Capitol Health’s hostile takeover bid for Integral Diagnostics — which would create one of Australia’s biggest diagnostic imaging groups — is shaping up as a battle of the funds.

Investors Mutual portfolio manager Simon Conn says it’s rare for a smaller company, in this case Capitol Health (ASX:CAJ), to try to buy a bigger, and in his opinion more successful, rival.

“It’s a bit unusual. Integral’s the bigger company, and a much more resilient business. It’s all a bit odd really,” he told Stockhead.

Capitol is offering 6.9 of its own shares and 36c cash, valuing Integral at $2.46 a share or $356 million.

But Integral (ASX:IDX) is worth more, says Perennial Value small cap manager Andrew Smith.

“We are not sure the current offer as it is structured delivers full value to Integral shareholders,” Mr Smith told Stockhead.

“We would prefer more cash as part of the bid — particularly a special dividend to release the franking credits.”

Capitol launched the off-market bid last week after friendly merger discussions broke down.

Integral responded, “strongly advising” shareholders to “TAKE NO ACTION” until Integral could consider the matter further.

Capitol, chaired by Andrew Demetriou and led by Andrew Harrison, provides diagnostic imaging services in Victoria through its own chain of clinics. It has an investment in diagnostic tech in the US and a partnership to enter the Chinese market.

Integral is slightly bigger, and offers similar services in Victoria, Queensland and Western Australia.

Integral Diagnostics shares over the past year. Source:
Integral Diagnostics shares over the past year. Source:

On Team Integral are Investors Mutual, Virburnum Funds and Perennial, and former Credit Suisse boss Michael Stock is advising the board.

On Team Capitol are Adam Smith Asset Management, Microequities Asset Management, Regal Funds Management and Wilson Asset Management.

Capitol says this gives it control over 19.55 per cent of its target’s shares.

However, those four funds have so far only sold 14.64 per cent of their holdings into the offer.

Acquisitions vs organic growth

Mr Conn believes Capitol is trying to use an acquisition to expand instead of doing the hard yards to build up its own business.

Capitol went on a debt and equity-funded buying spree in 2015 to expand into NSW, collecting four radiology businesses.

It sold off all of those NSW assets in June for $81.5 million, after failing to integrate the different business models which included bulk billing, hospitals, research, and private billing.

Capitol’s shares, once flying high above $1 during that heady year, closed Wednesday down 1.75 per cent to 28c.

Capitol Health's shares over the past year. Source:
Capitol Health’s shares over the past year. Source:

“They’ve retreated back to Victoria and sold Southern and they’ve reduced their cost base,” Mr Conn said.

“For them now to expand they have to staff up and increase their cost base, and I think they’re looking for an exit quite frankly.”

Perennial is less wary of a deal.

Mr Smith says the key risks are the management team who will be responsible for the combined entity.

“We have a high opinion of the Integral CEO and CFO who have done a good job in the short time they have been in those roles.”

The Capitol argument is that Integral hasn’t impressed since it listed at $1.91 in late 2015. Indeed, the only time its share price has cracked that ceiling was after Capitol floated its initial bid price.

However, since Ian Kadish joined as CEO in May things seem to be looking up.

Mr Conn says the old management team hadn’t efficiently run the business, whereas Mr Kadish has brought labour costs down by 2 per cent and making sure technology like MRI machines are being used more often and more effectively.