Merge Healthcare Upped from Sell

In our most recent report on Merge Healthcare (MRGE - Analyst Report), we upgraded the stock to a HOLD based upon the improved outlook for medical information technology and recent business developments within the company.

MRGE's Q109 results showed modest improvements in both its top and bottom lines, reporting its third consecutive quarter of net income. This is less than a year after the company received a much needed cash infusion ($20 million), turned over its management team, and instituted a severe restructuring program. The results have begun paying dividends with an increase in margins and positive cash from operations.

More importantly, the company tapped the Chinese healthcare market by forming an alliance with the leading healthcare IT provider there. We think that this will change the face of MRGE. Combined with recently announced stimulus spending in both the U.S. and China, the alliance is likely to yield dramatic improvements in its top line.

MRGE is presently trading at a P/S multiple of approximately 2.9x for 2009, close to both the industry mean and the comparables’ mean P/S multiple of 3.0x. We think that the stock should trade at 5% premium to its comparables’ mean P/S multiple. This drives to a target P/S multiple of 3.15x and a target price of approximately $3.45. We upgrade this stock to a Hold.