Description

Idea Overview

Grifols is a highly controversial overlevered biopharma turnaround that incurred a lot of debt for acquisitions and suffered during COVID when the cost of plasma collections (its main cost driver) skyrocketed. It’s been targeted by a short seller due to highly aggressive (but legal and disclosed) accounting with parties related to the founding Grifols family. The company’s stock dropped further after they announced that the business is not going to generate FCF in 2024 due to very high investments in growth capex. Some investors have given up on the company, others suspect it’s a fraud.

Despite all these, Grifols is the second largest player in the $38bn oligopolistic, high-growth, high barrier to entry market for blood plasma-derived therapies. Margins are improving as cost of plasma has declined and cost saves are kicking in. The business generated EUR700m+ in FCF in 2020, and can return to FCF generation in 2025 as capex declines and the interest burden is reduced. The recently announced $1.8bn asset sale will be used to delever. Remaining Grifols family members left the C-suite in January 2024, and the first professional outside CEO is due to start on April 1.

Grifols is a real business serving over 800,000 patients a year that has a reason to exist, not a fraud. A recovery to pre-COVID free cash flow generation (even after adjusting for higher leverage), a reduction in capex, deleveraging from asset sales and EBITDA growth suggest 3x upside for Nasdaq-listed Class B shares ADR(GRFS).

Company Overview

There is more detailed business overview on VIC from several years ago. Here is a condensed version.

Headquartered in Spain, Grifols is a biopharma company with a large manufacturing footprint and the second place after CSL in the $38bn oligopolistic market for blood plasma derived therapies.

Human blood is comprised of plasma, a yellowish liquid, and red and white blood cells. Plasma is 90% water, but it also includes proteins such as immunoglobulin (“IG”), albumin and clotting factors. Plasma-derived therapies work with ~20 proteins found in plasma, delivering the missing or lacking proteins and clotting factors to patients who suffer from immunodeficiencies, blood clotting disorders, and more.

While IG is the highest margin protein, driving overall supply, cost per liter of plasma is fixed, and to maximize margins Grifols must extract as many proteins as possible. Grifols’s plasma-derived therapies business is focused on 3 major proteins:
- Immunoglobulin or IG (~55-60% of Grifols biopharma sales): The most important protein, IG treats primary immunodeficiencies (PID), secondary immunodeficiencies (SID), and Chronic Inflammatory Demyelinating Polyneuropathy (CIDP), a neurological disorder, and other rare and autoimmune conditions. The IG market is growing 6-8% due to sicker populations and better diagnostics. While ~90% of the market is intravenous, Grifols is pushing the adoption of its high-margin subcutaneous IG product, Xembify
- Alpha-1 (25-30% of sales)
- Albumin (10-15% of sales)

Although Grifols and its competitors use proprietary formulation methods, plasma-derived proteins are not patentable directly – they occur naturally in human blood. As such, there are no “generics”. Plasma-derived therapies do face competition from small molecules and gene therapy (e.g. for hemophilia), but developing low toxicity drugs to replace blood plasma derived proteins has proven to be a very challenging undertaking. 

Despite the limitations of patent protection, the barriers to entry into the blood plasma industry are very high, largely due to the complexity, capital intensity and high regulation of plasma collection. As a result, there are 3 main players: CSL ($9.3bn plasma business), Grifols ($6bn plasma business) and Takeda ($4.5bn plasma business), with similar concentrations across 3 major proteins. They represent over 70% of the market and are growing in the 10-15% range, likely taking share from smaller players.

To compete, potential new entrants must collect the plasma, get FDA/EMA approvals, and build the purification infrastructure. Grifols alone processes over 920,000 donors annually through its network of over 390 donation centers, 298 of which are in the US. The US has the most liberal plasma donation policies, producing over 2/3 of worldwide plasma and 35-40% of plasma used in Europe. Canada also runs a large plasma deficit with the US (85%), and Grifols is working with the government of Canada to open up a plant in Montreal (expected in 2026). To incentivize donors to give plasma, Grifols pays them $40-60 per “donation.” Donors participate primarily to supplement their income, and donor fees account for ~35% of cost per liter (CPL) of plasma.

During the donation, machines separate the plasma from red and white blood cells, collect the plasma into bottles and return the blood cells to the donor along with saline solution. Plasma is then frozen, stored and shipped to a fractionation plant. Proteins are extracted, separated, purified, tested, packed and sent to customers such as hospitals and infusion clinics. The whole process is highly regulated by the FDA in the US and the EMA in Europe and takes about 9-12 months. Grifols has fractionation plants in North Carolina, California, and Spain, and they are building another one to supply the Canadian market.

COVID was a huge problem for the plasma industry. Potential donors in the US were getting stimulus checks and were unwilling to travel to plasma centers where they could be exposed to COVID. The number of donations dropped, and donor fees had to skyrocket, peaking in mid-2022. In addition, a lot of Mexican donors with B-1/B-2 visas were impacted by the US-Mexico border closing and not reopening until the second half of 2022.

Besides the vertically integrated blood plasma business (“Biopharma” Segment, 84% of 2023 revenues), Grifols operates several complementary businesses:
- Diagnostics (10% of revenue): Grifols sells blood/plasma testing instruments that can screen donations for infections, provide blood type information etc.
- Biosupplies and Other (6% of revenue): Grifols owns two smaller segments that supply blood plasma-derived proteins for use in research and provide consumables such as blood bags

Capital Structure and Org Chart Overview

Grifols has EUR 10.6bn in net debt, including loans, senior secured and unsecured bonds, a quasi-debt instrument from the Singapore sovereign wealth fund and leases. This equates to ~7.2x FY23 leverage based on Company Adjusted EBITDA, but real leverage, after adjusting for non-controlling interests (NCI) is likely ~8.0-8.5x. There are EUR2.3bn of maturities in 2025 (including EUR1.9bn in bonds) and a further EUR3.3bn in 2027.

High leverage is a key investor concern in light of the upcoming bond maturities and lack of FCF generation. However, this appears to be more of an equity concern - the company has been a long-term participant in the credit markets and longer-dated unsecured bonds are trading roughly in line with the single B high yield index (~8%).

Management intends to take care of the upcoming maturities with the proceeds of a $1.8bn asset sale of their China business (Shanghai RaaS) to Haier, which is supposed to close in 1H’24. The buyer has now completed their diligence on the acquisition. Having said that, yields indicate that refinancing should not be a problem in current market conditions, even if it will result in reduced FCF generation. Management has been very reluctant to discuss issuing equity, likely due to the potential dilution to the Grifols family.

Grifols has a dual share structure with A (~62%) and B Shares (~38%) listed in Spain. While B Shares have the same economic ownership as the A Shares, they have a liquidation preference but no voting power. They have generally traded at a 20-30% discount. Grifols has 2 ADR programs for both types of shares: A shares are listed in the OTC and B shares are listed on the Nasdaq under GRFS. There was some talk of collapsing the structure, but that doesn’t appear to be imminent.

The org chart is extremely complex with numerous subsidiaries in which Grifols owns minority and majority stakes. Some of these are fully consolidated, and Grifols doesn’t break out non-controlling interest EBITDA, though it was likely in the €100-150m range (i.e., 10% of EBITDA). Very controversially, Grifols fully consolidates 2 “subsidiaries”, Haema AG and BPC Plasma, that it acquired and then sold to a Grifols family affiliated family office, Scranton Enterprises, in 2018. They are allowed to do that as per IFRS because they have a call option on both subsidiaries. This treatment was fully disclosed and OK’d by KPMG, which just issued an unqualified audit opinion for FY2023. According to management, Haema/BPC subsidiaries generated only ~€30m in EBITDA in 2022. However, this treatment was at the core of the recent short seller report targeting the company and led to stock selling off to its lowest level since 2012.

The founding Grifols family owns ~30% of the business, including ~8% through Scranton Enterprises. Scranton also owns the company’s HQ and facilities in Barcelona (Grifols pays annual rent of ~EUR6m). Beyond the 2 acquisitions and the real estate, as far as we know, there are no other transactions between Grifols and Scranton. Management claims that they understand the need to simplify the org chart and avoid all related party transactions going forward.

Key Thesis Points

1. Asset-sale and performance improvement driven deleveraging

The company is actively selling assets to delever, starting with a 20%/$1.8bn stake in a Chinese plasma company, Shanghai RAAS, to Haier. The transaction is expected to close in 1H’24, with proceeds repaying 2025 bond maturities. Grifols has suspended its dividend until leverage is <4.0x and is contemplating other asset sales.

While there won’t be FCF generation in 2024, the business has been highly FCF-generative pre-COVID. Profitability fell off a cliff during the pandemic due to the cost of plasma collection from mostly US-based collection centers. While cost per liter has started to recover from the high in mid-2022, it takes 9 months to see any margin improvement due to the long processing cycle. Competitors like CSL are yet to fully recover margins, too.

With the cost of human plasma dropping and post-2024 extraordinary capex and restructuring charges (€480m combined) hopefully moderating, the business should be able to generate €500-600m in FCF in 2025 and more after that. We may also see the benefits of the €450m restructuring program, which is supposed to be reflected in the numbers throughout 2024. Current management believes they can generate €2-2.5bn FCF in 2025-2027, though their projections should be taken with a grain of salt.

2. Improved corporate governance?

Following the founding of Grifols in 1909, family members have continued to be large shareholders (with a ~30% ownership today) and to occupy top roles in the C-suite. The company has had very poor investor communications, and, despite going public in 2006, didn’t even hold quarterly earnings calls until Q3 2022, following declines in the stock price. Grifols has a very complicated org chart which takes up many pages in its annual report, as well as related party dealings involving Scranton Enterprises, the multi-family office which includes the Grifols family.

While related party transactions, which have been prominently disclosed in audited financials signed off by KPMG, have raised eyebrows in the investor community for quite some time, in January 2024 Grifols was targeted by a short seller, Gotham City Research. The short seller raised issues that were well-known to existing investors (including debtholders), such as the consolidation of two relatively immaterial subsidiaries that Grifols sold to Scranton back in 2018 but continues to fully consolidate because they have a call option to buy them back. Apart from this well-known issue, Gotham City largely focused on add-backs to Credit Agreement EBITDA, claiming that the holders of €10bn of debt did not know how levered the business really was. In fact, they do, the add-backs such as pro forma cost savings are allowed by the Credit Agreement, and are well-understood. While reporting 5 different EBITDA metrics is a bit much, debtholders in complex capital structures have seen it before.

The short seller report was also factually incorrect e.g., in claiming on several occasions that information was not disclosed while in fact it was and was easy to find, and showing a very limited understanding of how credit markets work, credit adjustments, rating agencies, etc., though they did make valid (and largely known) points about the complexity of the org chart and a multitude of related party transactions. Unsurprisingly, the short seller exited their position after the stock dropped 40%, despite claiming that the equity (with €6bn in market cap) was worthless.

Having said that, the short seller was a wake-up call to the company. In January 2024 the remaining family members, Raimon Grifols and Victor Grifols Deu, departed from their C-Suite and an independent CEO with 25-years of experience, Nacho Abio, was brought in. Management promised to not engage in any related party transactions going forward. Grifols shares the main source of wealth for the Grifols family, and, in the end, they are motivated to make changes to governance to appease the buy and sell-side.

3. Potential upside from acquisitions and capex starting 2025
Grifols spent €1.5bn in 2022 to acquire Biotest AG, a German bioplasma company, which gives Grifols a near-term opportunity to launch two new plasma proteins, fibrinogen and trimodulin, that could lead to structural EBITDA margin improvement. So far, Biotest burns FCF and doesn’t generate EBITDA. However, the potential approval and commercialization of additional derivatives is a free option. Trimodulin is currently undergoing Phase III trials for severe community-acquired pneumonia (sCAP) and TAM is ~$1bn. Regulatory approval for fibrinogen ($800m TAM) is expected to commence in Q4 2024.

Grifols’s current portfolio is heavily levered to just 3 proteins – IG, albumin, and alpha-1 – and given fixed cost per liter, additional proteins could help margins. (Management projected 500 bps + of improvement at the time of the transaction, though that may have been somewhat premature.)

Further, Grifols will see the benefits from the capex program, including the staggered openings of 28 new plasma centers built with Immunotek. While this may be beyond many time an investor time horizon, from July 2026 the network of Canadian plasma centers that will exclusively supply Canadian Blood Services is expected to be fully operational.

Valuation
2025 FCF should improve substantially as extraordinary capex and restructuring expenses (EUR480m in 2024) come down. This doesn’t assume material margin or revenue upside from new protein launches. Excluding the growth capex of EUR370m and restructuring charges of EUR110m (restructuring was not always a recurring expense), FY24 was guided to ~EUR500m. I expect FY25 FCF of EUR600m, with EUR100m increase driven by revenue growth with margin expansion and offset by inventory growth and EUR80m in remaining growth capex. This would imply real net leverage of ~5x, down 3x from ~8x today.

While pre-COVID Grifols traded at > 15x EBITDA, and best comp CSL trades at 19.5x, even using a lower multiple of 13.5x to account for higher leverage implies a 3x upside for the Class B ADRs.

FY25 "real" EBITDA: EUR1.7bn
Multiple: 13.5x
EV: EUR23 billion
- Net Debt: EUR9.2bn (~40% loan-to-value or 5.0x leverage)
Market Cap: EUR13.7bn

• Class A share: EUR21.5 (426m o/s)
• Class B Share: EUR17.2 (assuming a 25% spread between Class A and Class B Share) (261m o/s)
• Class B ADR (GRFS) at 1.08 EURUSD: $18.6

Price today: $6.3/share (~3x upside)

Risks
- Sale of the Shanghai RAAS asset falls through for regulatory reasons. There is no termination fee, which are not customary in the Chinese M&A market. As a result, the company will have to refinance the bonds at higher rates resulting in additional cash flow burn. (While this would be a negative to the thesis in the short-term, the business should be able to refinance 2025 maturities and continue to pay off debt via FCF generation (2027 secured bonds yield < 6%, unsecured bonds 8%)
- Possible competitive threats from small molecule and gene therapies e.g., Sanofi’s recent acquisition of INBRX-101; gene treatments now available for hemophilia A (but likely a long way to go)
- The complexity of the org chart / capital structure is an issue for investors and likely results in a discounted multiple and suspicion. The short seller is right to point out that reporting 5 (!) different EBITDA metrics is a bit high, though not completely unheard of in a complex leveraged situation. (Management promised to simplify the chart and after the short seller allegations said that future transactions would be “plain vanilla”)
- Fraud could be discovered. As a result of the short seller report, Grifols is now under investigation under Spanish regulator, CNMV. Given the complexity of the corporate structure, there is always a risk of negative findings and undisclosed transactions
- Grifols continue to be terrible with investor communications, especially the legacy CFO, who kept contradicting himself and seemed unaware of basic facts about business cash flows on the last call (possibly some of that is due to insufficient command of English)
- The Biotest acquisition has underperformed to date with launch timelines lagging materially

Catalyst