Improved prospects for margin expansion

Consort Medical 16 March 2016 Outlook

Consort Medical

Improved prospects for margin expansion

Upgrade to financial forecasts

Healthcare equipment & services

16 March 2016

Price

1,055p

Market cap

£518m

Net debt (£m) at October 2015

99.2

Shares in issue

49.1m

Free float

99%

Code

CSRT

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

11.1

7.7

26.5

Rel (local)

5.2

6.4

37.0

52-week high/low

1155p

832p

Business description

Consort Medical is an international medical devices business with more than 2,000 staff. It consists of Bespak (inhalation, injection and other drug delivery technologies) and Aesica (contract development and manufacturing, CDMO).

Next events

FY16 results

June 2016

AGM

September 2016

Analysts

Lala Gregorek

+44 (0)20 3681 2527

Christian Glennie

+44 (0)20 3077 5727

Daniel Wilkinson

+44 (0)20 3077 5734

Consort Medical is a research client of Edison Investment Research Limited

Following the integration of Aesica, Consort Medical has expanded from its leadership position in drug delivery technology in Bespak to become a full-service contract development and manufacturing operation. With strong margin expansion already underway, we raise our EPS CAGR FY16-20e from 9.5% to 10.6%. Our DCF-based and peer group valuation is 1,292-1,399p.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

04/15

184.8

22.7

47.8

18.1

22.1

1.7%

04/16e

272.9

31.0

51.8

18.1

20.4

1.7%

04/17e

280.8

33.4

55.5

18.1

19.0

1.7%

04/18e

298.4

36.2

60.3

18.1

17.5

1.7%

Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments.

Aesica advances the diversification strategy

We believe the 2014 acquisition of Aesica has improved Consort Medical’s ability to capitalise on the strong growth in outsourcing development and manufacturing functions in the pharma industry. With profitability already on an improving path, we see further upside to Aesica’s margins from 6.2% in H116 to 11% in FY20e, driven by operating efficiencies and growth in higher-margin business.

Bespak goes from strength to strength

Driven by investments in innovation and development capabilities and high-capacity utilisation, Bespak’s recent margin improvement has exceeded our forecast. As it diversifies from its core strength in medical inhalers, we expect margins to plateau at a high level of 20%, with 6.2% revenue CAGR FY16-20e. Our forecasts reflect the initial costs for new product launches, eg the novel nicotine inhaler Voke, new inhalers and autoinjectors (Syrina/Lila) that we expect to secure long-term growth.

Upgraded margin forecast drives EPS acceleration

We have increased our EPS CAGR FY16-20e from 9.5% to 10.6%, primarily driven by upgrades to our margin forecasts in Bespak (raised from 18.5% to 20% in FY20e) and Aesica (from 9% to 11%). We forecast 5.1% group sales CAGR FY16-20e with 6.2% at Bespak and 4.3% at Aesica. Solid cash flow should rapidly improve Consort’s balance sheet from 3.0x net debt/EBITDA in FY15e to 1.8x in FY18e, allowing it to reinvest in the business or raise dividends.

Valuation: Range of 1,292p-1,399p per share

We value Consort Medical using a combination of peer comparables and a risk-adjusted NPV for Bespak’s pipeline. Based on calendarised 13x EV/EBITDA in FY16e and 12x in FY17e, at a 0-5% discount to its peers, our average equity valuation of the current business is 1,080p/share. Adding 240p to 319p for the product pipeline results in a group valuation of 1,320p-1,399p per share. On DCF, we value Consort at 1,289p per share.

Investment summary

Company description: Riding outsourcing trend in healthcare

Consort Medical is an international medical devices (Bespak) and contract development and manufacturing company (CDMO, Aesica). Bespak is focused on the development, manufacture and, increasingly, the commercial drug handling of high-margin disposable drug delivery devices. Aesica provides active pharmaceutical ingredient (API), finished dose development (FDD) and finished dose manufacturing services (FDM) to pharmaceutical companies. Bespak is based in the UK with manufacturing facilities in King’s Lynn and Milton Keynes, an innovations centre in Cambridge and a subsidiary, IAC (Nelson, Lancashire), which produces anodised aluminium ferrules. Aesica was established in 2004 and has grown organically and through acquisition to provide a range of services across the pharmaceutical supply chain. It operates from five European sites (the UK, Germany and Italy), boasting commercial relationships with key global pharmaceutical clients, with the top five representing 57% of group revenue.

Consort Medical originally listed on the London Stock Exchange in August 1983 as Bespak. The name was changed to Consort Medical in 2007 (with the Bespak brand retained for its inhaled drug delivery division) to reflect the then broader business. King Systems was acquired in December 2005 for $95m (£55m) and divested to Ambu in December 2012 for maximum consideration of $170m with $135m received to-date as a function of an earnout clause based on King Vision blade sales. In November 2009, The Medical House was acquired for £16.9m, subsequently rebranded as Bespak Injectables. Bespak employs c 830 staff and Aesica c 1,250.

Valuation: Implied share price range of 1,292p to 1,399p

We value Consort Medical using EV/EBITDA coupled with an rNPV for the Bespak development pipeline. Based on calendarised EV/EBITDA multiples of 13x in FY16e and 12x in FY17e (0-5% discount to peers), the value of the current business is 1,080p/share, plus 240-319p for the pipeline, resulting in a group valuation of 1,320p to 1,399p. We use a three-phase DCF model as a reality check and this yields a value of 1,289p a share.

Financials: Solid growth driven by new business and synergies

We forecast 5.1% revenue and 10.6% normalised EPS CAGR FY16-20e, with new product launches in the Bespak division and new contract wins in the Aesica division as the key growth drivers. We forecast 128bp EBIT margin improvement FY16-20e spurred by the same factors, but also increased efficiencies in Aesica. We envisage the return on the £230m invested in the Aesica acquisition (11.5x trailing EV/EBITDA) to reach 7% by FY18.

Sensitivities: Diversifying product ranges and customer base

Consort Medical’s business is subject to sensitivities common to both medical device and drug manufacturing companies. In particular, it has a relatively high customer concentration, with the top five customers representing 57% of group revenues in H116. This is mitigated by long-term contracts and its focus on diversifying its product and customer bases. Moreover, there are risks pertaining to product development and commercialisation, ie clinical or regulatory failure or delays, new product uptake and supply chain rationalisation, delivery on business development and successful implementation of its growth strategy. The integration of the Aesica acquisition is progressing to plan, although the effectiveness of the wider cross-selling programmes remains to be assessed. It terms of currency risks, a 1c weakening of €/£ rate reduces revenues by £0.7m and operating profit by £0.1m.

Outlook: Tapping solid growth healthcare outsourcing

In late 2014, Consort Medical added a second leg to its strong drug delivery business, Bespak, by acquiring Aesica Pharmaceuticals, a leading European pharma CDMO, for £230m. The commercial rationale for the deal is to offer pharma customers a suite of services enabling them to shorten product development cycles and streamline supply chains. In this note we review the early progress of integrating Aesica Pharmaceuticals and the delivery of Consort Medical’s overall growth strategy. We also review our forecasts and update our valuation with positive implications.

As shown in recent financial results, both divisions are delivering healthy financial returns (Bespak 70% and Aesica 30% of EBIT in H116) demonstrating strong margin improvement in H116, with Bespak reaching an all-time high. We expect the enlarged Consort to produce CAGR EPS of 10.6% in FY16-20e. This compares to -2.9% in FY12-15, a period marked by price pressure and the loss of a key contract. This prompted restructuring, but also investment in production automation and manufacturing systems, which led to improved efficiencies and product quality.

The Aesica acquisition is the largest corporate deal in Consort Medical’s history, crowning its strategic transformation, which aims to diversify its business, both horizontally to harness more of the value chain with pharma customers, and vertically into other new administration forms beyond its stronghold in inhalers.

Strategy: Capture pharma companies’ supply chain activities

One of management’s main objectives is to improve the group’s product and service mix and to sustain long-term earnings growth. Consort prioritises organic growth, but is ready to make acquisitions provided they meet the group’s strategic objectives and prove accretive to the group’s return on capital within a couple of years. Excluding equity financing, we estimate that Consort has a residual £36m in financial firepower before it reaches its debt covenants of 3x EBITDA.

Exhibit 1: Consort Medical’s strategy for growth

Source: Consort Medical

Exhibit 1 illustrates the pathway of the corporate strategy, although activities are performed in parallel. An important objective for Consort is to capitalise on new drug administration modalities, as underlined by the February 2016 development/manufacturing collaboration and equity investment into retinal therapeutics company, Precision Ocular. More broadly, this objective has prompted it to invest in operational scale in the development and manufacturing functions. Another strategic goal has been to broaden the service offering to be able to capture a larger share of pharma companies’ supply chain activities, which has been catapulted by the Aesica acquisition (Exhibit 2). Indeed, one significant merit of the combination is the high degree of complementarity between Bespak’s and Aesica’s respective customer bases, with only four shared clients in the joint top 20. Moreover, we believe Aesica’s wide geographic manufacturing footprint should facilitate the expansion of Bespak’s already constrained production capacity over time.

Exhibit 2: Consort Medical’s integrated pharma services offering

Source: Consort Medical

Bespak set to accelerate growth by broadening its portfolio

Bespak’s core competency lies in the high-volume, high-quality development, manufacturing and supply of tightly regulated medical devices for drug delivery. These include valves, dose counters and actuators for metered dose inhalers (MDIs), dry powder inhalers (DPIs) and medical check valves. Consort is the world’s largest producer (500m units per year), competing mainly against other global suppliers such as Gerresheimer and West Pharmaceuticals. In recent years, Bespak has diversified into other delivery devices, such as nasal devices, autoinjectors and point-of-care diagnostics, but still has 87% exposure to the asthma inhaler market, which grew by 6.4% CAGR 2010-15, according to Consort. Bespak develops products on the basis of its own, as well as customers’ intellectual property.

Bespak has invested heavily in regulatory and quality systems in recent years, but also in equipment and industrialisation processes. Backed by contracted manufacturing volumes, Bespak has invested £20m in manufacturing the nicotine inhaler device, Voke, and £20m in DEV610, a novel dry powder inhaler device. We forecast Bespak’s annual revenue growth (CAGR) at 6.2% in FY16-20e, although we see upside potential to our forecast, reflecting the following factors:

Advancing the development pipeline to market: we expect the launch of the nicotine delivery device Voke, initially in the UK and selected European markets, in FY16e. As the sole supplier to Nicovations (subsidiary of British American Tobacco), we see Voke as a crucial growth driver for Bespak. Another important growth contributor should be the novel DPI platform DEV610, due for launch in H216e and a further three to four pipeline launches over the coming 18 months.

Diversifying the business into adjacent markets and territories: Bespak’s diversification into autoinjectors (The Medical House acquisition), nasal delivery (organic), ocular delivery (Precision Ocular deal and investment), and point-of-care diagnostic devices through its c 17% stake in Atlas Genetics, also represents important growth drivers. Over the next 12 months, we expect the launch of point-of-care diagnostic and service revenues from the Lila and Syrina autoinjector projects, stemming from Bespak’s customisation of devices to the specifications of its pharmaceutical customers. Furthermore, a development programme with a major biotech company to develop product demonstrators has been completed in the past few months. The commercial launch of Lila and Syrina should take place before the end of the decade, prompting a step change in their revenues and a further driver for Bespak’s revenue diversification.

Focusing on higher-value businesses: Consort targets products with a disposable and/or consumable component and those with potential for commercial synergies. It is supported in this aim by its Cambridge-based Innovations Centre, set up in 2010. It plans to more than double investments from the current £2m level, spurred not least by the expansion plans in autoinjectors.

Exhibit 3: Growth and diversification of Bespak’s business

Source: Consort Medical

Under the headline growth forecast, we expect a continuation of the FY13-15 trend, during which period the dominant inhaler franchise grew at 2% CAGR, while injectable devices (other devices) sustained 39% revenue CAGR. The primary factors underpinning growth in injectables are rapidly expanding use of biologic drugs and health economic advantages with self-administration. Specifically, the introduction of Bespak’s Vapoursoft, Syrina, Lila and Lapas technologies has elicited considerable interest among pharma companies with injectable drug portfolios. In November, Bespak unveiled a new highly compact autoinjector, Syrina 2.25. This standard-sized (2.25ml) pre-filled syringe can be adapted to the dose size and power source as determined by the viscosity of the drug. This reduces the risk of inappropriate delivery mechanisms, which can create safety hazards for users. Its key competitors in autoinjectors are Ypsomed (Switzerland), SHL (Sweden) and Owen Mumford (UK).

Bespak’s recent trading has sustained a solid growth trend in recent years (6.8% revenue CAGR 2010-15), delivering 5.4% overall revenue growth in H116. The dominant MDI franchise grew by 3.1%, including 26% growth from deliveries of Chiesi’s NEXThaler. Other devices, including Dr Reddy’s Sumatriptan autoinjector, saw sales jump by 30.7%. Service revenues, which we estimate at about 10% of Bespak’s revenues, leapt by 49.3%. Bearing in mind that the cycle from service revenues to product sales can be as long as three to five years, we see buoyant service revenue growth as an indicator of growth to come.

Bespak has 13 respiratory, nasal and autoinjector programmes in late-stage development or under regulatory review, each of which represents a minimum £3m peak revenue potential, but some up to £25m, based on the company’s assessment. The most recent addition in the past six months is VAL050, a supply agreement for a proprietary pMDI valve and actuator technology for Aeropharm (Sandoz). It is also in late-stage discussions concerning two other opportunities.

Exhibit 4: Bespak’s major product development programmes

Project

Description

Customer

Status

VAL310

Easifill primeless valve

US pharma company

Awaiting regulatory approval

INJ570

Autoinjector

Global pharma company

Awaiting regulatory approval

VAL020

MDI valve

Global pharma company

Stability trials complete

DEV200 (Voke)

Nicotine delivery

Nicovations

Awaiting launch

POC010

POC test cartridge

Atlas Genetics

Awaiting CE marking

NAS020

Nasal device

Global generic company

Formulation change; brief under review

DEV610

Dry powder inhaler

Global pharma company

On schedule, launch expected in H216

NAS030

Nasal device

Pharma company

Early-stage programme

INJ600

PatchPump infusion system for Treprostinel

SteadyMed Therapeutics Inc

NDA submission planned H116

INJ650

ASI autoinjector

Global generic company

Submission planned H116

INJ700

Lila Mix injector

Pharma company

Continuing progress

IDC300

Oral IDC

Pharma company

Continuing progress

VAL050

pMDI valve and actuator

Aeropharm

Awarded November 2015

Source: Consort Medical

Aesica broadens the scope and reach of services

Consort’s capabilities in handling the interface between drugs and devices serve as the main link to its expansion into commercial drug handling by means of the Aesica acquisition. Aesica operates through three businesses that collectively address most of the drug development process, from manufacture of the active pharmaceutical to packaging the finished product. Optimising drug delivery device development and manufacture with API and finished dose formulation and manufacture offers pharma customers the potential to accelerate the route to market for new drugs.

In the Aesica division, Consort offers a broad range of integrated drug development and manufacturing services spanning inhaled, oral and injectable technologies. The division consists of three operating units that can, collectively, address most of the stages in the development of drugs and supply chain, from process development through to packaging the finished product for pharma company customers. Aesica employs c 1,250 people, mainly in production across five facilities in Cramlington and Queenborough (UK), Monheim and Zwickau (Germany), and Pianezza (Italy).

Exhibit 5: Aesica’s operating units

Finished dose manufacturing (FDM)

84% of Aesica turnover with stable manufacturing volumes. FDM employs c 900 people across four sites in Germany, Italy and the UK and provides contract manufacturing (including formulation) and packaging (fill and finish) services for oral and liquid dosage forms. FDM’s future earnings visibility is particularly high since the manufacturing contracts have long-term durations and form an integral part of the client’s regulated supply chain.

Active pharmaceutical ingredients (API)

12% of Aesica revenues. API employs c 250 people across two UK sites. It provides full-scale contract development, process development and drug manufacture, with the key products currently being flurbiprofen (a non-steroidal anti-inflammatory) and a range of controlled drugs. The earnings visibility is good, with the larger contracts being long term and well established.

Finished dose development (FDD)

4% of Aesica revenues, but has the greatest overlap with Bespak’s operations. FDD focuses on providing formulation and analytics services at the earlier stages of drug development, including producing formulated product for clinical trials. These can include a whole range of formulations from capsules and tablets through topical products to liquids and inhaled pharmaceuticals. FDD is based at the Queenborough site.

Finished dose manufacturing (FDM)

Active pharmaceutical ingredients (API)

Finished dose development (FDD)

84% of Aesica turnover with stable manufacturing volumes. FDM employs c 900 people across four sites in Germany, Italy and the UK and provides contract manufacturing (including formulation) and packaging (fill and finish) services for oral and liquid dosage forms. FDM’s future earnings visibility is particularly high since the manufacturing contracts have long-term durations and form an integral part of the client’s regulated supply chain.

12% of Aesica revenues. API employs c 250 people across two UK sites. It provides full-scale contract development, process development and drug manufacture, with the key products currently being flurbiprofen (a non-steroidal anti-inflammatory) and a range of controlled drugs. The earnings visibility is good, with the larger contracts being long term and well established.

4% of Aesica revenues, but has the greatest overlap with Bespak’s operations. FDD focuses on providing formulation and analytics services at the earlier stages of drug development, including producing formulated product for clinical trials. These can include a whole range of formulations from capsules and tablets through topical products to liquids and inhaled pharmaceuticals. FDD is based at the Queenborough site.

Source: Consort Medical

Aesica provides services to a wide range of pharmaceutical companies, although UCB is the largest revenue contributor (estimated at around 45% of Aesica’s sales), followed by AbbVie/Abbott (c 23%), with smaller contributions from GSK, Johnson & Johnson and Merck & Co. Aesica’s revenue mix reflects the legacy of having acquired manufacturing units from UCB, Abbott and Merck over the past decade.

Aesica generated revenue and EBITDA CAGR 2011-14 of 7.6% and 15.5%, respectively. Its operating cash flows have been consistently positive, despite heavy capital investments.

The majority of Aesica’s revenues arise from long-term manufacturing contracts in finished dose manufacturing (FDM). We expect to show modest growth from existing FDM contracts, reflecting the maturity of clients’ products. However, we forecast that Aesica’s 4.3% revenue CAGR FY16-20e will be spurred by new contract wins in FDM, helped by investments made in improving facilities and processes at Cramlington and Queenborough. Albeit from a more modest base, we also see a helpful contribution to growth from finished dose development (FDD), which offers the most significant opportunities for cross-selling and margin expansion in the long term. We expect the integrated development and manufacturing of drugs and delivery devices to improve Aesica’s efficiency, reduce costs and accelerate its product development process. Accordingly, we forecast the operating margin in the Aesica division to improve from 5.2% in FY15 to 11.0% in FY20, while management guides to low-teens margins in the medium to long term. This results in a 16.8% CAGR in Aesica’s operating profit in FY16-20e vs 9.4% for the group and 5.2% for Bespak. We note that one of the leading CDMOs, Catalent, generates a group EBITDA margin of 24%, albeit with a revenue base eight times larger than Aesica’s.

Exhibit 6: Consort Medical’s streamlined services supply chain

Source: Consort Medical

Operationally, Aesica and Bespak report as separate divisions. However, their respective commercial teams work closely together to facilitate introductions to customers and to secure combined formulation and device contracts. In management’s opinion, customers have reacted favourably to the joined-up approach in the past year, prompting numerous enquiries about device development projects based on Bespak’s own, as well as customer’s platforms. In October 2015, a new joint branding was launched at the CPhI exhibition in Madrid, the largest global trade event for the pharma services industry. In our view, the joint approach allows the device expertise to be brought in earlier to the customer, reinforcing Consort’s role as a device supplier.

Aesica offers an integrated supply chain management service to some of its customers and has announced the extension of this service. In addition to providing its finished dose, packaging and release operations to the customer, the service model provides management of product supply chains of upstream and downstream processes at third-party suppliers on the customer’s behalf. This additional service enables the customer to reduce the overall number of CDMO partners with which it deals.

Exhibit 7: Aesica restructuring activities

Restructuring activity

Comment

Commercial

Identify cross-selling and integrated commercial offering opportunities; significant number of joint meetings held.

Reorganisation

Validation and realisation of potential synergies; action of appropriate reorganisation steps to realise the synergies.

Alignment

Alignment of Aesica’s business with Consort control and management systems.

Sites and facilities

Newcastle: changed from a corporate head office to a shared service centre – cash cost c £1.2m.
Monheim: major restructuring of operations to improve productivity of the site – cash cost c £3.0m.
Nottingham: formulation development activities to be relocated to Queenborough – cash cost c £3.5m.

Leadership

Leadership reorganised, consolidating a number of duplicate corporate activities between Consort and Aesica.

Procurement

Combined spending power provides opportunities to leverage procurement benefits to the enlarged group.

Restructuring activity

Commercial

Reorganisation

Alignment

Sites and facilities

Leadership

Procurement

Comment

Identify cross-selling and integrated commercial offering opportunities; significant number of joint meetings held.

Validation and realisation of potential synergies; action of appropriate reorganisation steps to realise the synergies.

Alignment of Aesica’s business with Consort control and management systems.

Newcastle: changed from a corporate head office to a shared service centre – cash cost c £1.2m.
Monheim: major restructuring of operations to improve productivity of the site – cash cost c £3.0m.
Nottingham: formulation development activities to be relocated to Queenborough – cash cost c £3.5m.

Leadership reorganised, consolidating a number of duplicate corporate activities between Consort and Aesica.

Combined spending power provides opportunities to leverage procurement benefits to the enlarged group.

Source: Consort Medical

Since Consort’s acquisition, Aesica has concluded a development programme for a product manufactured using the first semi-continuous processing line and technology installed at a CDMO. The product is now approved and launched in the first major market, with others expected to follow over the next two years.

Furthermore, Aesica has been working with a leading Japanese pharmaceutical company (which we believe to be Taiho) to provide the active ingredient for an anti-inflammatory formulation containing S+flurbiprofen. The patch has received market approval with the Ministry of Health, Labour and Welfare in Japan for the indication of osteoarthritis. It is in the process of supplying API materials for launch stock under a new long-term supply agreement, with demand for the new formulation expected to grow steadily from 2016.

Sensitivities

Consort Medical’s investment in innovation and the resulting product launches are the key determinants for its organic growth, in our view. As an acquisitive company, Consort is additionally exposed to risks pertaining to integration of acquisitions in a timely and cost-effective way and the execution of its growth strategies.

The company is also subject to various other sensitivities common to drug and device CDMOs, on both the up and down side. In particular these include:

reliance on large contracts and key customers: historically, Consort Medical has been highly reliant on large contracts and single customers, although this risk has been diminishing in recent years. Its five largest customers represented 57% of group revenues in H116. It is mitigating such risks through diversifying its product and customer bases. In addition, the nature of its business provides some protection with long-term customer contracts and regulatory and IP/know-how barriers to switching manufacturer. Consort’s biggest clients include Boehringer Ingelheim, Chiesi, Dr Reddy’s, GSK, J&J, Merck & Co, Teva and UCB.

Exhibit 8: Diminishing customer concentration

Exhibit 9: Customer split and overlap between Aesica and Bespak

Source: Consort Medical

product development and regulatory risks: Consort Medical’s drug and device programmes could fail or be delayed in clinical trials or at the regulator (a greater risk for Bespak due to complexity of the regulatory requirements of drug-device combinations). With a number of pipeline programmes filed with respective regulators, regulatory timelines are a key sensitivity; however, as Consort Medical runs multiple projects in parallel, the impact of negative results from, or delays to, a single trial/product should be limited.

technology and commercial risks: Consort Medical is also exposed to regulatory changes that may render existing technologies obsolete, but this also represents an opportunity for developing next-generation devices. Commercial risks include new product uptake, supply chain rationalisation by large pharma companies (and the impact on Consort Medical’s margins) and supply continuity from Consort Medical’s own suppliers (minimised through dual sourcing and holding strategic stocks to mitigate risk of supply interruptions).

Valuation

We believe the valuation of Consort Medical needs to take into account the underlying business, as well as the business pipeline, which we evaluate on a risk-adjusted NPV basis. As a reality check, we also evaluate Consort Medical’s earnings multiples against a broad peer group.

Exhibit 20: Peer group multiples

Company

Market cap
($bn)

2015
P/E (x)

2016e
P/E (x)

2017e
P/E (x)

2015-17e EPS
CAGR

2015e
PEG

2016e
EV/EBITDA (x)

2017e
EV/EBITDA (x)

Advanced Medical Solutions

0.53

27.3

25.7

23.5

7.8%

3.50

11.3

10.3

Clinigen Group

1.01

27.1

18.3

15.1

34.2%

0.79

14.1

11.8

Smith & Nephew

14.05

18.8

18.2

16.8

5.6%

3.35

10.8

9.7

UDG Healthcare

1.92

20.1

22.7

21.3

-2.9%

NM

11.7

11.2

Average UK peers

4.38

23.3

21.2

19.2

11.2%

2.55

12.0

10.8

AptarGroup

4.74

25.1

23.3

21.1

9.1%

2.76

10.3

9.8

Gerresheimer

2.22

19.3

16.3

15.3

12.2%

1.59

8.3

7.8

West Pharmaceutical Services

4.61

34.9

29.4

24.6

19.1%

1.83

14.0

12.2

Ypsomed

1.74

82.9

52.4

37.2

49.2%

1.68

24.2

19.1

Average international peers

3.33

40.5

30.4

24.6

22.4%

1.97

14.2

12.2

Consort Medical

0.72

21.4

19.8

18.4

7.8%

2.74

13.2

12.0

Consort Medical (calendarised)

20.3

18.9

17.4

7.8%

2.59

12.4

11.4

Source: Bloomberg consensus except Clinigen, UDG Healthcare and Consort Medical based on Edison Investment Research. Note: Consort Medical multiples reflect the April year end and refer to FY15, FY16 and FY17, respectively. Prices as at 10 March 2016.

In our view, Consort Medical’s business model is unique in the context of the healthcare sector. Some of its closest peers are subsidiaries and divisions of wider groups involved in specialist contract development and manufacture for the pharmaceutical industry, such as Catalent, but also those involved in medical packaging solutions and drug delivery. In this context, we include AptarGroup, Gerresheimer, West Pharmaceutical Services and Ypsomed as peers. To benchmark its valuation against UK healthcare investments, we look at Advanced Medical Solutions, Clinigen Group, Smith & Nephew and UDG Healthcare.

Given the differences in capital structures between the constituents of our comparator group, we believe EV/EBITDA is the most appropriate parameter. With the international and UK peer groups trading at 14.2x and 12.0x 2016e EV/EBITDA, respectively, we note that Consort Medical trades at a 7% discount and 10% premium respectively. With 2015-17e EPS CAGR of 7.8%, below the 11.2% average of the UK peer group and the 22.4% (10.1% excluding Ypsomed) CAGR in the international peer group, we consider 13x FY16e EV/EBITDA and 12x FY17e EV/EBITDA to be justified. That derives an implied average valuation for the current Consort Medical operations of 1,080p per share.

For our DCF valuation, we consider the risk profiles of Aesica and Bespak’s underlying businesses to be similar and employ a WACC of 10% of the underlying business. For the business pipeline, we forecast known projects based on the company’s guidance that each of these will have peak revenue potential of at least £3m pa. We forecast an operating margin of only 15% (below Bespak’s 20%), success probabilities of 60-80% and a WACC of 12.5%.

We believe the development pipeline should meaningfully boost revenues from end CY16 onwards, In view of the undisclosed identity of many of these projects, our valuation may not adequately capture expected revenue growth (particularly if any of these programmes have significant potential, or material new contracts are secured).

On this basis, we value the Bespak project pipeline at 240p/share (at a 60% probability of success) to 319p/share (80% probability). When added to our peer group valuation of 1,080p/share, this gives a valuation range of 1,320p to 1,399p per share.

We have also performed a DCF-based valuation, including the financial impact of the product pipeline, as a reality check. We have employed a three-phase DCF, using our forecasts for free cash flows from our model from FY16 to FY20 to derive the first part of our NPV. The second phase sees the expected growth rates tapering from a high of 10% in 2021 to 3% in 2030, with a terminal value applied after that (using a 2% growth rate). We have used a 10% discount rate and assumed a tax rate of 18%. This approach suggests Consort Medical is worth 1,289p/share.

Exhibit 11: Assumptions for base case DCF valuation

Key assumptions

NPV (£m)

Free cash flow model FY15-20e

125.2

Tapering growth-free cash flows FY21-30e

278.7

Terminal value (2% growth rate assumed)

327.9

Total NPV

731.7

Cash/(debt) (FY15)

(99.2)

Valuation (£m)

632.5

Valuation/share (p)

1,289

Discount rate

10%

Tax rate

18%

Key assumptions

Free cash flow model FY15-20e

Tapering growth-free cash flows FY21-30e

Terminal value (2% growth rate assumed)

Total NPV

Cash/(debt) (FY15)

Valuation (£m)

Valuation/share (p)

Discount rate

Tax rate

NPV (£m)

125.2

278.7

327.9

731.7

(99.2)

632.5

1,289

10%

18%

Source: Edison Investment Research

Financials

In FY16, we forecast reported revenue growth of 47.6% and 12.7% operating margin (90bp y-o-y margin contraction reflecting the full year consolidation of lower-margin Aesica, partly offset by Bespak’s operating margin improvement, forecast to expand by 90bp y-o-y to 20.7%). The forecast 7.2% growth in EPS in FY16e accommodates a 20.7% increase in the number of shares, stemming from financing the Aesica acquisition.

We forecast group revenue CAGR of 5.1% in FY16-20e, with Bespak generating 6.2% and Aesica 4.3%. Our group EPS CAGR in FY16-20e is 10.6%, upgraded from 9.5%, driven by the revenue growth and 128bp EBIT margin expansion over the period. We raise our EPS by 2% in 2016 and 0.5% in 2017 reflecting higher margins in Bespak.

Aesica was acquired for £230m, representing a multiple of 11.5x FY13 EV/EBITDA and we expect the company to have reached a ROIC of 7.0% by FY18. The transaction was funded by equity issue of £105m, with £116m of new debt and £10.0m of existing cash. Consort benefits from a £160m long-term credit facility with rates ranging from Libor plus 165-190bp. The key covenants are that interest cover (EBITDA/net finance charge) must exceed 3.0x and leverage (debt/EBITDA) must be less than 3.25x until 30 April 2016 and less than 3.0x thereafter. We forecast an average borrowing cost of just under 4% over the forecast period.

Consort Medical does not have an explicit dividend policy, but adapts the dividend payout in relation to its operating cash flow and investment requirements. We forecast DPS to stay static at 18.1p (dividend cover of 2.8-3.3x FY16-18e).

We forecast healthy operating cash flow, but the company has identified growth opportunities in both divisions, which should sustain capex at a high level of £25-27m in FY16-18. Thereafter, we expect capex to drop back to £17-18m. Accordingly, we forecast net debt to stay around £100m in FY15-17, but debt repayments to take place thereafter such that the group reduces its net debt/EBITDA ratio from 3.0x in FY15 in to 1.8x in FY18e. Net debt/EBITDA as reported at end-December 2015 stood at 2.1x.

Consort benefits from the UK Patent Box and R&D Expenditure Credit tax breaks, which are likely to last into the foreseeable future. Therefore, we expect the effective tax rate for continuing operations before special items to be 18% in FY16e-20e.

Exhibit 12: Financial summary

£'000s

2014

2015

2016e

2017e

2018e

Year ending 30 April

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

100,010

184,825

272,867

280,824

298,386

EBITDA

 

24,434

33,188

45,310

49,937

54,240

Operating profit (before special items)

 

18,793

25,055

34,610

37,137

39,940

Intangible amortisation

(983)

(778)

(700)

(800)

(800)

Exceptionals/Special Items

(1,387)

(17,179)

(21,100)

(13,400)

(13,400)

Share-based payment

(1,821)

(1,557)

(1,588)

(1,620)

(1,652)

Operating profit

17,406

7,876

13,510

23,737

26,540

Net interest

(1,266)

(2,364)

(3,600)

(3,750)

(3,700)

Profit before tax (norm)

 

17,527

22,691

31,010

33,387

36,240

Profit before tax (FRS 3)

 

16,544

21,913

30,310

32,587

35,440

Tax

(3,611)

(3,269)

(5,582)

(6,010)

(6,523)

Profit after tax (norm)

13,916

19,422

25,428

27,377

29,716

Profit after tax (FRS3)

12,968

4,948

3,730

13,380

15,720

Average number of shares outstanding (m)

32.9

40.7

49.1

49.3

49.3

EPS - normalised (p)

 

42.3

47.8

51.8

55.5

60.3

EPS - FRS 3 (p)

 

39.4

12.2

7.6

27.1

31.9

Dividend per share (p)

18.1

18.1

18.1

18.1

18.1

EBITDA margin (%)

24.4%

18.0%

16.6%

17.8%

18.2%

Operating margin (before GW and except) (%)

18.8%

13.6%

12.7%

13.2%

13.4%

BALANCE SHEET

Fixed assets

 

79,699

329,831

345,072

357,272

367,972

Intangible assets

20,835

188,781

188,081

187,281

186,481

Tangible assets

49,955

133,725

150,725

163,725

175,225

Investment in associates

4,068

6,266

6,266

6,266

6,266

Trade investment & others

4,841

1,059

0

0

0

Associated with assets held for sale

0

0

0

0

0

Current assets

 

64,028

141,938

104,074

107,872

112,915

Stocks

10,203

31,303

32,957

35,103

37,298

Debtors

27,975

61,459

62,073

64,589

68,629

Cash

25,843

45,201

9,043

8,179

6,988

Other

7

3,975

0

0

0

Current liabilities

 

(17,868)

(221,930)

(191,023)

(189,440)

(186,750)

Creditors

(15,479)

(73,114)

(74,621)

(75,038)

(79,348)

Other creditors

(1,842)

0

0

0

0

Short-term borrowings

0

(144,414)

(112,000)

(110,000)

(103,000)

Provisions and other current liabilities

(547)

(4,402)

(4,402)

(4,402)

(4,402)

Associated with assets held for sale

0

0

0

0

0

Long-term liabilities

 

(5,505)

(47,578)

(25,540)

(25,434)

(25,328)

Long-term borrowings

0

0

0

0

0

Deferred taxation

(3,429)

(26,431)

(4,498)

(4,497)

(4,496)

Other long-term liabilities

(2,076)

(21,147)

(21,042)

(20,937)

(20,832)

Net assets

 

120,354

202,261

232,583

250,270

268,809

CASH FLOW

Operating cash flow

 

17,978

22,040

43,848

44,892

51,514

Net interest

(416)

(1,304)

(4,100)

(3,800)

(3,700)

Tax

(3,564)

(4,300)

(5,582)

(6,010)

(6,523)

Capex

(16,134)

(20,480)

(27,000)

(25,000)

(25,000)

Purchase of intangibles

(158)

(178)

0

0

0

Acquisitions/disposals

(387)

(202,832)

(2,000)

0

(1,500)

Financing

(2,598)

91,918

0

0

0

Dividends

(5,780)

(7,011)

(8,910)

(8,946)

(8,983)

Other

(64)

(2,909)

0

0

0

Net cash flow

(11,123)

(125,056)

(3,744)

1,136

5,809

Opening net debt/(cash)

 

(36,966)

(25,843)

99,213

102,957

101,821

HP finance leases initiated

0

0

0

0

0

Other

0

0

(0)

0

(0)

Closing net debt/(cash)

 

(25,843)

99,213

102,957

101,821

96,012

Source: Consort Medical, Edison Investment Research

Contact details

Revenue by geography

Ground floor, Suite D,
Breakspear Park, Breakspear Way,
Hemel Hempstead, HP2 4TZ
+44 (0)1442 867920
www.ConsortMedical.com

N/A

Contact details

Ground floor, Suite D,
Breakspear Park, Breakspear Way,
Hemel Hempstead, HP2 4TZ
+44 (0)1442 867920
www.ConsortMedical.com

Revenue by geography

N/A

Management team

CEO: Jonathan Glenn

Group Finance Director: Richard Cotton

Mr Glenn was appointed CEO in December 2007 and has served as group finance director since September 2006. Previously, he was CFO of Akubio and global head of finance at Celltech Group. He is a member of the Institute of Chartered Accountants in England and Wales

Mr Cotton was appointed CFO June 2012. Previously, he was group finance director of Vitec Group from 2008-11, Wagon from 2005-08 and McLeod Russell from 2001-05.

Chairman: Dr Peter Fellner

Dr Fellner was appointed chairman in May 2009 and has been a director since November 2005. He is also chairman of Biotie, Optos and Vernalis, vice chairman of Astex Pharmaceuticals and a director of UCB. Previously, he was a director at Evotec, chairman of Acambis, Premier Research Group and Celltech (2003-05; CEO 1990-2003). He was also CEO of Roche UK (1986-90).

Management team

CEO: Jonathan Glenn

Mr Glenn was appointed CEO in December 2007 and has served as group finance director since September 2006. Previously, he was CFO of Akubio and global head of finance at Celltech Group. He is a member of the Institute of Chartered Accountants in England and Wales

Group Finance Director: Richard Cotton

Mr Cotton was appointed CFO June 2012. Previously, he was group finance director of Vitec Group from 2008-11, Wagon from 2005-08 and McLeod Russell from 2001-05.

Chairman: Dr Peter Fellner

Dr Fellner was appointed chairman in May 2009 and has been a director since November 2005. He is also chairman of Biotie, Optos and Vernalis, vice chairman of Astex Pharmaceuticals and a director of UCB. Previously, he was a director at Evotec, chairman of Acambis, Premier Research Group and Celltech (2003-05; CEO 1990-2003). He was also CEO of Roche UK (1986-90).

Principal shareholders

(%)

Schroder Investment Management

7.3

Montanaro Fund Managers

7.1

Neptune Investment Management

6.2

Oppenheimer Funds

5.8

Clearstream Banking

3.9

Polar Capital LLP

3.8

BAE Systems

3.2

Artemis Investment Management

3.1

Companies named in this report

Advanced Medical Solutions, AptarGroup, Catalent, Clinigen Group, Gerresheimer, Smith & Nephew, UDG Healthcare, West Pharmaceutical Services, Ypsomed

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority (www.fsa.gov.uk/register/firmBasicDetails.do?sid=181584). Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Consort Medical and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority (www.fsa.gov.uk/register/firmBasicDetails.do?sid=181584). Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Consort Medical and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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