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Initiating coverage on Sartorius.

  • 07 Feb 17

Recommendation and upside: We are initiating coverage on Sartorius (market cap. of c.€4.8bn and a free float of c.42%) with a “Reduce” recommendation and a target price of €63.1 per share (c.2% downside). Sartorius 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 current 25% in 2016). We expect Sartorius to continue outpacing the market in the short-to-medium term, driven by its ability to offer the broadest range of products, 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 “Reduce” as we believe the dream run witnessed by the stock over the last five years (it multiplied by >6x) largely discounts these positives and we factor in some moderation in market growth and market share losses for Sartorius in the long term. Business: Sartorius operates two businesses – Bioprocess Solutions (c.75% of 2016 sales) and Lab Products & Services (c.25% of 2016 sales). While the Bioprocess Solutions business is operated entirely by its listed subsidiary Sartorius Stedim Biotech (SSB; in which Sartorius holds a c.74% stake), the Lab Products & Services business (excluding a small portion which is managed by SSB) is consolidated under Sartorius Lab Holding, which is 100% owned by Sartorius. The company offers high earnings visibility as c.65% of its revenue base is recurring in nature (single-use products in the Bioprocess Solutions division – which account for c.75% of the segment – and consumables in the Lab Products & Services business). The Bioprocess Solutions division offers products such as bags, bioreactors, filters and membranes used in the development/manufacturing of biotech drugs. Sartorius holds a leading position in the consolidated €5-6bn global bioprocessing market with a 15-20% market share and primarily competes with Merck, Danaher, Thermo Fisher and GE Healthcare. The industry possess strong barriers of entry in the form of regulatory approvals, close customer relationships, brand loyalty and high quality standards, making it harder for newer/smaller firms to take market share from the incumbents. While the conventional reusable stainless steel products still form 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 Sartorius 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. In the fragmented laboratory equipment market, Sartorius offers instruments such as lab balances, lab filtration, pipettes, water systems and tools for microbiological analysis as well as consumables and services to customers in the pharma/biotech, academia, diagnostics, food and chemical industries. In its targeted market size of c.€3bn, which is expected to grow by mid-single digit pa in the short-to-medium term, driven by the US and Asia, Sartorius holds a market share of >10%. The other key players in the industry are Mettler Toledo, Thermo-Fisher, Merck, Danaher and Eppendorf. The company targets to grow its revenue from €1.3bn in 2016 to €2bn by 2020, with 3/4trs of the growth coming organically. In terms of profitability, it targets to grow its adjusted 2020 EBITDA margin to 26-27% (2016: 25%), which we believe is conservative, given the potential of economies of scale in the business. Need to Know: Sartorius has a complex shareholder structure with two classes of shares – ordinary and preference shares (50% contribution each to total share capital). While each ordinary share carries one vote, preference shares do not carry any voting rights, but are entitled to a slightly higher dividend (additional €0.05 per share after adjusting for the 4:1 share split completed on 13 June 2016). With only c.2% of free float in the ordinary shares (mostly held by the Sartorius family and the US-based Bio-Rad Laboratories), most of the trading happens in the preference shares (c.91% free float). 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 the company resorting to the equity dilution of SSB in the foreseeable future.