Description

Vistin Pharma (VISTIN NO Equity)

Thesis summary:

Vistin Pharma is a is a producer of active ingredients and finished products for the pharmaceutical industry ("API's")and a forgotten spin-off of Weifa ASA. It is covered by only one analyst and gets very little attention despite an interesting story. The main reason for this is its small size and low liquidity in the shares, it has a market cap of only about 400 mNOK. In addition there has been limited visibility into historical figures since it hasn’t been a stand-alone company for long, making it difficult to assess Vistin's historical performance.

It has also suffered some temporary problems with some of the production equipment leading to a recent profit warning, in my opinion irrelevant to the longer term investment case. Vistin is in the process of expanding its metformin production capacity, which over the next 5 years should help the company achieve about 30% top line growth, a doubling of normalized EBIT margins (this year's EBIT margin and EPS are depressed due to an unexpected reactor shutdown in november) and 220% EPS growth compared to FY16 numbers. It is run by able, experienced management and has some interesting names among its largest shareholders. It has no debt today and will have only modest debt after the capacity expansion. Insiders own just shy of 20% of the company, and a very savvy investor (Oystein Spetalen) effectively controls the board.

Business quality and moats: It is not the moatiest of companies, but relationships with customers in its lines of business takes some time to cultivate, and best practices in API production are probably not completely straightforward. Also, there are clear barriers to entry in its opioid businesses because of heavy regulation. All in all, I think this is a good, profitable business capable of normalized ROE in the low twenties, currently trading at a really great price.

I believe Vistin shares are worth 44 NOK, almost twice the current share price of 22.90. 

Risks

Risks include (but are certainly not limited to): loss of big clients, loss of the important CMO contract with Weifa, FX risk, cost overruns on the expansion and unforeseen difficulties in placing metformin volumes at favorable prices. Continued price pressure in opioids is also possible. Valuation risk: Vistin trades at only 11.5x my EPS estimate for 2017, well below peers even adjusting for the small size of Vistin. So I view valuation risk as very low. Even if the expansion efforts are not entirely succesful, an earnings and multiple contraction from here is unlikely in my opinion.

Risks relating to the controlling shareholder(s): The largest shareholder effectively controls this company. Investing along side a great investor is usually a good thing. However, there is a risk that future M&A and/or capital raises can be done on terms that are not beneficial to a passive minority shareholder. I view this risk as low right now since the company is well capitalized, but this may change in the future and is likely not something that will be possible to see coming in advance. We have been involved in several of Mr Spetalens companies and our experience is that most of the time the market chooses to respond favorably to his plans, making possible dilution a risk worth living with.                  

Historical share price development

Company facts:

Vistin Pharma (VISTIN NO) is a spin-of of Weifa ASA (WEIFA NO) and was listed on Oslo Axxess in 2015. Vistin is a producer of active ingredients and finished products for the pharmaceutical industry. Its clients are both big pharma companies and generics companies. It has produced its main product metformin since 1969 and codeine API since the 1950s. It’s also a contract manufacturer of solid dose form tablets (Ibuprofen, Paracetamol and opioids). It is headquartered in Oslo and operates government approved (including FDA approved in the case of Metformin), modern production facilities in Kragerø, Norway. Its key geographies are Norway, Italy, Switzerland, Germany, the UK and Japan (Japan is an important growth market going forward) but Vistin is present in 40 countries.

Historical timeline (source: company)

Main business areas:

Metformin(B2B): 44% of revenues. Revenue CAGR 2011-2015: 13%. https://en.wikipedia.org/wiki/Metformin

Vistin produces about 8% of the global supply of Metformin, a drug used as first line treatment of diabetes type 2. Vistin is the leading independent producer of Metformin globally. It is one of only two producers in Western Europe. Revenue CAGR in this segment has been 13% for the last five years. Vistin produces three types of Metformin, bulk, which is dry powder, DC, a pretablet granulate form, and tablets (ready for consumption). Historically, Vistin has been good at becoming increasingly cost efficient, supposedly COGS/kg in Metformin has fallen from 40 NOK/kg in 2008 to NOK 28 in 2014 (the most recent numbers I have seen). I believe they will continue to improve in terms of cost over time, though not at this pace. The company does not break down its COGS by segment, I have tried to model what I believe are reasonable assumptions in terms of total COGS increase going forward.

The company initiates long term strategic agreements with key customers and is the only company today with a listed DMF (drug master file) with both the FDA and Japanese authorities. Vistins advantages are, according to the company, an ability to deliver quickly and reliably (within 24 hours), its customer support and customized products and services and relationships with regulators. In my opinion, Metformin is to an extent a commodity product, but there are some qualitative differences (homogeneity, flow properties). But Vistin’s location in Western Europe and reputation for reliability and quality is probably an advantage vs lower cost, lower quality producers in China or India. In terms of cost the company is about in the middle of the cost curve today, but claims new efficiency programs should move it to the 25th percentile in terms of cost within a couple of years.

The most interesting aspect of Vistin’s Metformin production is that it could be doubled. First of all, there should be room to add about 500 metric tonnes of capacity from today’s 3000 mt at little additional cost. Secondly, the company has after an extensive feasibility study over the last year decided to add an additional 3000 mt of capacity. This should be pretty easy since there is space in their facilities for an extra reactor. The cost of the capacity expansion is estimated at about 120m NOK to be spent over 2017 and 2018. It will be financed through existing cash (the company is debt free today), cash generation in the interim and bank loans. It is believed to be EBITDA accretive already in the first year, though I think full sale of the increased capacity is some years away. The engineering studies are done and the project was initiated in September 2016. The underlying fundamentals for the Metformin market look pretty good, since demand for Metformin is believed to grow in line with diabetes long term. (From 1980-2014, the WHO says diabetes patients globally grew by 4.1% per year). Currently the Metformin market grows faster, supposedly at about 7% per annum.

With the capacity expansion in place, Vistin will become one of the largest manufacturers  of Metformin in the world. The market is believed to grow at about 3000 mt annually, more or less the same as Vistin’s capacity increase. Vistin will probably be even bigger in the premium market which comprises only 13500 mt/year and about 55% of Vistin’s sales (this fluctuates). Vistin’s strategy has been and continues to be to increase its marketing efforts toward the high value or premium segment. In the short term, new volumes may be more difficult to place there, but 60% should be possible over time.

This combined with the overall increase in volumes will likely have a profound impact on the total revenues from Metformin over time and the overall operating margin of Vistin (they should double by 2020). I first modeled out the high/low value split and exact tonnage increase per year in Metformin HCI from the new capacity, but ultimately decided it is likely a fruitless excercise (predictability is probably low, and the company does not disclose the split or realized prices per product group). Instead I choose to assume that they can increase revenues by at least 10% per year in total Metformin until 2020, which I think is highly likely. The outcome might very well be more positive. After 2020 the revenue growth probably tapers off relatively quickly, and I have gone with a growth of 7.5% in 2021 and 5% in 2022 at the far end of my forecast period.

From Vistin Pharmas Q3 2016 presentation on the capacity expansion:

The diabetes market is still growing at a healthy clip it seems (graphic from Reuters):

Opioids (B2B): 17% of revenues. Revenue CAGR 2011-2015: 9%.

Vistin produces both codeine phosphate used in syrup and analgesics and pholcodine (syrup only), and has about 6% global market share in a 400 mt market. In Pholcodine it has about 12% share. In this segment, barriers to entry are higher than in Metformin. Getting permission to produce opioids is naturally a bigger deal given its addictive properties.. The business of opioid production requires permission by the International Narcotics Control Board, and there are strict import quotas in many markets. Almost half of the global market is closed, and domestic monopolies are not uncommon. This means factors like production costs are less important. Western countries will thus probably continue to control this market. Most of the growth however, comes from emerging markets. North America is the largest market, but this is off limits to Vistin for regulatory reasons.

There has been strong growth in global opioid consumption over the last couple of decades, but this seems to have leveled off in recent years. I can’t find any particular reason to believe it will re-accelerate, and frankly I think that’s kind of a good thing (the Oxy-epidemic in the US for example is scary). That said, there is no reason to believe that consumption will decrease much either.

Global opioid consumption 1994-2014 (source: INCB)

There has been some price pressure on opioids recently because of rich poppy harvests, but as volumes of planted poppies have come down again, this should abate in the second half of 2017. I expect revenues in this segment to rise 3% per year due to inflation and a positive mix shift toward more end-product manufacturing (pills e.g which today represent about 37% of opioid revenue and carry higher margins than bulk production. They are supposedly also less difficult to import for pharma companies than bulk product.

Vistin’s advantages in the opioids business are mainly the high barriers to entry. There is little reason to believe they are more cost effective than competitors since many of them are integrated from poppy to pill so to speak, and Vistin is not (they must buy raw material inputs, which they do on long term contracts. On the bright side they recently cut their input costs by about 30% through new agreements). So costs are basically fixed going forward while the sales prices of the finished products could fluctuate.

I basically view this as a stable business for Vistin (as evidenceed in the quarterly figures below) and I don’t expect this segment to be a major growth engine for the company going forward. That being said, the company claims to see an increase in demand from key clients in some markets and there could be upside from a possible 25% capacity increase as well.

Sales volume opioids by quarter

CMO: 39% of revenues.

Vistin is the main supplier of prescription codeine pills, Ibuprofen and Paracetamol tablets for Weifa ASA. Weifa markets these drugs under the brand names Paralgin Forte, Ibux and Paracet (the latter two have 88% market share in Norway). This agreement expires in 2020. The stock market seems nervous about the renewal of this agreement, since Weifa could get better prices elsewhere. I think they’ll renew, but at a somewhat lower margin. Weifa has stated repeatedly that it depends greatly on timely and dependable delivery and Katrine Gamborg Andreassen, the CEO of Weifa is a board member at Vistin. They’re likely to come to an agreement in my view. Details on the CMO contract from page 26 of Vistin’s listing prospectus:

Vistin is also instituting a cost savings program with 20m savings potential which should partially offset the probable margin contraction on the new CMO contract, but it remains to be seen how much weaker the profitability will be going forward. Over time I expect Vistin will get some new clients in the CMO division as well but I’m not including this in my revenue estimates going forward despite Vistin’s claims that this market is growing at 10-11% per year on a global basis.

Valuation:

Experience has taught me that all my estimates will prove to be wrong, the question is only to what extent, but I think these assumptions are pretty reasonable. The WACC assumes about 50m in IBD which may be a little on the careful side in the long term, costing the company 5% pre-tax. I use 9% for the cost of equity (approximately the inverse of the estimated 2017 EPS multiple) arriving at a 8.4% WACC. Note that even if I had used 10% as the discount rate, the stock would still be undervalued by well over 30%. My estimates imply a 2019 EV/EBIT of roughly 12x or a P/E multiple of 14x (I assume it will take 3 years for the market to agree with me on the value of Vistin). I think that seems achievable. The upside to the DCF value is 93%, very good for a business with some defensive characteristics. That translates to an expected CAGR of 25% until 2019e. In addition I think we can expect dividends of about 2.5-3% for 2016 and 4-4.5% for 2018. I like the asymmetry here: With the current P/E around 11x, I think the risk of a large loss is limited even if my assumptions should prove too optimistic.

I assume the company will have payout ratio of about 50%. Knowing the largest owner is a man who understands capital allocation, buybacks are a clear possibility if the share price should remain depressed. But I'm not counting on it, and the stock is fairly illiquid as it is.

Management and board (most of these people are Spetalen allies).

Ole Enger, Chairman

Mr. Enger has extensive industrial experience and is currently the Chairman of the Board of REC Solar ASA. Mr Enger was previously the CEO of REC ASA, a position held from April 2009. Prior to REC ASA, Mr. Enger was the president & CEO of SAPA AB, and he has also held the position as president & CEO of Elkem AS and Executive Vice President of Elkem AS. In addition, he has lead Norsk Hydro’s Bio-division, including the development of Omega 3 products for both pharmaceutical and food applications, and has been the COB of Borregaard, a producer of lignin, cellulose and fine chemicals (some for the global pharmaceutical market). He owns about 144k shares.

My comment: My principals has extensive experience with O. Enger. He is as far as I can determine honest, hard working and competent.

Kathrine Gamborg Andreassen, Board member

Ms. Andreassen is the CEO of Weifa ASA. She joined Weifa in August 2012, as Vice President of Weifa’s Consumer Health business area, and was appointed CEO from June 2015. Ms. Andreassen is an experienced marketing professional and she has held several top management positions within the FMCG, food and health business (Orkla, Bakers).

My comment: Kathrine has impressed us in Weifa, she is an asset to the board and we expect she will stay on at least as long as Weifa and Vistin cooperate on CMO production.

Einar J. Greve, Board member

Mr. Greve works as a strategic advisor at Cipriano AS. Mr. Greve has previously worked as head of the legal department of Oslo Børs ASA, as partner at Wikborg Rein & Co and as Partner of Arctic Securities ASA. Owns 375k shares in Vistin.

Ingrid Elvira Leisner, Board member

Ms. Leisner has previously worked as Head of Portfolio Management for Electric Power in Statoil Norge AS. She also has a background as a trader of different oil and gas products in her 15 years in Statoil ASA. Owns 100 000 shares in Vistin.

Øystein Stray Spetalen, Board member

Mr. Spetalen is originally a chartered petroleum engineer from NTNU. Today Mr. Spetalen is Chairman and owner of investment firm Ferncliff TIH AS. Self-made billionaire investor, one of the best in the Nordic region over the last 30 years. The guy’s brilliant. Spetalen and known associates like QVT control > 25% of the shares in Vistin and most of the board members including the COB have been Spetalen allies for some time at other companies. So this board is in my opinion clearly controlled by Spetalen. This is for the most part a good thing, I think.

CEO: Kjell-Erik Nordby

Mr. Nordby has been CEO of Weifa since February 2009, and as of June 2015 CEO of Vistin Pharma. He was Vice President Business Development at Photocure, a Norwegian biotech company. Previous experience includes several years at Alpharma, a leading international generic pharmaceutical company listed on NYSE. He held several top management positions in the company including Head of S&M North Europe Region and as Senior Director API Business Development. Owns 200k shares.

My comment: Mr Nordby receives a great deal of praise from our industry contacts and is reputedly a very competent and driven CEO. On the negative side, we wish he owned more shares.

CFO: Gunnar Manum

Mr. Manum joined Weifa as CFO in August 2014, and as of June 2015 as CFO of Vistin. He previously held the positions as CFO at Aqualis for 7 years (means Spetalen knows him well). Prior to that he was a corporate finance advisor at SHB Capital Markets for 8 years. Owns 104k shares in Vistin.

Qualitative assessment:

Proprietary checklist score: 76% (= «solid company, good opportunity»).

Shareholder overview (top 10):

1. Strata Marine and Offshore 1.965m 12%

2. QVT Financial 1.869m 11%

3. Storebrand ASA 1.553m 9%

4. MP Pension 0.878m 5%

5. SEB 0.839m 5%

6. Solan Capital 0.787m 5%

7. Humle Asset Management 0.779m 5%

8. Holberg Funds 0.771m 5%

9. Ferncliff 0.582m 3%

10. Dukat AS 0.547m 3%

Links of interest: Vistin IPO prospectus and Weifa Information Memorandum. Lots of detail on the different business lines etc.

http://www.vistin.com/getfile.php/131899/Documents/PDF/Prospectus%20-%20Vistin%20Pharma%20150522.pdf

http://www.weifa.no/getfile.php/131530/Filer/Weifa%20ASA%20Information%20Memorandum%20020615.pdf

Catalyst

Possible catalysts:

Capacity expansion and earnings growth

Increased analyst coverage