellent company. The problem is that NIC trades for about four times revenue at the acquisition multiple, and Tyler is at more than 10 times revenue; it’s more than 70 times free cash flow. Again, I am not willing to swap what is a lower valuation company for a higher valuation company where my preferred company, that’d be NIC, is just 30% revenue and growing at a slower rate.
You start to ask yourself these questions, what are the traits of the acquiring company? How excited am I to be there? What does the valuation look like? That could hopefully form your answer. Again, you’re getting a 36% premium on where Glu was before the acquisition was announced. I hope you bought it closer to its 52-week low, which is in a $3-$4 range, so you’re making […] like a bandit here. But even so, 36 […]. These things you want to ask. Look, if you do nothing, you end up with cash. I think we lost trading slightly above the acquisition price, our proposed price. Maybe there is some hope that someone who comes out offers a superior price to EA. Can’t say for sure whether it’ll happen. It’s not that big of a premium, but maybe you might get someone else to play here, but EA will probably come back and say, “Well, OK, we’ll offer $13 or something.” There are worse things that have happened. I’ll put it that way.
Hill: Absolutely. To bring it back to Walmart, and you touched on this, a question everyone needs to ask themselves when they’re in this position is what place does this stock occupy in my portfolio? As you said, Glu Mobile is a smaller company. It’s maybe more on the growth side of the equation. To take this to an extreme, if instead of Electronic Arts buying Glu Mobile, if Walmart bought Glu Mobile, it’s like, wait a second. [laughs] I’ve got the bedrock portion of my portfolio covered. It’s like, no, I’m going to get out of this. I’m going to find myself another growth-oriented mobile game company. Always good talking to you, my friend. Stay warm up there.
Gillies: I appreciate it, Chris, and take care.
Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. That’s going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I’m Chris Hill. Thanks for listening. We’ll see you on Monday.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.