Was TomoTherapy really sold on the cheap?

Some folks apparently believe Accuray, the Silicon Valley radiosurgery firm, got quite a steal when it agreed to acquire TomoTherapy for $227 million in cash and stock. Not surprisingly, Fred Robertson, president and CEO of the Madison firm, is not among those who think the UW-Madison spinoff was sold on the cheap.

Granted, his bias is a special one, but in his view the notion that the deal valued TomoTherapy at a 25% discount, which was the assessment of Morningstar's Bill Buhr, is to put it politely, "not accurate."

Robertson notes that the sale price negotiated, which equated to $4.80 per share, is a 30.8% premium over the previous day's closing price, and it represents a substantial premium to where the stock has been trading for the past 2-1/2 years. "I don't know the basis for the Morningstar report, but the market value is the stock [price] every day," Robertson noted, "and the stock has been in the same trading range for quite a long time."

There has been plenty of grumbling about TomoTherapy's business performance, especially since netting about $185 million in a 2007 initial public offering, when it opened at $24 per share. There have been shareholder lawsuits alleging false statements about the backlog of orders (they have tentatively been settled), large quarterly losses, and difficulty gaining traction in a vital profit-and-loss center – the service function. While the company has gross margin of +50% for its products, it reported a negative 46% for service.

Robertson acknowledged that that negative service margins were obviously a major contributing factor to overall business profitability, and a major factor in driving valuation, but he said TomoTherapy is making progress on one of its most difficult business problems.

"In this space, the customer expectation of the [Hi-Art] system is that it's always up ready to treat patients, so we have been very careful to minimize that clinical disruption," he explained. "In the early days of our product, I think that the systems required a lot of attention, both in terms of hands-on work from the service engineers and in component replacement, and we were able to meet those customer up-time expectations, but at considerable expense."

Over the past few years, a series of initiatives, including some with suppliers, a host of design changes in the product at the component system level, and training initiatives, has allowed TomoTherapy to make a real dent in that cost of ownership, he added. "So we've continued to improve margins without impairing the customer experience or the patient experience," Robertson stated.

Contrary to popular belief, Robertson said TomoTherapy also was working to develop a platform of technology tools with its standard Hi-Art treatment system; TomoHD, which allows for the treatment of a broader range of cancers; and a mobile application for more flexible use in cancer centers. The company tiered the products to reach different price points, but was careful to stick to its core competencies while working on improving the cost of ownership. It deliberately avoided what Robertson called "a binge of acquisitions" that would potentially distract the employees from those more critical issues.

In other words, TomoTherapy has been working to solve its business problems, without which it would not be much of an acquisition target. In its most recent guidance, contained it its 2010 earnings report, the company projected getting near break even in the fourth quarter of 2011, but that news was greeted by a yawn by the analysts.

Great combination?

The combined companies sound synergistic enough. Accuray is a maker of a robotic radiosurgery system known as CyberKnife, which is installed at 220 facilities worldwide. TomoTherapy manufactures and sells a suite of radiotherapy systems that are used in 350 cancer centers worldwide. Their annual revenues are similar, both in the $200 million range, and they serve complementary patient populations. At the time the sale was announced in early March, TomoTherapy had more employees and a larger installed base; Accuray was more profitable.

Robertson characterized Accuray as the one company in TomoTherapy's space that is not a direct competitor. Despite the fact they are not direct competitors, both sell to the radiation and oncology community, so while they have different applications for different patients, there is a fair amount of overlap in the end customer.

From a distribution perspective, there is the potential to have a better reach, both with the direct sales force and with the global distribution network. "If you look at the customer support side, one of the limiting factors of our movement to profitability and customer support has been truly one of scale," Robertson noted. "The combination of that installed base will enable us to move more quickly to profitability in the combined customer support organizations."

While the companies foresee a premier radiation oncology company, others are concerned about the loss of another Wisconsin headquarters, and the possibility of more Madison job losses.

The latter is an inevitability for some of TomoTherapy's 340-strong workforce, but it should not be dramatic. Given that Madison is home to a major research university that is considered a center of innovation, Accuray would be foolish not to fulfill its commitment to retain a strong production presence here.

That's no guarantee, of course, but Accuray would undermine its new growth potential without a strong commitment to Madison. "The TomoTherapy technology is not going away," Robertson said, "and I think you'll see an opportunity for more investment. It's a story about growth, not about cost cutting."

Time will tell on that point, just as it will on Robertson's future direction. Since Accuray's Euan Thomson is the CEO of the combined entity, Robertson is unsure of what he'll do next. "My plans are to stay in Madison," he said. "This is a great place to live, and I'm sure there will be more opportunities here."

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