Techne Corp. (Nasdaq: TECH)
Health Care – Life Sciences Tools & Services Recommendation: Buy –Target Price: $77.54 Matt Baumgartner 612-716-8561, baummatt@comcast.net
Stock Price Information: Recent Price (3/11/09): Target Price 52-Week Range: Market Capitalization: Forward P/E 2009 EPS growth Revenue 2008 2009E 2010E EPS 2008 2009E 2010E $50.17 $77.54 $45.38 - $82.92 $1.88 billion 16.78 6.71 %
$257.4MM $268.5MM $289.6MM
$2.64 $2.82 $3.13
TECHNE Corp. (TECH) develops and manufactures biotechnology products and hematology calibrators and controls.
Investment Thesis TECHNE Corp. (TECH) is the world’s leading supplier of cytokine and cytokine-related reagents to the biotechnology research community. These valuable proteins are produced in minute amounts by different types of cells within the human body and can be isolated from these cells or synthesized through recombinant DNA technology. Currently nearly all of the company’s cytokines are produced by recombinant DNA technology. Researchers throughout the world use these reagents to aid in the understanding of cancer, development, endocrinology, immunology, neuroscience, signal transduction, and stem cells to name a few areas of research. Customers are researchers at university labs, biotech/pharmaceutical labs, government labs and diagnostic firms.
Growth Drivers • TECH is a market leader within the global Life Science tools & services sector of the biotechnology industry, with a focus on consumable products. • Sector-leading margins, ROE, & ROA. • Long product life cycles, with compounding revenues, and a recent increase in the number of new products released per year. • Large amount of free cash flow to reinvest into business and repurchase outstanding shares or pay future dividends. • Newly established sales and marketing subsidiary in China in late fiscal 2007. • An increasing demand for reagents for diagnostic assays, most notably the preeclampsia assay currently under development by large diagnostic companies. • Investments in early-stage development companies.
Company Overview TECHNE Corporation (TECH) was incorporated on July 17, 1981 in the state of Minnesota. TECH and subsidiaries are engaged in the development and manufacturing of biotechnology products and hematology calibrators and controls. These activities are conducted domestically through its wholly-owned subsidiary, Research and Diagnostic (R&D) Systems, Inc. TECH distributes biotechnology products in Europe through its wholly-owned U.K. subsidiary, R&D Systems Europe Ltd. (R&D Europe). R&D Systems Europe Ltd. has a sales subsidiary, R&D Systems GmbH, in Germany and a sales office in France. In late fiscal 2007, TECH established a subsidiary, R&D Systems China Co. Ltd. (R&D China), in Shanghai, China, to distribute biotechnology products throughout China. TECH began fulfilling orders for all third-party Chinese distributors from R&D China beginning in the first quarter of fiscal 2008. R&D Systems acquired two subsidiaries effective July 1, 2005. Fortron Bio Science, Inc. (Fortron), a developer and manufacturer of monoclonal and polyclonal antibodies, antigens and other biological reagents, was relocated, as planned, to the Company's Minneapolis, Minnesota facility in the first quarter of fiscal 2006. On July 1, 2007, Fortron was merged into R&D Systems. The second subsidiary acquired on July 1, 2005, BiosPacific, Inc. (BiosPacific), located in Emeryville, California, is a worldwide supplier of biologics to manufacturers of in vitro diagnostic systems and immunodiagnostic kits. These were strategic acquisitions to acquire diagnostic customers that R&D Systems did not currently supply. TECH has three reportable operating segments based on the nature of products and geographic location: Biotechnology, R&D Systems Europe and Hematology. Biotechnology Segment – FY08 - 65% sales, 79.7% gross margin The biotechnology segment consists of R&D Systems' Biotechnology Division, Fortron (through June 30, 2007), BiosPacific and R&D China,
which develops, manufactures and sells biotechnology research and diagnostic products world-wide (Ex-Europe). The growing interest by academic and commercial researchers in cytokines is largely due to the profound effect that a tiny amount of cytokine can have on cells and tissues of the body. Cytokines are intercellular messengers. They act as signals by interacting with specific receptors on the affected cells and trigger events that can lead to significant changes in a cell, tissue or organism. In recent years, TECH has added enzymes and intracellular cell signaling reagents to its product portfolio. Enzymes are biological catalysts that accelerate a variety of chemical reactions in cells. Most enzymes, including proteases, kinases, and phosphatases, are proteins that modify the structure and function of other proteins. Many enzymes have the potential to serve as predictive biomarkers and therapeutic targets for a variety of diseases including cancer, Alzheimer’s, arthritis, autoimmunity, diabetes, hypertension, obesity, AIDS and SARS. TECH currently manufactures and sells in excess of 12,000 biotechnology products. The majority of the biotechnology products are for research use only and they do not require FDA approval. Three immunoassay kits have FDA clearance and they can be sold for clinical diagnostic use. Biotechnology Product Lines • • • • • • Cytokines and Enzymes Antibodies Assay Kits Clinical Diagnostic Kits Flow Cytometry Products Intracellular Cell Signaling Products
R&D Europe – FY08 - 29% of sales, 56.5% gross margin R&D Europe distributes Biotechnology Division products throughout Europe. R&D Europe also provides technical and customer support roles for the European market. The separation of R&D Systems and R&D Europe is due to geographic and time differences for customer service and support. Also,
R&D Europe has the ability to ship product to customers in a timely manner, 24-48 hours after ordering. Hematology Segment – FY08 - 6% of sales, 41% gross margin The hematology segment develops and manufactures hematology controls and calibrators for sale world-wide. Hematology controls and calibrators are products composed of the various cellular components of blood which have been stabilized. Proper diagnosis of many illnesses requires a thorough and accurate analysis of a patient's blood cells, which is usually done with automated or semi-automated hematology instruments. Controls and calibrators ensure that these instruments are performing accurately and reliably. Blood is composed of plasma, the fluid portion of which is mainly water, and blood cells, which are suspended in the plasma. There are three basic types of blood cells: red cells, white cells and platelets. Hemoglobin in red cells transports oxygen from the lungs throughout the body. White cells defend the body against foreign invaders. Platelets serve as a "plug" to stem blood flow at the site of an injury by initiating a complex series of biochemical reactions that lead to the formation of a clot. These fundamental blood components (red cells, white cells and platelets) differ widely in size and concentration. As noted above, hematology controls are used in automated and semi-automated cell counting analyzers to make sure these instruments are counting blood cells in patient samples accurately. One of the most frequently performed laboratory tests on a blood sample is a complete blood count or CBC. Doctors use this test in disease screening and diagnosis. More than one billion of these tests are done world-wide every year, the great majority with cell counting instruments. In most laboratories the CBC consists of the white cell count, the red cell count, the hemoglobin reading, and the hematocrit reading (the percent of red cells in a volume of whole blood after it has been centrifuged). Also included
in a CBC test is the differential, which numbers and classifies the different types of white cells. These and other characteristics or "parameters" of a blood sample can be measured by automated or semi-automated cell counters. The number of parameters measurable in a blood control product depends on the type and sophistication of the instrument for which the control is designed. Ordinarily, a hematology control is used once to several times a day to make sure the instrument is reading accurately. In addition, most instruments need to be calibrated periodically. Hematology calibrators are similar to controls, but go through additional testing to ensure that the calibration values assigned are within tight specifications and can be used to calibrate the instrument. The Company offers a wide range of hematology controls and calibrators for both impedance and laser type cell counters. The Company believes its products have improved stability and versatility and a longer shelf life than most of those of its competitors. Hematology control products are also supplied for use as proficiency testing materials by laboratory certifying authorities of a number of states and countries. Hematology Product Lines • • • • • • • • Whole Blood CBC Controls/Calibrators Linearity and Reportable Range Controls Whole Blood Reticulocyte Controls Whole Blood Flow Cytometry Controls Whole Blood Glucose/Hemoglobin Control Erythrocyte Sedimentation Rate Control Multi-Purpose Platelet Reference Controls Original Equipment Manufacturer (OEM) agreements represent the largest market for hematology controls and calibrators made by the Company. In fiscal 2008, 2007 and 2006, OEM contracts accounted for $7.0 million, $6.0 million and $5.8 million, respectively,
Sales History Historically TECH has averaged 12% organic sales growth over the past five years (see figure below) with relatively no contribution of price increases over the fiver year time period as seen by other competitors. TECH currently targets 9-12% organic growth into the foreseeable future. Figure 1: 5-yr CAGR of sales.
Select Financial Ratios Table 1: Historic ratios Year ROE ROA FY04 FY05 FY06 FY07 FY08 Earnings History Historically TECH has averaged 20% EPS growth over the past five fiscal years (see figure below). Over the last few years, this has been accomplished by management effectively controlling costs, paying off long-term debt and through the repurchase of outstanding common shares. Figure 2: 5-yr. CAGR of earnings. 19.8% 23.4% 24.1% 21.9% 22.4% 19.0% 21.3% 22.0% 20.6% 21.5%
Gross Margin 78.4% 79.4% 77.4% 79.1% 79.5%
Op. Margin 52.01% 55.41% 54.52% 56.28% 56.49%
TECH Business Advantages Figure 3: Compounding product life cycle.
As seen in the figure above (source: TECH annual report 2008), the year of product release is tracked as a “class of 1999” as an example. This figure shows
the compounding of revenues with each year of products released. As seen below in Table 2, 492 products were released in 1999 (mid point in graph). Table 2: New Product Releases
Fiscal year FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 # products released 492 504 567 800 1,015 1,275 1,538 1,390 1,540 1,439 Approx. Total Product Offering 2,500 3,004 3,571 4,371 5,386 6,661 8,199 9,589 11,129 12,568
R&D Systems China In fiscal 2008, R&D Systems established a whollyowned foreign subsidiary (WOFE) in Shanghai, China. Previously, products were sold and distributed by third-party distributors, but management learned of poor marketing and promotion, customers were waiting three to six weeks for products they ordered and a lack of technical service support and training on products. With the establishment of R&D Systems China, product lead times have been significantly reduced and the Chinese market holds very good potential for TECH into the future. Capital Deployment Due to TECH's highly profitable business model and excess cash generation, this enables TECH to buyback common stock and potentially the payment of a regular dividend and the growth of that dividend payment in the future. Share Repurchase Programs In fiscal 2008, the Board of Directors authorized TECH to purchase up to $150 million of its common stock with no specified expiration date. In fiscal 2008, TECH purchased and retired 899,000 shares of common stock at a market value of $58.7 million (~$65.29). Previously, in March 2005, the Company repurchased approximately 2.9 million shares of its common stock under an accelerated stock buyback (ASB) transaction for initial value of $100 million ($34.45 per share). The ASB agreement was subject to a market price adjustment provision based on the volume weighted average price during the ninemonth period ending in December 2005. In December 2005, TECH settled the ASB agreement with a payment of $26 million using cash and equivalents on hand as of the settlement date. Dividends TECH started paying a quarterly dividend of $0.25 a share, which was announced on October 23, 2008.
As seen in Table 2, an increasing rate in product releases was seen in the early 2000s, with stabilization in the 1,300-1,500 products released per year seen in the last four fiscal years. Also, the product class release is tracked (figure not included) and on average it takes four to seven years for the product class to reach fruition and continues steadily growing to a plateau out as far as 10-15 years or more after release. Future of Proteomics When the human genome project came to completion in 2003, the publications showed there are between 20,000-30,000 unique genes (FY07 Annual Report). This in turn can give rise to potentially as many as 100,000 to 200,000 proteins that arise from the normal structural modifications which occur during protein synthesis and expression. TECH offers more than 2,500 proteins and some are of other animal species (i.e. mouse, rat, etc.) As each protein is developed, subsequent products as in antibodies and kits are made for the detection and quantification of the particular protein. TECH offers more than 8,000 antibodies and more than 1,200 kits. Key take away, there is plenty of room for growth in new products for TECH, and as each new protein is developed this could lead to a few antibody products and to another couple of kit products.
Minority Interest in Start-up Companies (<20% ownership) ChemoCentryx, Inc. (CCXI) – 19.3% ownership as of June 30, 2008 CCXI is a technology and drug development company working in the area of chemokines. Chemokines are cytokines which regulate the trafficking patterns of leukocytes, the effector cells of the human immune system. In conjunction with the investment and joint research efforts, the Company obtained exclusive worldwide research and diagnostic marketing rights to chemokine proteins, antibodies and receptors discovered or developed by CCXI. In August 2006, CCXI entered into a strategic alliance with Glaxo Group, Ltd., an affiliate of GlaxoSmithKline (GSK). Under the terms of the agreement, CCXI is responsible for the discovery and development of small molecule antagonists targeting four defined chemokine and chemo-attractant receptor targets through clinical proof-of-concept, at which point GSK will have exclusive options to license up to six product candidates for further development and commercialization on a worldwide basis. In addition, CCXI will receive research funding and will be eligible to earn milestone payments up to, potentially, $1.5 billion, across six product options on the four targets, assuming successful development and commercialization. Furthermore, under certain circumstances, upon an initial public offering by CCXI, GSK will invest in CCXI's common stock. CCXI is the proposed NASDAQ ticker and CCXI has filed for IPO on November 9, 2007. Due to the bleak IPO market in the first eight months of 2008, CCXI withdrew its IPO. GSK has invested an additional $50 million in August 2008 to help fund CCXI’s product development and clinical trials. ACTGen, Inc. – 19% ownership as of June 30, 2008 ACTGen is a development stage biotechnology company located in Japan. ACTGen has intellectual property related to the identification and expression of molecules. The technology covers techniques to identify cellular molecules which are destined to be secreted into tissue fluids
or shuttled to the cell membrane. Such molecules represent an ideal target as disease biomarkers. Hemerus Medical LLC – 19% ownership as of June 30, 2008 Hemerus was formed in March 2001 and has acquired and is developing technology for the separation of leukocytes from blood and blood components. Hemerus owns two patents, has several patent applications pending and has received FDA clearance to market its products in the U.S. In parallel with this investment, R&D Systems entered into a Joint Research Agreement with Hemerus. The research involves joint projects to explore the use of Hemerus' filter technology to applications within R&D Systems' Hematology and Biotechnology Divisions. Such applications, if any, may have commercial potential in other laboratory environments. Nephromics LLC – 16.8% ownership as of June 30, 2008 Nephromics has licensed technology related to the diagnosis of preeclampsia, a disease that affects 510% of all pregnancies, and has sublicensed the technology to several major diagnostic companies (Beckman Coulter, Abbott Laboratories and Johnson and Johnson’s Ortho Clinical Diagnostics) for the development of automated diagnostic assays. Beckman Coulter announced on 8/18/08 that it has bought out its royalty obligations from Nephromics in the U.S. for the preeclampsia test and is currently conducting clinical trials and it expects to release the test in 2H09. As stated in the 2007 annual report, TECH has been working with four diagnostic companies to supply the proteins (control) and antibodies (detection) for the preeclampsia assay on their high-throughput automated systems. Management Thomas E. Oland has been Chairman of the Board, President, Treasurer and CEO of TECH since 1985. Mr. Oland also served as CFO from 1985 to 2004. Mr. Oland holds ~4% of outstanding shares. Gregory J. Melsen (VP-Finance, CFO) joined TECH in 2004 after previously serving as VP & CFO of the PLATO Learning, Inc. (NASDAQ: TUTR), an educational software company, which he had joined
in 2002. Previously, he was Vice President of Finance, Treasurer and CFO of American Medical Systems Holdings, Inc., a publicly traded medical device manufacturer, from March 1999 through July 2001. Marcel Veronneau (VP- Hematology) joined TECH in 1993 as Director of Operations for R&D Systems’ Hematology Division and currently is the VP of Hematology. Risks TECH’s revenues are significantly dependent on sales to research scientists in the private and public sector, and a decrease in research spending could negatively impact revenues. TECH operates in rapidly changing and intensely competitive industries, and TECH may not be able to keep pace with competition. TECH’s Ex-US sales are 31%, which are made in foreign currencies, therefore TECH’s revenues and earnings are affected by fluctuations in currency exchange rates. TECH may incur losses as a result of investments in other companies, the success of which is largely out of TECH’s control.
The PE valuation of $47.86 is based on 2009 EPS of $2.82 and a multiple of 17x, which has been historically higher than peers due to TECH’s strong balance sheet, stable growth, predictable earnings and higher operating margins. Disclaimer I personally own shares of TECH through an ESPP and stock bonus plan for over seven years and I am currently employed by R&D Systems, Inc., the biotechnology subsidiary of TECH. I work in the Cell Culture Development department as a Research Associate/Supervisor in an internal R&D role. I do not have any knowledge of the future financial results (i.e. 1Q09) of TECH. Also, Q109 results are due for release on 10/22/08 before market open, which is the morning after presenting this “new idea” to the Aristotle Fund. Sources www.techne-corp.com TECH annual reports – 2003-2008 10-K SEC filings – 2006-2008 TECH’s 1Q, 2Q, 3Q, 4Q Releases www.chemocentryx.com www.beckman.com
Research Reports
Baird Leerink Swann S&P report Valueline
Valuation My target price of $77.52 is based on a combination of a DCF and several other relative valuation techniques. The 10 year DCF model is based on a terminal growth rate of 3.5% and a WACC of 6.80%, using a fundamental beta of 0.55. The EV/Rev valuation is based on a 3 year average EV/Rev multiple times TECH’s 2009 forecasted revenues. This valuation has some limitations as it is hard to value the minority interests in TECH’s investments in private development stage companies.