Will Kinetic Concepts Make Your Portfolio Move?

Kinetic Concepts (NYSE: KCI) -- the $4.8 billion (market capitalization) wound-care and hospital bed provider-- is rumored to be in talks to go private. Its stock popped 12.6% on the news after an 84% rise in the last 12 months. Is that rumor a reason to buy the stock?

Blackstone Group (NYSE: BX) is in talks to buy Kinetic Concepts for about $5 billion, making it one of the largest leveraged buyouts since the financial crisis, according to the Wall Street Journal. Blackstone has recently raised a $16 billion fund and that cash may find its way to Kinetic Concepts shareholders. If the deal goes through, I would not buy the stock because there is little upside opportunity assuming that the buyer pays cash.

If the deal does not go through, there are three good reasons to consider this stock:

• Strong first quarter performance. Kinetic Concepts beat earnings and revenue estimates. Its adjusted EPS (excluding non-cash acquisition-related items and expenses associated to the debt refinancing during the quarter) was $1.11 -- 9% ahead of the Zacks Consensus Estimate of $1.02 while revenues of $501.2 million were up 3% from the year before and 2% ahead of the Zacks Consensus Estimate of $494 million.
• Long-term financial strength. Kinetic Concepts has grown rapidly. Its $2 billion in revenues have increased at an average rate of 10.8% over the last five years while its net income of $272 million has climbed at a 16% annual rate over that period. Its $935 million in 2010 debt is down 34% since its 2008 peak, and its cash has grown at a 31% annual rate between 2006 ($107 million) and 2010 ($317 million).
• Out-earning its capital cost. Kinetic Concepts earns more after-tax operating profit than its cost of capital and it has solid EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, Kinetic Concepts EVA momentum was 1%, based on 2009 revenue of $1.99 billion, and EVA that improved from $69 million in 2009 to $85 million in 2010, using a 9% weighted average cost of capital.

One negative is Kinetic Concepts high valuation. Kinetic Concepts price to earnings to growth (PEG) ratio of 2.05 makes it quite expensive (a PEG of 1.0 is considered fairly priced). Kinetic Concepts P/E is 17.6 and its earnings are expected to grow 8.6% to $5.47 in 2012.

My conclusion is that Kinetics Concepts is a good company but a bad stock investment for now. If the buyout rumors prove false, the stock is sure to plunge. If it plunges enough, the stock's valuation might become attractive. If the rumor is true, there is very little upside unless a higher bid comes along.