Bringing together a band of businesses in a busy, acquisitive 2007, former cash shell Concateno has quickly transformed itself into Europe’s largest and most experienced drug and alcohol testing services provider.

With its acquisitive phase complete, the company is now well under way with the successful integration of last year’s acquisitions, of which the largest was rival AIM group Cozart, a specialist in ‘point-of-care’ testing acquired for £65.5 million cash.

European number one in a defensive market, characterised by high entry barriers, growth and margins, Concateno promises organic growth aplenty. Its experienced management is now looking to expand the business geographically and to exploit cross-selling opportunities across a large and diverse roster of clients, typically providing visible levels of repeat business. Adding to its investment attractions is the ongoing development and exploitation of new technologies, helping clients address society’s drug and alcohol abuse problems.

Results for 2007 were encouraging, and with analysts forecasting rapid growth, the shares, trading on modest multiples, look terrific value. And having swiftly transformed itself into a market leader, one could expect strategic bidders to come calling at some point in the future.

Strategy
Concateno was originally floated on AIM in April 2005 as a vehicle for water industry guru Keith Tozzi to buy businesses in the regulated water sector. However, when his plans in this market were thwarted, the brief was changed, with shareholders’ blessing, and in 2006 Concateno made its first acquisition in the drug-testing market – paying £30 million for Medscreen in a deal that brought in chief executive Fiona Begley.

Last year was a pivotal one, with the acquisition of six ‘drugs of abuse’ testing businesses – among them TrichoTech, CPL, Euromed and Cozart. There is much growth to go for in this market, which, according to Tozzi, ‘is huge and fragmented and still in its embryonic stages’.

2007’s highest-profile acquisition was Cozart, focused on point-of-care testing and giving the group scale as well as a better balance between laboratory-based and point-of-care testing. Cozart brought with it a laboratory products division as well as the ability to manufacture drug-testing devices in house. This will benefit margins, while also accelerating Concateno’s stated strategy of European expansion.

Concateno now offers a unique service akin to a one-stop shop to 8,000 or so clients. ‘We are a niche business in an attractive market, with high growth rates and high margins,’ enthuses Tozzi, who says the company carries out eight million drug tests annually and has a global network of 500 sample collectors.

Current activities include the testing of employees, testing in order to support the judicial system and testing workers who might be under the influence in safety-critical sectors. Hair testing supports family law and child protection efforts, as well as forensic investigations. Meanwhile, the client base is exceptionally diverse, ranging from the police and the prison service to Esso, Rolls-Royce and a host of major shipping companies, with many clients tied into three- and five-year contracts.

Management
Affable chairman Keith Tozzi brings his formidable business-building experience to bear at Concateno, following periods with Southern Water, the British Standards Institution and Swan Group.

Fiona Begley, Concateno’s chief executive, has held management positions at Syva UK and Behring Diagnostics UK before she joined Medscreen in 1996. She was appointed managing director in 2000 and led a 1992 management buy-out of the company from PharmChem.

Finance director Neil Elton brings with him considerable experience of acquisitions and integration, while investors can also take a good deal of encouragement from the credentials of the non-executive team.

Prospects
On target to hit this year’s numbers, current trading gives cause for optimism. Although parts of the public sector drug-testing market present some short-term challenges, overall, demand for Concateno’s services remains robust, with growth rates ‘particularly strong’ in the workplace and legal sectors.

Long-term prospects are underpinned by new technologies and applications in development, with recent highlights including the launch of blood-borne virus testing for HIV and hepatitis.

In a revolutionary development in point-of-care testing, Concateno is developing a next-generation handheld testing device via a 50/50 joint venture with European electronics giant Philips. Branded ‘Cozart-Philips’ and set for launch in 2009, this device, aimed at the roadside testing and workplace markets, can uniquely test oral fluids for up to eight drugs within a minute and is up to 100 times more sensitive and accurate than any other point-of-care analyser in the market. Currently undergoing trials with European police forces, it could provide strong growth for the group further down the track.

In terms of the financials, last year’s results were clouded by the sheer number of acquisitions. However, the pro forma figures (assuming all group businesses were owned for the entire period) demonstrated 12 per cent turnover growth to £41.8 million and a 63 per cent increase in adjusted EBITDA to £8 million. Year-end net debt of £27.1 million reflected recent takeover activity, yet, given the group’s cash-generative characteristics and synergies and savings to come, particularly from the Cozart deal, this should not unduly concern investors.

Concateno is forecast to deliver some aggressive growth over the coming years. For 2008, Kaupthing Singer & Friedlander’s Kean Marden sees profits rising to £10 million pre-tax from turnover of more than £56 million, with earnings burgeoning by 46 per cent to 10.5p per share. For 2009, he forecasts further profits progression to £14.5 million from revenues approaching £65 million, with earnings likely to come in at 12.8p.

Valuation
Based on forecasts in the market, Concateno trades on a prospective multiple of 14 times, falling to 11.4 times for 2009. That rating looks anything but testing, given this year’s anticipated earnings advance and the EPS growth of 22 per cent pencilled in for next year.

On a PEG (price/earnings to growth) basis, ratios of 0.3 and 0.52 suggest the shares represent very good value indeed for investors, with the relatively lowly rating perhaps reflecting the lack of a like-for-like peer quoted on the London market. However, it is worth pointing out that Concateno trades at a discount to the more highly rated diagnostic technology sector.

Significantly, from a strategic point of view, there are three large US players in this market, namely First Advantage, Quest Diagnostics and Inverness Medical Innovations, all with stated ambitions to move into the European market. In order to mount any sort of bid for such a strategically well-placed concern as Concateno, a premium price would have to be offered.