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Life Technologies Corp. is a “picks and shovels” type business in the biotech industry. It has three main product groups: 1) molecular systems which produce products used to prepare biological samples and analyze gene functions, 2) cell systems which produce products used to grow cells and analyze cell functions and, 3) genetic systems which produce products used to sequence and analyze DNA.
The business has several attractive characteristics. First, the company sells into diversified end markets including hospitals, commercial applications, biotech and pharma, and academic and government research laboratories. End market uses include forensic testing, molecular medicine, synthetic genomics, food safety, and animal health. Second, the majority of the revenue stream is recurring. Consumables and services make up about 80% of revenues with instruments sales contributing the remaining 20%. Third, the company sells into a diverse geographic footprint. The Americas, which includes North and South America, make up about 50% of sales, Europe 32%, Japan 10%, and Asia-Pacific the remainder 10%. Growth is positive in all markets. Emerging markets, which make up about 10% of revenues, are currently growing at about 30% per annum.
Consensus Viewpoint
The majority of sell-side analysts have included margin and top line growth into their models as evidenced by consensus estimates.
The current share price, however, does not reflect future margin improvement or growth potential. This suggests that the market is either 1) unaware or misunderstands margin and growth opportunity or, 2) is skeptical of the story. As a significant portion of revenue comes from government funded biotech research, perhaps some anticipated funding cuts are already priced into shares.
Investment Thesis
LIFE shares have two main valuation improvement levers: 1) margin improvement and, 2) growth potential.
The creation of LIFE in 2008 through the merger of Invitrogen and Applied Biosciences created an entity with large potential synergies relating to cost reduction. There are several post merger margin improvement opportunities in the areas of manufacturing productivity, supply chain efficiencies, and fixed cost leverage. Management’s goal of expanding operating margins by 230 basis point over the next two or three years seems reasonable given the large redundancies between the legacy Invitrogen and Applied Biosciences businesses. A reading of LIFE’s proxy statement reveals that part of executive compensation is directly tied to ‘synergies’ giving a direct incentive to boost profitability. Using Economic Value Added (EVA) based discounted cash flow models, margin improvements prospects do not appear to be reflected the current share price.
The company makes equipment and consumable products used in the study of genes and proteins. The end uses of these products are growing rapidly, even in slower growth developed economies. LIFE’s products are used in the fast growing fields such as forensic testing, molecular medicine, food and water safety, and synthetic biology. As an example, LIFE products were used in the recent E. coli crisis in Germany. While assuming an above average growth rate in valuation models would seem reasonable, the current price does not reflect a large growth premium. Investors are getting a low cost (or possibly free) growth call option.
Valuation
Using the concept of Earnings Power Value (as defined by Columbia professor Bruce Greenwald in his book Value Investing), we approximate the no growth value of LIFE shares to be between the mid 40’s and 60 suggesting investors are not paying much (if anything for growth) at the current market price.
Our valuation estimate assumes 5% top line growth and continued margin expansion. By 2012 the top line should be about $4 billion with 35% EBITDA margins. Using TEV/EBITDA multiple of 10x with a reduce shares outstanding count of 170 million (management has indicated share buybacks are a cash use priority) we come to an intrinsic value of $70 per share.
