Description

Note all financials are in Euros unless noted otherwise

EBITDA 2009: 175.3 mill Euros (First Call Est)

EBITDA 2010: 201.6 mill Euros (First Call Est.)

TEV/EBITDA 2009: 6.7x

TEV/EBITDA 2010: 5.8x

Thesis: 

Gerresheimer AG is a well positioned, highly defensible, economically resilient business with exposure to secularly growing end markets trading at a depressed valuation due to temporary short term issues.  At 23.5 euros, Gerresheimer trades at 5.8x EBITDA with the ability grow equity value >20% for the forseeable future through a combination of organic revenue growth, margin expansion and financial leverage.   Both topline growth and margin expansion is highly visible as new capacity is added in higher growth product areas (ready-to-fill syringes, medical diagnostics, etc) - with effectively pre-sold capacity in higher margin product areas.  Gerresheimer is now past the most difficult comps and headwinds - namely - pharmaceutical company de-stocking, high-end cosmetic weakness, refurbishment of 2 glass furnaces and divestiture of a low-profit business line.  Management has specifically stated that "the turning point has passed" as of the 3^rd quarter, citing the bottoming of demand and the improvement they are seeing across all the businesses.  Over the next 6-18 months the company has visibility into the addition of 5 new lines which will both accelerate topline growth and expand margins (both from the addition of higher margin product and the elimination of startup costs that are expensed).  Despite this visibility - the analyst community appears to be underestimating the operating leverage in the business.  Furthermore the company trades at a substantial discount to it's peers (5.8x ebitda vs. BDX/WST trading at >8x - despite GXI having a faster growth profile).  Finally - over the long run GXI is positioned to gain share as it has the broadest pharmaceutical/biologic packaging line in the industry as pharma companies look to consolidate their suppliers.  The profile of this business is highly suited for a private equity type investor who understand the defensibility and stability of the operations - and this is corroborated by 2 of the largest shareholders being managers with deep private equity experience (former KKR principals), and they have been building their positions.  Using our estimates the upside/downside is 40 euros upside vs. 20 euros downside using conservative estimates:

Upside: 

Assuming 210 euro ebitda in 2010 and applying 8x ebitda (still a discount to the group) - 40 euros is a reasonable 12-18 month target - with the opportunity of steady equity appreciation beyond.

Downside:

Assuming 6x a flat ebitda in 2010 - it is hard to  imagine a scenario where ebitda is flat considering the capacity being added and the annualizing of the weak cosmetic business -  but this would be a 20 euro target.  At these levels the company would be trading at or below private market value.

Business Overview:

Gerresheimer is one of the leading pharmaceutical/consumer packaging companies in the world.  Gerresheimer was a private company until June 2007 when it was taken public by its private equity backers at 40 euros/share.  Since that time they have added a significant plastic pharmaceutical packaging manufacturer (Wilden) and several smaller tuck-in acquisitions and divested an auto-related plastics business (Technical Plastic Systems or TPS) that was much below corporate profitability.  Total revenues should be approx 984 mill euros with 18.5% adjusted ebitda margins or approx 180 mill in adj. EBITDA in 2009.  The business is divided into 4 segments:

1.       Tubular Glass - approximately 31% of total revenue - with highest margins (approx 25% adj. ebitda margin) - this business manufactures borosilicate glass tubing.  They are vertically integrated - and the supply of the high quality glass required for pharmaceuticals/biologics is limited giving them a competitive advantage.  This division manufactures ampoules, vials and syringes (including the fastest growing segment - ready-to-fill syringes).  Importantly - these products are "designed" into product lines by pharmaceutical companies and are part of the approval process.  Therefore - they are typically locked into a product once they are designed in due to the cost and complexity of getting a new product packaging approved.  While growth was impeded by destocking last yr (1-3% growth) - it should accelerate with the return of end demand and added capacity to over 10% topline, and longer term could be high single digit with higher than corporate margins.  They are the distant #2 supplier to Becton Dickinson, but they have been gaining share as pharma companies have looked for a second source.

2.       Plastic Systems -  approximately 30% of total revenue - margins approximately 22-23%.  This business manufactures medical plastic packaging and delivery systems for pharmaceutical, diagnostic and medical device industries.  Some examples of the higher growth areas are for the more sophisticated products (with development costs typically paid for by the customer) - such as inhalers and insulin pen systems.  As for tubular glass - these products are designed into the products and often are a differentiating factor - more convenient delivery/dosing.  This group also manufactures other packaging for liquids and solids including eye-droppers, nasal spray vials, etc. Having only growth 5% in 2009 - this should also accelerate to high single digits with several new product cycles coming on-line (also enhancing margin expansion)

3.       Moulded Glass - approximately 30% of topline - margins approximately 16% in 2009 (depressed for several reasons) - this business manufactures primary drug packaging as well as packaging for cosmetics and food and beverage industries.  The products include amber glass vials, injection bottles, dropper bottles, etc.  This business was hit significantly in 2009 due to its exposure to the cosmetics business - in particular high end cosmetics that got hit very hard during the downturn.  Furthermore margins were pressured due to the rehaul of 2 major furnaces that were taken out of commission for 12 weeks.  Moulded glass also has a facility that was acquired a few years ago that was losing money until recently.  Filling that unit to capacity should help improve margins as well.  Revenues were down 10% and were arguably the biggest disappointment in 2009 as the management had not adequately communicated the risk to high end cosmetics.  This should grow mid-single digits over time, while expanding margins

4.       Life Science - approximately 9-10% of revs and margins of 9%.  This unit is a joint venture with Thermo Fisher (50/50) and is relatively new designed to use the glassware to sell into the life science research market.  It was down 2% last yr - but should return to growth in 2010.

Geographic distribution

The company is predominantly European with 67% of sales in Europe, 27% in the US and2% in China.  They have recently expanded into South America and are growing rapidly in China.  Importantly they are one of only a few companies that can manufacture pharmaceutical quality product on multiple continents - which is important for large pharma/biotech companies that want local manufacturing often.

Customer Concentration

No customer accounts for more than 5% of sales, and no product is more than 2-3% of revenue.

Revenue growth:

Overall revenue growth for 2009 is expected to end up at -2.5 to -3.5% in constant currency.  This is after a complete collapse in the high end cosmetics market, de-stocking in their pharmaceutical business and the shutdown of 2 furnaces for maintenance.  2010 and beyond should prove to be much different as several of the one time items are removed (de-stocking of inventory completed, stabilization in cosmetics, full capacity in furnaces).  In addition, the advantage of Gerresheimer's businesses is that there tends to be relatively good visibility into growth.  There are several significant projects that have either recently come on line or will be shortly - each of which presents an attractive growth opportunity:

1.       3^rd RTF line - the 3^rd Ready-to-fill syringe line was completed and has now been validated by their major customers.  This capacity is now starting to come on-line and will ramp throughout the year with full capacity sometime in Q3 or Q4 of FY 2010.  This will reverse some startup costs incurred in 2009 (total of approximately 1.5 million euros).  This line will increase capacity from 200 mill syringes to 330 mill syringes.  The total revenue contribution should be approx 39 mill euros at full capacity (approximately ½ that amount in 2010, the full annualized amount in 2011).  This will add 12+ mill in ebitda growth over the next 2 yrs.

2.       Plastic pen lines - 2 new plastic pen lines are being added - both starting currently.  These are for insulin pens and are driven by new designs.  They should add approximately 12 mill euros of revenue each at full capacity.  These lines should be approximately 22% ebitda margins at capacity

3.       Diagnostic lines - 2 new diagnostic lines are being added in 2009 - they will ramp slowly but ultimately should deliver approximately 10 mill euros each over the next 3-4 yrs at 22+% margins.

4.       4^th RTF line - as the 3^rd line is filled - the company will undergo a review to determine whether to add a 4^th line depending on customer demand.

The additional capacity helps insure that there will be meaningful revenue growth over the next few years and a positive mix shift towards higher margin, higher growth areas.  Longer term the business should grow >5% topline.

Margin Expansion:

2009 should be a trough margin level for several reasons (1) de-stocking of higher margin products (2) weakness in high end cosmetics (3) one-time expenses with higher than normal furnace overhauls and new line startup costs.  As we move into 2010 - the new capacity is all being added at a much higher margin level than corporate, while divesting the lowest margin TPS business.  As a result 18-18.5% adj. ebitda margins should expand by 100 bps per yr for at least the next 3 yrs -with peak margins exceeding previous peak levels due to mix shift.  They should be able to exceed 20.5% in adjusted ebitda margins on a regular basis

Recent weakness:

2009 was a challenging year however overall revenues are likely to only be down marginally y/y (2.5-3.5% in constant currency).  The company however did not communicate sufficiently the negative impact of the weakened economy that hit both the high end cosmetics business, but also the impact of prolonged de-stocking of pharmaceutical inventories as their customers focused on cash.  Therefore, the analyst and investor community got disillusioned with the story and estimates came down from what were clearly overly-optimistic levels.  With the estimates now re-set - and the analyst community much more skeptical, there is a clear opportunity for the business to outperform over the next few years.  The latest earnings call the company clearly stated that the worst is behind them and that there were signs of stabilization and improvement across the businesses.

Catalysts:

The main catalyst is for the company to start exceeding estimates and show significant revenue growth and margin expansion in the next few years. 

Risks

No recovery in cosmetics

Continued destocking of product

Product issues - if a product that they produce packaging on gets recalled - they could suffer some loss of revenue/ebitda.  No product accounts for more than 2-3% of revenues and no customer accounts for more than 5% of revenues - so the risk is fairly diversified

Estimates/Valuation:

Revenues should grow above normal rates for the next few years with margins expanding.  This would give 210 in ebitda in 2010 (first call is 201.6) growing to 236 mill in 2011.  EPS should be 1.95 (first call is 1.68) growing to 2.52 euros in 2011.  Using a 15% discount to comps and to still generate attractive equity returns - 8x ebitda would imply a 40 euro price target based on 2010 estimates that should grow  12+% in 2011.

Summary :

Gerresheimer AG offers a very attractive risk reward for a highly defensible business in a secular growth market.  Highly visible growth should offer significant downside protection with the opportunity to close the gap with slower growing peers.  It is rare to find such a high quality business trading at a significant discount to fair value.  With upside to 40 and downside to 20 euros the risk/reward appears very attractive, with the catalyst being near term performance exceeding expectations.

*Net Debt is net financial debt as calculated by the company and does not include 154 mill euro pension obligation

**Adj. EPS - major adjustment is for amortization of goodwill from Wilden acq'n.  FY is November.

Catalyst

The main catalyst is for the company to start exceeding estimates and show significant revenue growth and margin expansion over the next few years.  Estimates for 2010 appear to be significantly too low, which should become apparent in the first half of 2010.