Friday, 02 July 2010 00:00

Nordion: An Interesting Situation

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I originally sent this as an email1318 to a friend in February of this year and I thought I would post it here as I still find the situation interesting.

The company is called MDS INC (Ticker: MDZ) (soon to be renamed to Nordion). The background history of the company is one filled with a legacy of value destruction but it has now sold all but its core business (more later) with the biggest legacy business being sold to Danaher recently for which the company received $650 million. At this point all the old business divisions besides Nordion have been sold but there are still some legacy obligations remaining.

The prior management team has been replaced, with the exception of the CEO of the Nordion business who is now the CEO. The company is now refocusing on its Nordion business, a medical isotope supplier.

So what is the deal here? Well medical isotopes are only produced, currently, in 5 nuclear research reactors, the newest one coming into service in 1965. Out of those five there are two that produce about 65% of the world's supply of medical isotopes. The HFR (Netherlands) and NRU (Canada) reactors are those 2. Nordion gets 100% of the Mo-99 produced from the NRU reactor and then processes it into Tc-99m and exports it to Lantheus who distributes it.

Tc-99m is used in 30 million patients yearly to treat a range of issues including Myocardial perfusion, bone scans, etc. Its advantages include low dose, a six hour half-life and a historically low cost. All these are also important competitive advantages that have kept away competition for 30+ years.

The business, under normal operating circumstances is solidly profitable.

So what is the problem? The first is that the NRU reactor is old and has been offline since late 2009 due to a small heavy water leak. That presents supply problems to Nordion which in turn has lead to unprofitable operations. The company had been working with a division of the Canadian government, AECL, to design and constructing two new nuclear research reactors, the now infamous (in these circles) Maple project which has now been completely stopped by the current Canadian government.

So with NRU down and Maple cancelled the stock is in the doldrums, for good reason.

Why even bother with this? Well when NRU gets back online (scheduled for late April but I have my doubts*) they should be up for a healthy time period because during the repair the reactor was completely shutdown. This allowed the AECL to do a bunch of additional work inside the reactor that it normally can't do (because the reactor was almost continually in service) which to date has included new wiring, critical values and chiller units. The AECL is going to put patches over the problem areas and so far is 48% completed*.

Weekly updates (as well as a bunch of informative videos talking about the process (can be seen at www.aecl.ca) The AECL is going to apply for a life extension with the Canadian nuclear regulatory agency to keep it running until 2016 which I think is highly likely to pass based on comments from the government, etc. So if they can get it back online and if they get the license extension Nordion should have a good period of profitability.

Value added action being taken:

The company is doing a buyback and will be purchasing between 40-46% of the outstanding common shares (This has since been completed. Their press release stated that "On March 29, 2010, MDS repurchased and cancelled 52,941,176 Common shares at a purchase price of $8.50 per Common share for a total cost of $450 million under the substantial issuer bid.")

Why might you want to look it more closely?

- Even after this the company with have a clean balance sheet with between $85-110 million in cash and no debt. (On Jun 14, they reported a cash balance of $134 million)

- The company could potentially receive a settlement from AECL (i.e. Canadian government) for a portion of the $350 million they spent on helping to develop Maple

- Will be quite profitable when they get supplies from NRU again and return to normal operations although it may take some time to return to earlier margins levels as customers come back on line

- Due to issues with the way product is developed (with Highly Enriched Uranium) there is no way this is going to be a program that doesn't involve cooperation with governments and there are unlikely to be any major sources on new supplies on the near to medium term horizon

Problems:

- With global supply issues causing the price of Tc-99m to increase users are looking for replacements that, so far, have meet resistance due to low price point. One such is PET technology may be more attractive

- New research is being done into the production of Tc-99m which could mean at some point could mean more competition

- Outlook is cloudy for when NRU will come back online and if it can get license extended to 2016.

*I was correct as the project was delayed with a new tentative date of late July. On June 30 the AECL posted in their regular updates that they believe the repairs have been completed and think the NRU can be returned to service. They further advised that they will be appearing before the Canadian Nuclear Safety Commission (CNSC) in a public hearing to consider AECL's application for the restart of NRU on July 05, 2010, at 2:30 p.m.

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