Monday's announcement that radiosurgery device maker Accuray Inc. would buy radiation therapy business TomoTherapy Inc. in a $277 million cash-and-stock deal drew mixed reactions from observers.

TomoTherapy's stock shot up 24 percent, but Sunnyvale, Calif.-based Accuray's tumbled about 9 percent.

Acquiring companies usually experience some "headwinds" but the news also brought out vocal skeptics.

Seeking Alpha writer and TomoTherapy investor Stephen D. Simpson, who thinks Madison, Wisc.-based TomoTherapy is undervalued, didn't believe Varian Medical Systems Inc., the market leader, and Elekta, a Swedish rival, had much to worry about.

"This deal may raise an eyebrow or two at Varian and Elekta, but neither company is likely to sweat too much until the combined company shows that 'one plus one' equals something more than two," he wrote.

But in conversation with DOTmed News, both Accuray CEO and President Euan S. Thomson and TomoTherapy CEO Dr. Frederick A. Robertson have hopes the transaction will have an "emergent" property greater than the sum of its parts.

Both men argue the combined companies will streamline overhead expenses and also combine technological know-how to make TomoTherapy's previously struggling service business break even by the end of the year. They also see benefit to what they're viewing as a melding of Silicon Valley marketing and Madison's engineering strengths.

"I do expect when people step back and look at the transaction, they'll realize what an exceptional value this is for shareholders," Thomson said.

TomoTherapy also thought it was a good deal for the company. "I would point out that TomoTherapy has been trading in the mid three dollar range for the past two and a half years," Robertson said. "Even with the recently released 2010 financials, where we had 19 percent revenue growth, 17 percent year-over-year growth and new orders with a view toward profitability...the transaction as announced on Monday involves almost a 33 percent premium."

Bigger installed base, increased efficiency

One of the main "vital signs" of a capital equipment company is its installed base, Thomson said.

Accuray has installed, worldwide, about 220 of its CyberKnife systems, devices that use radiation to treat solid tumors. And TomoTherapy has installed around 350 Hi-Art systems, a CT-guided intensity modulated radiation therapy system which delivers precisely sculpted doses of radiation.

"The level of stability of a capital equipment company can be to some extent measured by the size of its installed base, because it represents the level of ongoing revenue that can be expected," Thomson said. "Going from 220 plus systems to all the way 500 plus systems is truly a transformative transaction."




Thomson also said the two technologies are largely used on separate patients (or the same patient at separate phases of treatment) but could often be owned by the same clinical specialty, meaning the "sales force has twice as many reasons to contact and build relationships with the same customer."

He also thinks that as two relatively small public companies, they carry overhead expenses that are significant relative to their financial size. Combining resources could cut back on those costs.

But perhaps the biggest effects could be in helping to turn around TomoTherapy's previously ailing service business.

Service woes

TomoTherapy, based on technology developed by University of Wisconsin-Madison scientists, had a celebrated IPO. After its May 2007 debut, its shares quickly soared to $25. But in July 2007, its shares peaked at $27.20. In 2008, it went on a steep decline. Before this week's acquisition announcement, it was trading at $3.67.

2008 was a tough year for capital equipment all around: Medicare reimbursement cuts for some procedures had just come into effect the year before, following the Deficit Reduction Act of 2005. The Great Recession had cast a pall over financial markets, tightening the flow of credit. And for TomoTherapy, there was an extra hit: Varian received U.S. Food and Drug Administration clearance for RapidArc, a radiation therapy unit seen as a competitor to the Hi-Art system.

But the company had also been plagued by high service costs due to uneven reliability. "They've had some difficult technology challenges," Thomson said.

"The way they've compensated for that, quite rightly, is to invest in customer support and customer service. They are proactively managing the reliability challenges they have by absorbing the pain themselves, by absorbing the cost pressure by proactively changing out components and making sure they have dedicated service engineers for their systems. That creates a financial burden on their company, and drags down, particularly, their service margins."

The biggest challenge five years ago was the treatment couch, Robertson said, but he said those issues have been resolved. Already, revenues have inched up 5 percent for services, according to the most recent financial statement, released in February.

"We will get to break even on the fourth quarter of this calendar year," Robertson said. "The Accuray scale and expertise will help us move faster."

Accuray said they would be able to help service linear accelerator parts, another issue for the Hi-Art system. Accuray said it has expertise in the field after its approximately $8.3 million purchase of American Science and Engineering, Inc.'s linear accelerator manufacturing facilities in Mountain View, Calif in 2004.

"We have one of the strongest teams in the world in linear accelerator manufacture," he said.

New technology

As for what else lies ahead for the two companies, both Robertson and Thomson are tight-lipped. Both men said that aspects of the deal will be revealed once the U.S. Securities and Exchange Commission filings are completed in the near future.

Among the unknowns is the fate of TomoTherapy's Madison headquarters. However, Thomson said Accuray was committed to maintaining a "presence" there but that the details still had to be worked out.

"We recognize the value of the academic relationship they have locally as well as the workforce itself," Thomson said. "We're definitely committed to maintaining a significant employee presence there."

University of Wisconsin-Madison said TomoTherapy employed 350 of its global 650 employees locally.

Accuray said it expects TomoTherapy to be profitable for the company starting July 2012.

"Last year's history shows the companies were approximately equal in annual revenue. The implication is if they had already been operating as one company, revenue would have doubled where it is today," he added. The predicted combined revenue for the companies is around $400 million.

Thomson also hinted at areas where they could collaborate technologically. For CyberKnife, Accuray makes a solution that tracks tumor movement as the patient breathes, known as motion management.

"Now that type of capability, if that were built into the TomoTherapy product line with its dose sculpting, I think that would be a terrific enhancement," he said.

The CyberKnife was developed in 1987 at Stanford University; it received its first U.S. Food and Drug Administration clearance in 1999. TomoTherapy, which makes a computed tomography-guided intensity-modulated radiation therapy system, was founded in 1997.

Accuray's stock fell 3.85 percent and closed at $8.50 Wednesday. TomoTherapy fell about 1 percent and closed at $4.47.