Description

Uploading my application write-up, updated to reflect subsequent publication of FY22 annual report. 

LONG medmix AG (MEDX SW). Medical/pharma packaging companies are highly rated by investors for their recurring revenues and long-term contracts. A consolidated industry and regulatory approval often tied to a specific packager supports high margins and ROCE. Large players West Pharmaceutical (WST US), Aptar (ATR US) and Daetwyler (DA SW) currently trade at 44x, 28x and 22x NTM PE, respectively.

An ill-timed spin-off, a factory divestment forced by the Ukraine war, overhang from a major Russian shareholder, and a market cap which has dropped below liquidity thresholds for many institutions combine to offer a leading medical packaging company for a normalized PE of just 11x with a strong BS and optionality on several future drug programs. MEDX has firmly entered the “too hard pile” for many investors due to its tangential association with Russia. A precedent to resolve the overhang exists (Sulzer 2018) and investors receive a 3% dividend yield whilst they wait.

Company overview

MEDX is a high-precision dispenser manufacturer with leading positions in several niche markets. Listed in Switzerland, the company reported 2021 revenues CHF 450m and EBIT of CHF 60m. A reasonable investor could use CHF 65m of EBITA for valuation purposes (stripping some transaction costs and non-economic amortization). EBIT divided by tangible assets plus net working capital has averaged 20% for the last 5 years. The two business units are Healthcare and Industrial+Beauty. Geographic revenue mix is 60% Europe, 30% USA, 10% Asia. They have never had any operations in Russia. Their core competency is manufacturing nozzles to dispense pastes in precise doses and ratios, entrenched via long-term relationships with device/drug manufacturers.

Healthcare comprises c55% of group gross profit and is growing faster. Gross margin is c55%. Healthcare serves three sub-markets. Dental (60% global market share in prosthetics dispensers – impression, cement, crown/bridge materials), drug delivery (50% global market share in fertility drug pen-injectors) and surgery (top #3 position in biomaterial delivery devices eg bone cement). Why is a dispenser high tech? Most applications involve delivering a volatile substance either in a precise amount, into an awkward space, or combining multiple substances in a specific ratio to activate them. For example, picture a gun with two separate input pastes, which are forced into a long nozzle with interior ridges to mix the components quickly before they react, with a specialized tip for accurate delivery within a tooth/bone. The medical professional buys the substances pre-packaged and often pre-loaded. Therefore MEDX’s customer is the manufacturer who just wants a solution that works. For regulated devices/drugs, the approval is frequently linked to the specific packaging manufacturer. Lead times for developing packaging are typically multiple years. Changing packaging can often require reentering the certification process. This dynamic is well understood by investors and can be seen in the rich multiples of the aforementioned peers. Dental comprises 2/3 of this division and is mature, expected to grow MSD via vols and some pricing. Drug delivery and surgery are newer products and are growing mid-teens. MEDX is the preferred supplier on several pipeline treatments (fertility, diabetes) which could provide upside to growth. Customers include Merck (for fertility), Sanofi, Ferring, Biocon, Stryker. Base case the division grows HSD/LDD and is margin accretive to group. I assume 10% for valuation purposes.

Industrial+Beauty is c45% of group gross profit with a lower c32% gross margin, given more commoditized products and lack of regulatory capture. Split is roughly equal between the two subsegments. Products include dispensers for industrial, construction and chemical markets. The core product in beauty is a nozzle for high-end mascara (to prevent clumping) with a leading market share in the premium segment. This unit is lower quality vs Healthcare, with lower barriers to entry and some longer-term questions around Chinese competition in beauty (common to many packaging companies). Base case the division grows with GDP plus perhaps scope for some additional pricing via R&D or additional vols via tuck-in M&A. I assume 4% for valuation purposes.

Company history

MEDX was incubated within the Swiss industrial business Sulzer. Initially more industrial focused, Sulzer increased the healthcare weighting via R&D and bolt-on acquisition. In 2021 Sulzer determined MEDX had reached critical scale (CHF 450m revs) and that the medical division would benefit from the ability to independently deploy capital. For example shortly before spin MEDX acquired Haselmeier for EUR 100m or 2.8x revs. Haselmeier owned IP for several drug delivery platforms but lacked the capital or expertise to develop manufacturing at scale.

The MEDX CEO Girts Cimermans was previously at Hoya Vision and formerly at Danaher. He appears intelligent. Short term bonus is linked to revenue growth, EBITDA margin and cash flow. Long term bonus is a 3 year vest linked to revenue growth, EBITDA margin and TSR vs the Swiss index. Whilst the absolute targets are not disclosed, a fair criticism is that the FY23 targets appear to benefit from being struck from the low starting point created by the current dislocation. I would also prefer to see an explicit return on capital metric. That said, the largest weighting in the long term bonus is the TSR, so the management are incentivised to realise value.

In September 2021 MEDX was spun-off to Sulzer shareholders, simultaneously raising CHF 300m in fresh equity to boost free float and provide a war-chest for growth. Equity was raised at CHF 45/share. This implied a valuation of 33x EV/EBIT (inc leases) or 42x PE on YE2021 reported numbers. This was a peak bubble valuation but illustrates how far sentiment has swung today.

Shareholder structure and what went wrong

MEDX’s current issues are linked to the largest (49%) shareholder of Sulzer, Viktor Vekselberg. Vekselberg acquired a stake in Sulzer in 2007 in the open market, ostensibly as a financial investment. He is a Russian national with links to the Kremlin. Vekselberg was placed on a sanctions list by the US in 2018 during the Crimea crisis. At that time Vekselberg owned >50% of Sulzer. Sulzer stock dropped 40% that year. This caused a headache for the Swiss government given Sulzer is a large employer and manufactures various important products. Sulzer was shortly granted an Office of Foreign Assets Control (OFAC) license by the US, which enables companies to continue operating independently of their sanctioned shareholders. As part of this agreement, Vekselberg sold down his stake in Sulzer to below 50%. Payment for the shares was deposited in a blocked US account, to be released at such time as sanctions are lifted. Additionally, dividends associated with his remaining stake are held in treasury on the Sulzer balance sheet. Whilst some investors may object to this arrangement, shares of Sulzer have outperformed the Eurostoxx since YE18.

Vekselberg did not participate in the fresh equity raise at MEDX spin, and therefore got diluted to a 40.5% stake. MEDX shares started tanking in Q1 2022 when Russia invaded Ukraine and Vekselberg was placed on various sanctions lists, troughing at CHF 26 in March 2022. Whilst understandable and doubtless prudent, there was no economic impact to MEDX at that time. Hopes of a Sulzer-esque compromise developed and shares recovered to CHF 34. Then in May 2022 the Polish government levied sanctions on MEDX, freezing their manufacturing site in Wroclaw, Poland. This was a major factory for MEDX, representing an estimated 10-15% of group EBITDA (albeit via the Industrial+Beauty segment only). This was a direct economic hit to MEDX and the shares have declined ever since to the current level of CHF 17.50/share. It is notable that Poland is an outlier in Europe for applying such sanctions.

Going forward

Whilst hairy, I believe it is timely to revisit MEDX with the shares down 60% from spin. The company has chosen to fully divest their Polish assets, and have acquired a replacement site in Valencia, Spain for 2/3 of lost volumes, with the remainder covered by expanding capacity at other sites (in the US, China, Switzerland). They have recorded a CHF 25m write-off for the Polish assets, some of which may be recovered in the event of sale to a new owner (currently being explored). Acquisition of the Valencia site plus initial capex will cost CHF 40m. I estimate the new capacity in China will cost CHF 20m, which is partly normal course capex and partly replacement of lost Polish capacity. Additionally, management have stated they will incur CHF 15m ramp-up opex to adjust to the new production scheme.

MEDX announced the Poland exit on 11 Jan 2023, issuing an accompanying profit-warning implying c10%/20% cuts to near term consensus EBITDA and EPS. The profit warning is driven by a mixture of lost revenues via missing Polish production and relocation costs. Realistically, relocating production to a mixture of Spain, US and China will likely result in a permanent increase in operating cost vs low-cost Poland.

The situation is a mess, but we now have all the ingredients we need to reprice the share for the future. Replacements have been found for lost capacity and cost roughly quantified.

There is a downside risk that other countries could decide to adopt similar sanctions to Poland. I will not get into a discussion of politics, other than observing firstly that the Polish stance on the Ukraine conflict has been somewhat of an outlier. And secondly, that the world needs to source packaging for 60% of its dental prosthetics, 50% injected fertility drugs etc from somewhere. The Poland site differed from MEDX’s other sites in that it produced the majority of the more commoditized products in Industrial+Beauty. So it was the easiest for society to turn off.

In my view base case is that MEDX will be allowed to continue operations under the OFAC license inherited from Sulzer. Management have confirmed this licence came across with the spin. Vekselberg’s ownership is now passive and he receives no dividends. I believe that if the situation were to deteriorate, the Swiss government would find a pragmatic solution as they did with Sulzer in 2018 (they could force Vekselberg to divest the shares in some way and hold them in trust, or frankly just seize them). My understanding is that Vekselberg has limited de facto voting input (his Sulzer Board representatives “abstained” on the vote to acquire some of his stake in 2018), so potentially the company could explore selling the going concern out of the current shareholding structure if things get really spicy (albeit I am not a lawyer and I hope it never gets to that point).

There is an upside risk that the Ukrainian conflict is resolved at some point.

An interesting datapoint is the recent rights issue by German travel operator TUI. TUI’s largest shareholder is another oligarch, Alexei Mordashov, who had a 30% stake. On 24-Mar TUI surprised the market by pricing their long expected rights issue much lower than expected. Assuming all non-sanctioned shareholders exercised their rights, the effect is to substantially dilute Mordashov (to c11%) to the benefit of other shareholders (relative to pricing the issue more richly). MEDX does not need to raise equity and is a Swiss rather than German company, so the comparison is only tangential. But TUI is an interesting example of a European Board getting comfortable with taking a deliberate action which is clearly prejudicial to their majority sanctioned Russian shareholder.

Valuation

As stated the situation is hairy, but so is the current valuation. Using the aforementioned growth rates and margins (before the Poland debacle) we could have pencilled CHF 80m and CHF 65 of EBIT and net income for 2023, rising to CHF 110m and CHF 90m in 2026.

Illustratively, I will assume the Industrial+Beauty segment permanently loses half the sales associated with the Polish site due to customers who never return (total loss in FY22 is estimated to be 9% of divisional sales) and permanently sees 5% margin compression (equivalent to the opex ramp costs continuing indefinitely). This would imply CHF 90m and CHF 70m of EBIT and net income in 2026. For comparison, brokers UBS use more aggressive assumptions and currently model (post profit warning) CHF 89m of net income in 2026.

A current share price of CHF 17.50, shares exc treasury of 40.9m, CHF 167m of EV adjustments (including leases, pension and provisions – simple financial net debt of CHF 85m) and an estimated CHF 45m of remaining relocation cash outlay, and assuming all free cash is distributed as dividend (for ease of modelling) gives us the following:

Current – Equity: CHF 716m and EV: CHF 928m

YE25 – Equity less free cash received: CHF 544m and EV: CHF 756m

Taking the 2026 P&L as the NTM at YE25, this would put MEMX on 8x EV/EBIT and PE using my stressed case. If they are successful in fully offsetting the impact of the factory relocation, the figure would be 5-6x.

Under this scenario c65% of the business would comprise the Healthcare unit. I assume capex ex relocation of 9% of sales (historic average 8.5%, FY23 guide 9%, mid term target 7-8%). Net income and normalized equity FCF are equivalent in this analysis (w/c investment requirement is minimal so I ignore for simplicity).

I believe Aptar is the most relevant peer, given a similar mix of healthcare vs beauty/other. Aptar currently trades on 28x consensus NTM PE.

A target multiple of 20x for MEDX in Dec-25 (on the stressed NTM net income of CHF 70m in 2026, plus accrued FCF) would imply CHF 39/share for a 34% IRR. 15x would imply CHF 31/share for 22%. A “breakeven” 8% IRR requires 10x PE. This is below the 11x where the share is currently trading on a normalised basis (likely c15x 2023E on a reported basis inc relocation costs).

I believe by Dec-25 they will have found a solution to their current shareholder overhang or taken steps to realise value.

In the meantime, the company has committed to pay a dividend of not less than CHF 0.50, targeting 50% of net income on average. This equates to a c3% yield while we wait. 

Catalyst

Resolution of Ukraine conflict, or resolution of shareholder overhang.

Successful relocation of operations.