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Why Paragon Care Ltd. surged after announcing a large capital raising

It defies conventional wisdom but hospital equipment supplier Paragon Care Ltd. (ASX: PGC) has surged ahead after announcing a $45 million capital raising at the same time as it handed in its earnings report card.

The share price of the hospital equipment supplier surged over 10% at the opening bell before giving up half of its gain to trade 5.4% higher at 82 cents.

That’s still a good outcome as most other companies doing a capital raise typically see their shares come under pressure as new shares are almost always offered at a discount to the current value.

The difference here is that Paragon has done the opposite and completed the share placement at a big premium to its market value. Hong-Kong listed China Pioneer Pharma Holdings Limited has agreed to buy 50.4 million new shares in the ASX company at a price of 91 cents a pop.

That’s a 17% premium to Paragon’s last traded price on Friday and is quite a coup for management. It shows that the new investor is very confident that the stock is under-priced or it wouldn’t have coughed up to purchase 15% of the company.

I am not surprised to see the stock pull back from the morning peak and I suspect we won’t see Paragon trade above 91 cents in the near-term even as management posted a 17% increase in full year revenue to $136.7 million and a 6% improvement in earnings before interest, tax, depreciation and amortisation (EBITDA) to $18.2 million for the period ended June 30, 2018.

It is a good result but I think it misses the mark on a few fronts. While group earnings are up, its earnings per share (EPS) have fallen 13% to 5.4 cents due to recent acquisitions. This is a little below consensus data on Reuters.

There are also signs of cost pressures building. While gross margin is up 1 percentage point to 40%, EBITDA margin is down even if you discounted the impact of acquisitions.

Some may also question the synergies that China Pioneer can bring to the table outside of capital. China Pioneer is also a supplier of hospital equipment but to the Chinese market. The idea is that there could be cross-selling opportunities between the two entities (I suspect more so Paragon selling product into China through its new investor).

That makes strategic sense but some might argue that distribution partners don’t usually take a stake (and such a large one at that) in each other.

What probably persuaded Paragon is that China Pioneer was willing to offer so much and at such a big premium.

Paragon is a prolific buyer of businesses and it will use the cash injection to fund two potential acquisitions. The company has not released any details on the buyouts as it hasn’t signed any binding agreements.

I would normally be nervous about companies doing acquisitions, particularly at such a pace, although Paragon has a good track record on this front – at least so far.

In my view, the stock is a better way to gain exposure to the hospital industry instead of Ramsay Health Care Limited Fully Paid Ord. Shrs (ASX: RHC) and Healthscope Ltd (ASX: HSO) who are impacted by the drop in private patients.

Paragon is also trading on a more attractive valuation, although the stock will probably struggle to trade much higher until management releases details on the two latest potential acquisitions.

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Motley Fool contributor Brendon Lau owns shares of Paragon Care Limited. The Motley Fool Australia has recommended Paragon Care Limited and Ramsay Health Care Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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