Description

EuroAPI – EAPI.FP  

EuroAPI (EAPI) trades for €5.10 per share today, compared to €12.00-€13.00 just before management once again revised guidance downward in early October. The then CEO was fired soon thereafter, and the company is undergoing a strategic review on how best to proceed with the assets. This was the third guidance change in under 12 months, and many investors lost faith in the management team (and rightfully so). User nha855 wrote up EAPI in March, in which they highlighted the spinout dynamics (spin from Sanofi), the business segments, and the other two guidance revisions. Please refer to that pitch for details on that.

            Several months ago, the pitch on EAPI was as follows: a minimally levered spinout that is trading at a big discount to peers like SFZN, with traction in CDMO work (and APIs to a lesser extent) that should grow well and support meaningful margin expansion to peer levels. The discount to SFZN when EAPI shares traded for €12.00 was 40-50%+ on any metric. A big portion of this discount could be attributed to customer concentration (Sanofi is about 48% of revenue, compared to Siegfried’s largest customer representing about 15% of its revenue. However, the Sanofi revenue is diversified across ~95 unrelated projects). Another part of the pitch was that the company was taking a growth-focused approach to capex by investing €510mm over a 4-year period to put more capacity into the high growth, highly differentiated areas of APIs and the higher growth CDMO business (with the best margins of the mix). This would help them diversify away from Sanofi and improve the mix shift of increased exposure to CDMO. To many value investors, the setup seemed particularly attractive.

            Of course, this was wrong. Management had communicated to investors that following the guidance revision in Q1 2023, the numbers were attainable even if there was more pressure in the market. This was completely untrue, as competition and biotech macro put pressure on the business. The management team (CEO and others) were very slow to recognize this, and this business has a lot of fixed costs. Ultimately, it was a recipe for disaster, and the disaster has been had. Now with the CEO gone, the chairwoman has stepped into an interim CEO position and is conducting a review of how to proceed. In the early October guidance revision, the former CEO cited a few key factors: more pressure in APIs from increased competition (in the 45% of API revenue that is less differentiated/more generic), customer destocking in APIs and an unwillingness to order more than what they need on a just-in-time basis, and that 20 of the 40 CDMO projects were facing pauses, changes in scope, or cancellations (with no metrics as to how many are cancelled vs paused). Adj EBITDA estimates for 2023 went from €134mm to €100mm. Adj EBITDA estimates for 2024 went from €170mm to €126mm, with those estimates needing to come down further in our view.

            The story has become that of a deep value turnaround pitch, largely due to the uncertainty plaguing the story. Here is what we do know. The latest that the company will update investors with the go forward plan is the end of February when they report the full year 2023 figures. This strategy will most likely include fixed asset restructuring in the more competitive portions of the API portfolio. The company just announced a new COO yesterday who comes from Bain and TEVA before that. His expertise appears to be more restructuring oriented. We also know that the company has begun fielding candidates for the CEO role, but this placement could take 3-6 months. We also know that the CDMO business growth will not be as robust as expected given the project pauses and cancellations, although the company should be able to still slightly grow this segment YoY in 2024. What we don’t know is the scope of the API weakness heading into 2024 and how quickly this will improve. Putting this all together, it is a challenging operational setup, but we believe the valuation reflects this.

            While the uncertainty of the 2024 setup merits consideration, it is worth noting that these assets are critical healthcare assets to Europe (as seen by France’s planned subsidies in EAPI for the production of essential medicines in 2025) and to EuroAPI’s clients. It is very difficult to switch providers on the API side of the business that is differentiated (55% of API revenue). API manufacturing partners are deeply ingrained in the workflows of drug production, and the process to replace mono-sourced, differentiated APIs takes 12-18 months to complete at a minimum. Further, EAPI is a key provider for B12, peptides and oligos, prostaglandins, certain hormones, and more in Europe. This portion of the API suite is where the restructuring will leave unaffected, and the growth capex not dedicated to the CDMO business will be in these high value API areas. The CDMO business is also highly sticky if programs are seen through (which we are seeing budgetary macro constraints on certain clients now). But their CDMO business is very immature in terms of scale and breadth between early-stage and approved/commercial drugs. As the business continues to win new business and further spreads the project wins between early and late stage, the CDMO business will generate strong margins and grow HSD to LDD for several years following 2024, in our view.

            When we think about the value of this business, we can underwrite a tough 2024 print on Adj EBITDA and FCF and still have confidence that the shares are greatly undervalued. The tangible book value of EAPI is about €1.1B. Remember that we believe there will be fixed asset restructuring that will write down the asset values of at least two of their plants (not full write downs but partial ones for the shuttering of certain manufacturing lines dedicated to APIs). The write downs could amount to one hundred million euros, but we are not sure. Meanwhile, the enterprise value of EAPI is likely to end the year at €600mm with a share price of €5.10, giving them some credit for net debt movement (working capital inflows) in H2 that have yet to be reported. The business is not over levered and is trading at a meaningful discount to tangible book value today. These assets should not trade this way in perpetuity, and the issues at EAPI are not permanent.

            If properly operated, this is a business that should at a minimum be producing €1.05B in revenue in 2025 at 13-14% Adj EBITDA margins. With the likely revisions in the total capex spending (reprioritizing of the projects) and the reduced maintenance capex on the restructured plant lines for generic APIs, we estimate that ~€140mm of Adj EBITDA converts to €45mm of IFRS FCF. After 2025, the capex should fall off by €10mm a year or more on a run-rate basis given the competition of their project pipeline. At that point, a business doing ~€1.13B of revenue operating at 14-15% Adj EBITDA margins (peers are at low 20s%) and growing to high teens margins over time (maybe better), would be generating €164mm of Adj EBITDA and converting €70-€80m of IFRS FCF in 2026. These are conservative estimates if they can get the restructuring done in FY24, but we cannot extend too much credit to them until they show signs of improvement.

            Given the above, we think the shares should be materially higher two years from today. If we believe the shares will trade for a 10% NTM FCF yield on 2026 numbers (peer group trades for a 3-4% yield, with some lower), the share price would be €7.50 at our midpoint FCF estimate, representing a two-year 21% IRR between now and late 2025. This is still conservative if they prove to investors that they can, in fact, drive margins to peer levels and diversify away from the generic API business. Bear in mind that the business is unlikely to be greater than 1X net leverage during this holding period. This is indeed a turnaround and bears all of the turnaround risks, but we believe the assets are strategic in nature and would likely change hands to a private equity sponsor if they fail to improve the equity valuation.

Catalyst

• Strategy update Feb 2024, perhaps earlier
• CEO appointment