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Initiating coverage on Sartorius Stedim Biotech.

  • 07 Feb 17

Recommendation and upside: We are initiating coverage on Sartorius Stedim Biotech (SSB; market cap. of c.€5.3bn and a free float of c.26%) with an “Add” recommendation and a target price of €61.7 per share (c.7% upside). SSB is one of the top five players in the high growth €5-6bn oligopolistic bioprocessing industry (the top five players together control >80% of the total market) with a market share of 15-20%. The industry presents robust growth opportunities and is expected to grow at 9-10% pa over the next five years, driven by the growing dominance of branded biotech drugs as well as the arrival of biosimilars in the US (the proportion of biotech drugs out of the total drugs is expected to increase to 28% in 2020 from a current 25% in 2016). We expect SSB to continue outpacing the market in the short-to-medium term, driven by its ability to offer the broadest range of products, its dominant position in the fast-growing single-use products sub-segment (expected CAGR of >15% over the next five years) and the opportunities for market share gains in the US (where it traditionally had a lower market share compared with US-based peers Thermo Fisher, GE and Danaher). However, we limit our recommendation to “Add” as we believe the spectacular run witnessed by the stock over the last five years (it multiplied by >7x) largely discounts these positives and we factor in some moderation in the market growth and market share loses for SSB in the long term. Business: The France-headquartered SSB is primarily engaged in the manufacturing and distribution of products/equipment (such as bags, bioreactors, filters and membranes) used in the development/manufacturing of biological drugs (c.93% of 2016 sales). It also has a small presence in the laboratory equipment business (c.7% of 2016 sales), in which it manufactures lab filters and sells to parent company Sartorius. The company offers high earnings visibility as c.75% of its revenue base is recurring in nature (single-use products in the bioprocessing business). SSB holds a c.15-20% market share in the consolidated €5-6bn global bioprocessing market and primarily competes with Merck, Danaher, Thermo Fisher and GE Healthcare. The industry enjoys strong entry barriers in the form of close customer relationships, brand loyalty, high quality standards and validation requirements, making it difficult for newer/smaller firms to take market share from the incumbents. While the conventional reusable stainless steel products still form a major part of the market (60-70%), the usage of single-use products is becoming more prevalent, driven by advancements in technology as well as advantages such as production flexibility, cost savings and the lower risk of contamination; the share of single-use products is expected to grow significantly to 70-80% in the long term from the current 30-40%. The USP for SSB is its ability to offer the most comprehensive range of products, spanning the entire spectrum of the biopharma production process, ranging from cell culture media, fermentation, filtration and fluid management to purification. The company targets to grow its revenue from €1.1bn in 2016 to €1.5-1.6bn by 2020, with 4/5ths of the growth coming organically. In terms of profitability, it targets to grow its adjusted 2020 EBITDA margin to 29-30% (2016: 27.5%), which we believe should be achievable, given the potential of economies of scale in the business. Need to know: By the virtue of holding c.74% of the total shares and c.85% of the total voting rights of SSB, the parent company Sartorius exerts a firm grip on SSB, meaning little say for minority shareholders. Shares registered in the same name for at least four years are entitled to a double-voting right (c.76% of the total shares as on 31 December 2015; all shares held by Sartorius carry double-voting rights), while the rest carry a single-voting right. The will of Horst Sartorius restricts the company from issuing new ordinary shares until 2028. It also can not issue new preference shares as the German regulations prohibit issuing more than 50% of the total share capital as preference shares. To circumvent the problem of raising equity, Sartorius acquired France-based Stedim in 2007 and reverse merged its bioprocessing business with Stedim to form Sartorius Stedim Biotech. Sartorius left SSB as a listed company so that, if necessary, it can raise equity indirectly through SSB. However, we believe raising equity would be necessary only in the case of a big acquisition and, considering the scarcity of big acquisition targets (in the relevant markets), we do not see Sartorius resorting to the equity dilution of SSB in the foreseeable future.