ADL Bionatur Solutions — CMO business driving growth

ADL-BS reported Q319 headline results on 14 November, with significant revenue growth in its core CMO business. Following the merger between ADL Biopharma and Bionaturis (BNT) in April 2018, the firm classifies its operations under three primary business lines (CMO, Pharmaceutical and R&D & Licensing Services), along with other operating income, which we believe is largely driven by the firm’s agreement with Wacker Biosolutions León whereby Wacker pays operating, usage and maintenance-related costs to ADL-BS.

CMO growth was up 205% year-on-year in Q319 to €9.9m, and up 195% in 9M19 to €26m. These results remain indicative of continued success in management’s strategy (since 2015) to direct the firm’s industrial fermentation facilities increasingly towards CMO production for third parties, with a focus on higher-value end-products (which can be more complex and carry higher margins than simpler or more commoditised products produced by fermentation, such as alcohols). The API division also delivered 8% year-on-year growth in Q319 and 9% growth through 9M19 (to €3.5m in revenue).

As a whole, operating revenue was up 127% through 9M19 to €33.2m, with CMO driving the most growth, as has been the overall trend since the company closed the merger with BNT. Importantly, profitability ramped up significantly in Q319, as quarterly adjusted EBITDA of €1.57m accounted for 72% of the 9M19 adjusted EBITDA. Importantly, the CMO business drove 80% of Q319 adjusted EBITDA (and 78% of 9M19 adjusted EBITDA). These trends provide us comfort that the company will be able to meet its guidance of positive company-wide EBITDA in FY19.

ADL-BS reported mid-year financials in October, with H119 CMO growth up 190% year-on-year to €16.0m (vs our €21.9m estimate) and API revenue of €1.9m (up 10% year-on-year), but below our €2.6m forecast. Overall operating revenue was €20.7m, lower than our €28.8m forecast, but still up 143% year-on-year and gross profit of €14.4m was above our estimate of €13.9m, due to stronger than expected gross margins. After including grant revenue and work performed on assets (capitalisation of development expenses), ADL-BS reported H119 total revenue of €22.6m.

The firm reported positive H119 EBITDA of €0.1m and, excluding non-recurring costs, adjusted EBITDA came in at €0.6m. Due to the timing of the BNT/ADL merger, BNT’s operations prior to May 2018 were not included in the comparable H118 financials.

In its Q319 release, ADL-BS reiterated its full-year guidance for €50m in total revenue and positive company-wide EBITDA. We believe the guidance remains achievable as the company had previously stated that it expected 2019 revenue to be weighted more heavily towards the second half of the year. This has already been shown in the top-line Q319 results (thus far the strongest quarter of FY19 year to date). Further, our prior 2019 revenue forecast (€60.8m) was well above the company’s guidance and, as discussed below, we are reducing our 2019 estimates accordingly.

Much of the revenue visibility for ADL-BS’s CMO business has been contractually committed through multi-year (or renewable) contracts; we estimate the two largest of these are a six-year €146m flucosil-lactose deal (signed in H217) and a renewable two-year contract signed with Amyris (AMRS, Nasdaq) in early 2018 and then extended three times since (most recently in July 2019), to produce fermentation-derived products for the health and wellness, beauty and flavours and fragrances markets. Under the July 2019 expansion, their CMO production agreement was extended to 2020, with the associated additional revenue expected to exceed €12m. ADL-BS will produce up to five ingredients for Amyris during the contracted period and an extension option is in place for future years.

On 2 December, ADL-BS announced a new seven-year CMO contract with a Swiss biotech client (worth €20m) to produce two novel cosmetics and/or nutrition products. The agreement includes technology transfer, upscaling and industrial-scale production of two novel high value-added ingredients for the cosmetics and nutrition industry. This agreement supports ADL-BS’s position and reputation, in our view, as a leading and trusted European player in fermentation. Technology transfer is expected to be completed in early 2020, with scale up and industrial-scale production anticipated to start afterwards.

Also in July 2019, ADL-BS reported that it expanded its CMO production agreement with an unnamed longstanding client (active in the nutrition, health and sustainable living industries). ADL-BS has produced a specific food supplement for several years for this client and the production extension represents a 75% increase (reflecting over €2.5m of additional revenue) compared to the initial amount agreed for 2019.

In its API segment (which also employs the firm’s fermentation facilities), ADL-BS announced in August 2019 that it entered a strategic alliance with an undisclosed new customer in Japan to produce sterile APIs. The customer is a producer of pharmaceuticals, agricultural chemicals and veterinary drugs, and the revenues associated with the contract represent €13m over the next five years. This announced contract provides support to our current API sales growth forecasts. Our current API revenue forecast for 2020 is €9.4m increasing to €13.7m in 2024. Hence, the average run-rate of this contract reflects about 19–28% of these current API sales estimates.

ADL-BS will have 2,400m3 of total fermentation capacity available before the end of Q120. Much of this is provided through eight 225m3 fermenters, six of which are online and in production. The two remaining 225m3 fermenters are expected to be available for commercial production by the end of Q120 following recent upgrades and reconditioning. ADL-BS indicates that over 85% of its available fermentation capacity has been contractually committed for the next two years, which should support its ability to meet its growth targets, in our view.

We reiterate that committed capacity differs somewhat from full operating utilisation. The company’s arrangements with contracted customers allow certain fermentation facility allocations to be committed to a given client, without requiring the allocated capacity to be up and running 100% of the time (as there is some natural downtime needed between production batches). ADL-BS expects to optimise run times as efficiently as possible to augment overall utilisation at all of its fermenters while ensuring the production mix is geared as much as possible towards high-margin products.

Given the 9M19 results, we have reduced our full-year CMO sales estimates and adopted slightly more conservative forecasts for future growth in 2020 and beyond. However, due to the August 2019 €25m Kartesia financing described below, which provides the firm with sufficient resources to meet near- to medium-term working capital and capex needs, and following discussions with management, we are confident that the firm can meet our CMO growth targets. It was previously more financially restrained in its ability to fully take on potential customer contracts; with the additional funding in place, it now has more flexibility to fully maximise the CMO revenue potential at its facilities (including forthcoming upgrades).

We have largely maintained our forecasts for Q419 and beyond for the API division, given that the recent signing of the Japan-based client described above supports our medium- and long-term API growth expectations.

We have also reduced our medium-term expectations for the R&D and Licensing segment, which had come in well below our expectations in H218 and now also for 9M19. This segment is still largely based on the BNT side of the ADL/BNT merger and it contains many moving parts and R&D projects, and it appears to have a less predictable or consistent revenue stream than the larger CMO and API segments.

Given the recent results, we have mildly reduced our COGS estimates and raised our other operating expenditure forecasts, resulting in a slight net decrease in expected EBITDA margin for most future years (largely due to a mildly lower revenue base).

ADL-BS reported end June 2019 total debt of €54.4m, offset by cash and equivalents of €4.2m, resulting in net debt of €50.2m. This is up from comparable net debt of €43.1m at YE18.1 The firm’s gross debt includes an €8.7m shareholder loan from its majority shareholder, Black Toro Capital, which carries a variable interest rate tied to the company achieving earnings before interest and taxes (EBIT) in excess of €30m. Excluding the shareholder loan, we calculate the firm’s adjusted net debt at mid-2019 to have been approximately €41.5m.

ADL-BS announced in August that it has agreed to obtain €25m in debt financing with Kartesia, a private lender, at a rate of Euribor plus 5% per year with a one-time 7% fee on repayment. Gross proceeds will be used to fully fund the company’s existing capex plans to modernise ADL-BS’s CMO facilities (totalling 2,400m3 in fermentation capacity), to provide the working capital needed to respond to its CMO client demands and to refinance €5.7m of existing debt. Altogether, ADL-BS expects this debt financing to fully fund the company’s business plan for the next four years, mitigating financing uncertainties and allowing the company to focus on executing its business plan. The company also specified in its Q319 release that it expects to invest about €20m across FY19 and FY20 to modernise its facilities, and then spend about €2m per year in maintenance costs thereafter. We have raised our FY19–20 combined capex estimate to €19.1m (from €12.5m, previously) to account for this guidance, with the bulk (€14m) of the spending now expected in FY20.

ADL-BS retains the option of drawing an additional €5m from Kartesia (a second tranche) at similar terms. This option could be exercised if ADL-BS seeks additional flexibility to accelerate its business development or expand its fermentation capacity. Management indicates it will not need to use this additional tranche or raise additional funding if it does not expand its operations beyond its current four-year business plan or if it does not build fermentation capacity beyond the existing 2,400m3 installed base. The company may need to refinance some of its existing debt in the next two to three years, however.

We value ADL-BS using a discounted cash flow (DCF) approach and, as per our usual policy for operating healthcare firms with a non-insignificant amount of net debt within their capital structure, we apply a 10.0% cost of capital (CoC).

To determine the EV of ADL-BS, we continue to apply a 10% CoC to three forecast periods. Our explicit forecasts cover our estimates for FY19–28, followed by an intermediate growth period (3% per year company-wide growth between FY29 and FY35) and finally a terminal value from FY36 (1.5% per year growth). Given the firm’s €4.8m in non-current deferred tax assets and based on our discussions with management, our model does not anticipate the firm will pay income taxes until 2023.

After revising our forecasts as described above and rolling forward our estimates, we now derive an EV of €165.8m, versus €159.5m previously. After removing €50.2m in H119 net debt, we now determine an equity valuation of €115.6m (vs €118.8m previously), or €2.94 per share (vs €3.02 previously). We reiterate that our valuation represents our assessment of the intrinsic value of the company at present and is not a ‘target price’ over any forthcoming time period.

We reiterate that ADL-BS’s campus in León has land available to expand existing or build new fermentation facilities (and associated buildings/housing) if and when its fermentation/production demand exceeds current capacity. Our model and forecasts do not consider further fermentation capacity expansion (beyond the 2,400m3 capacity), but if the company pursued an expansion strategy it could add potential long-term upside to our growth and valuation forecasts.