Description

Investment Summary

Meridian Bioscience (VIVO) is a $1bn market cap life science and diagnostics company that remains underappreciated after a transformation in business mix and profitability. The business was historically weighted towards the Diagnostics segment prior to 2020, but the company’s repositioned (and higher quality) Life Science segment took advantage of significant share gain and market growth opportunities during COVID, creating an extremely sticky revenue stream from supplying critical components to diagnostic test manufacturers. Life Science now makes up more than 100% of the consolidated TEV while the Diagnostics segment, nearing the end of a multi-year turnaround, represents a call option given its negative implied TEV. At 8.5x 2024e EBITDA, the company trades well below both diagnostics and life science peers. We expect Meridian’s valuation to re-rate closer to peers as confidence in the sustainability of HSD/LDD growth in the highly profitable Life Science business increases, the Diagnostics business starts to reap the rewards of the turnaround and the company posts consistent HSD consolidated revenue growth over the next few years.

Background

Once viewed as an innovator in the diagnostics space, VIVO was run as a dividend yield play and underinvested in for more than a decade before the new CEO (Jack Kenny – not to be confused with the previous CEO Jack Kraeutler) came in starting early FY 2018 (FYE 9/30). Jack Kenny is a veteran in the diagnostics space, with previous experience at Siemens, Becton Dickinson, Danaher and Quest Diagnostics. For reference, Meridian cumulatively paid out ~95% of its free cash flow in dividends from FY 2008 to 2017 under the previous CEO. When Jack Kenny joined, the company faced a number of

headwinds in Diagnostics including competitive losses in the molecular franchise and the expiration of a key patent in the profitable H. pylori Stool Antigen product. Jack cut the dividend entirely in FY 2019 and reinvested in the business, making a couple of key acquisitions to shore up the molecular and H. pylori franchises, building out a new immunoassay platform and turning a lawsuit with DiaSorin into a profitable royalty stream.

While Diagnostics required a multi-year investment to turn the business around, the new team found a gem in the Life Science segment which at the time was run as two separate businesses: a US-based immunoassay reagents (antibodies/antigens) business primarily selling to in vitro diagnostics (IVD) customers and a UK-based molecular (mostly PCR) reagents business primarily selling to researchers. The new management team saw the opportunity to further monetize the molecular franchise’s product portfolio by leveraging the immunoassay team’s customer relationships to sell to the highly sticky and attractive IVD market. They consolidated the two businesses and realigned the sales force and R&D team to focus on IVD manufacturers while fulfilling research demand through distributors. Meridian completed the transition in FY 2019 but faced long sales cycles and a conservative customer base of R&D professionals. However, COVID presented the opportunity for Meridian to show the benefits of the company’s product portfolio as R&D customers scrambled to develop COVID assays. This effort resulted in VIVO winning supply agreements on a significant number of new assays and tripling the Life Science revenue base from 2019 to 2021.

COVID presented growth opportunities for Life Science, but it actually further depressed Diagnostics as non-COVID diagnostic testing declined. The company will likely see a rebound in the demand for its core products over the next couple of years as non-COVID testing demand normalizes, but Meridian still has some work outstanding before Diagnostics completes its turnaround.

Business Overview

Meridian Bioscience is based in Cincinnati, OH and operates out of two segments: Diagnostics and Life Science. The Diagnostics business historically made up the majority of the sales and profits of the company, but Life Science now dominates the profitability mix.

Life Science (~55% of 2022e revenue at a 50%+ EBIT margin)

The Life Science segment produces reagents used as critical raw materials for diagnostic test manufacturing and is broken into two key categories: immunoassay (~30% of revenue) and molecular (~70% of revenue) reagents. The immunoassay business supplies reagents that enable the development of antigen and antibody diagnostic products while the molecular business produces reagents that enable the development of PCR and isothermal molecular assays. Most of the molecular revenue comes from the sale of ready-made master mixes which contain the components needed to make a molecular diagnostic test.

These reagents are sold into R&D departments at diagnostic companies as part of the assay development process, and reagents are selected based on performance characteristics and security of supply rather than price. Reagents are rarely dual sourced. Once the assay goes through clinical trials and receives 510(k) clearance, the supply of reagents becomes a highly sticky annuity stream over the lifetime of the diagnostic test which could be 5-25 years or more. Customers rarely switch unless there is a supply issue. While some reagents can be replaced without a significant regulatory burden, changing out critical components like antigens, antibodies, blockers or master mixes requires customers to revalidate the assay essentially as a new product which could take years and cost millions of dollars.

Competitors in this segment include Thermo Fisher, Roche, QIAGEN, Promega and NEB, among others. Another source of competition is internal production, as large diagnostics companies often produce their own reagents for important assays to mitigate sourcing risk. Meridian isn’t the largest player in the space but has been a leader in innovations like Lyo-Ready, Air-Dryable and sample specific master mixes that allow for direct detection from crude samples, allowing them to win share over the past couple of years.

When COVID hit in FY 2020, the company’s realigned sales force and product portfolios were well positioned to capture demand for critical raw materials used in the development of COVID assays. Meridian was one of the first responders to the crisis, issuing a press release in January 2020 highlighting its molecular product portfolio capabilities for COVID assay development. The company fulfilled demand for IVD customers who were facing accelerated development timelines and had to come out with new COVID tests in a matter of months, not years. As R&D teams tested Meridian’s products for COVID assays and appreciated their functionality, it opened up the opportunity to further sell into customers’ other new assays. Meridian won a significant amount of business over 2020 and 2021, incorporating their products into >100 approved COVID assays and cross-selling into non-COVID assays. These wins caused Life Science revenue to triple from $64mm in FY 2019 to $190mm in FY 2021.

Meridian also benefitted from structurally higher market demand as molecular diagnostics grew in acceptance over the course of the pandemic. Molecular diagnostics providers have significantly increased their installed base of instruments and revenue over pre-pandemic levels. For example, Danaher’s Cepheid platform increased placements by >50% and tripled revenue, BioFire doubled its installed base, Hologic increased its Panther installed base by 2/3rds and DiaSorin doubled its non-COVID molecular revenue. These providers expect HSD to LDD molecular revenue growth moving forward and expect the molecular point of care market (where Meridian is well positioned) to grow even faster.

Given $112mm of Life Science’s $190mm of 2019 revenue was from COVID testing, the key debate in this segment centers around what the revenue base will look like as COVID testing inevitably declines. The resiliency of the company’s non-COVID share gain is demonstrated by the fact that only 5% of major ($1mm+) customers are only buying products for COVID assays while Meridian has been able to cross sell onto non-COVID assays across the other 95%. This share gain will become more apparent as recently commercialized assays ramp up production and as demand for non-COVID testing normalizes. While the peak of COVID revenues is likely behind us, Meridian believes that it has a $150mm, >50% EBIT margin base of revenue and is targeting HSD / LDD annual growth from there as COVID becomes endemic and non-COVID revenues grow. The company is also staking management’s pay packages on the achievement of continued Life Science growth, recently releasing new long-term incentives targeting $175mm of Life Science revenue in FY 2024 at a 50%+ EBIT margin.

Diagnostics (~45% of 2022e revenue currently at breakeven to LSD EBIT margins)

The Diagnostics business produces tests for infectious diseases with focus areas in gastrointestinal and respiratory tests. Meridian focuses on low cost, easy to use diagnostic tests and primarily targets small and medium size hospitals.

85% of 2022e segment revenue is from non-molecular products including ~50% from the company’s H. pylori franchise (stool antigen, breath testing and the DiaSorin royalty), ~10% from its blood lead testing business and ~40% from other rapid testing and stool transport products. The H. pylori franchise has very little competition, especially in breath, and should grow MSD. Blood lead (purchased by the previous management team) will be running at roughly half of normal revenue in 2022 as it works through manufacturing challenges that are weighing on the profitability of the overall segment. This business should fully recover in FY 2023 and should be able to grow MSD from increased testing both domestically and internationally – the previous management team targeted the business as a 10% grower when they acquired it in 2016. The last bucket of diversified immunoassay tests and transport products should grow LSD as +5% immunoassay market growth is offset by a shift to molecular and generic competition.

The remaining 15% of revenue represents the company’s legacy Alethia LAMP molecular testing business which is being converted to the Revogene PCR platform that Meridian acquired in 2019. Alethia’s revenue peaked around ~$40mm in 2015 and was facing significant competitive headwinds in its core GI category from multiplex PCR players like BioFire when the new management team came in. They quickly acquired Revogene, a ready-to-commercialize platform with essentially 0 revenue but 3 FDA approved assays: C. diff, Group A Strep and Group B Strep. These 3 disease states alone made up over 80% of historical Alethia testing, meaning the company could immediately convert existing customers and had the expertise to win new customers. Meridian has placed 359 Revogene instruments as of 4Q21 compared to 1375 active Alethia placements when last disclosed in 4Q17, and we estimate the $19mm of FY 2021 molecular revenue to be split $13mm Alethia and $6mm Revogene. We expect Revogene to ramp over the next couple of years and believe that Revogene’s revenue can exceed Alethia’s prior peak due to the structurally larger TAM in molecular testing.

Note that Meridian is not currently earning direct COVID revenue in Diagnostics. The company does not have its own COVID rapid test (relies on a partner) and has struggled to commercialize a COVID PCR test on the Revogene platform. While Meridian received an EUA from the FDA for its COVID PCR assay in early November 2021, the FDA later announced that the product was one of only a couple to likely fail to detect Omicron, temporarily halting commercialization. This issue will likely be resolved in mid-2022.

While Diagnostics remains a “show me” story until headwinds dissipate, the recovery in blood lead, ramp in molecular and growth in the rest of the business should drive HSD growth over the next two years and MSD longer term. Profitability is depressed in 2022 as the business absorbs costs from the Revogene scale up and blood lead manufacturing challenges, but margins should be able to approach 20% over the next 3 years as blood lead issues are resolved and the company completes new Revogene automated manufacturing lines in Cincinnati and Quebec.

Valuation and Returns

VIVO trades significantly below public and private peers even with Diagnostics at a trough in profitability in 2022. The company trades at 11x 2022e EBITDA, dropping to 8.5x in FY 2024 as Diagnostics recovers and Life Science grows. Publicly traded diagnostics peers trade at 16x while Life Science peers are closer to 22x. Recent M&A transactions have also demonstrated the value of critical reagent providers, with PerkinElmer recently paying ~14x sales / ~28x EBITDA for BioLegend and Abcam paying ~10x sales for BioVision. Meridian’s current TEV implies a negative value for Diagnostics at Life Science multiples far below those observed in the market.

Our returns contemplate a 40% IRR assuming a FYE 2024 exit at a 16x blended EBITDA multiple (18x Life Science and 12x Diagnostics), a discount to both public and private peers.

Risks

The key risk is that Meridian is not able to hold onto Life Science revenue as COVID wanes, a risk that is mitigated by the stickiness of the revenue stream, the registered assay diversity of the company’s major customer base and the ramp up of assays won over the last couple of years. Additional risks include potential failure to successfully commercialize Revogene and continued erosion of the company’s non-molecular diagnostics products

Catalyst

Dissapation of diagnostics headwinds