Not Blades But Spheres Propel NDI To Big Equity Gain: Corrected

Northern Digital had an acquisition opportunity right under its nose. But it took a little push from its sponsor, Audax Group, to consummate what would prove to be a transformative deal.

The roughly 120-person Canadian company, also known as NDI, manufactures surgical navigation systems that let surgeons track the location of their instruments during operations. When Audax Group purchased the company more than four years ago the company derived the overwhelming majority of its revenue from the sale of capital equipment.

OEMs like Medtronic pay NDI thousands of dollars to purchase the navigation system and incorporate it into their comprehensive surgical systems, which they then sell to hospitals. NDI also had a small business supplying the disposable spheres (well under $1,000 per procedure; the spheres attach to the surgical tools and allow them to be tracked.

As part of its due diligence of NDI, Audax Group identified the sale of disposable spheres directly to hospitals—much as disposable blades are sold to people who buy razors—as an attractive source of recurring revenue. One of NDI’s OEM customers, BrainLAB, had a far larger share of the spheres market than NDI, but the business unit wasn’t a core part of its business. Young J. Lee, an Audax Group principal who helped lead the transaction, recalls prodding the management team during one of its monthly operating reviews to consider asking BrainLAB about taking the unit off their hands.

“It never occurred to them this would be possible,” Lee said.

But possible it was, especially after BrainLAB proved open to a deal on a proprietary basis. The close of the June 2009 add-on deal, which nearly doubled NDI’s original EBITDA at a relatively low purchase multiple, proved to be the key to what turned into an exceptionally lucrative deal for Audax Group and NDI employees. After a three and a half year holding period Audax Group saw its original equity investment grow by several times.

Investment Thesis

Audax Group, which has $5.3 billion in assets under management, and which specializes in buy-and-builds, acquired NDI from its founder and CEO, David G. Crouch, after he ran into health problems. Bank of Montreal ran the auction. The sale price represented a fairly pricey multiple north of 8x EBITDA at the time. The deal closed in December 2007.

Lee and David J. Wong, a managing director who worked closely with the company after the acquisition, saw plenty of opportunity for EBITDA growth. One of the first orders of business was replacing Crouch with a new president and CEO. In April 2008 the company announced it had hired Jamie Fraser, previously president of a division of publicly traded Amphenol, a supplier of electrical connectors. Among the biggest improvements during Audax Group’s ownership, the company was able to achieve the following:

• Improve profitability by outsourcing manufacturing to low-cost centers in Mexico.
• Roll out equity value-driven compensation, to an extent that at exit time more than a third of NDI employees realized gains as co-investors or option holders.
• Reduce corporate overhead by $2 million.
• Introduce metrics to a company that had been run more to an eye with maintaining a certain lifestyle for senior employees.

Altogether NDI would more than double its original EBITDA through organic growth and through cost-cutting during Audax’s Group hold period. But it was the acquisition of the spheres business from BrainLAB, financed solely with debt, that had the biggest single impact on cash flow.

The deal brought only a product line and supply chain to NDI—no people. With guidance from Lee and Wong, NDI hired a two- to three-person sales team and built a network of distributors that could reach purchasers at hospitals. The company also built a Web-based ordering and fulfillment system, up and running by the time the add-on deal closed. Helping offset these costs, NDI sharply reduced per-unit costs by shifting production of the spheres to its contract manufacturer. It also lowered costs on its existing sphere production as a result of the additional volume.

The acquisition of the high-margin spheres business from BrainLAB saw NDI grow its EBITDA margins to 37.6 percent by the time it exited the business last June, up from 18.0 percent when Audax Group bought the company. The growth in the spheres business also meant that, at exit time, NDI generated 40 percent of its revenue from recurring-revenue sources, up from 11 percent at purchase time, while its potential customer base grew to more than 2,000 individual hospitals.

Buyer Roper Industries clearly appreciated how much more valuable the business had grown, both in size and quality of revenue. It paid more than four times what Audax Group had for the original NDI business, at a markedly higher EBITDA multiple.

Why The Firm Won

* Oversaw successful transition from founder to second-generation president and CEO

* Melted out costs through outsourcing manufacturing to Mexico

* More than tripled EBITDA through combination of organic growth, add-on deal and cost-cutting

* Key add-on acquisition, done on proprietary basis, expanded EBITDA margins and boosted percent of revenue derived from consumables

(Correction: Young J. Lee is a managing director at Audax Group. An earlier version of this online story gave his title as principal.)