This article is authored by MOI Global instructor Frank Fischer, CEO and CIO of Shareholder Value Management AG, based in Frankfurt, Germany.
Frank is an instructor at Best Ideas 2024.
The approach is familiar from the times of the gold rush in California or Alaska: only a few of the gold prospectors were really successful in the end and an even smaller number became really rich. However, those who sold the equipment to the gold seekers – whether shovels or buckets – reliably earned good money and achieved considerable prosperity through steady yields without straining their luck.
Sartorius Stedim Biotech (France: DIM) belongs to the category of bucket and shovel sellers: it is an international provider of products and services that enable biopharmaceutical manufacturers to develop and manufacture medicines. The company focuses on single-use technologies and value-added services.
Biotechnology is a long-term trend for the future – but only a few companies are really taking off to a flying start with their new pharmaceutical products. The risks in this sector are therefore very high. On the other hand, the risks for producers of the necessary equipment can be assessed much better. For them, the success of product developments plays only a subordinate role. It is precisely in this category that Sartorius Stedim Biotech falls with its high-quality single-use technologies, without which no production in biotechnology can be successfully set up.
To understand Sartorius Stedim Biotech’s business model, we need to take a quick look at the drug development processes. Historically, drugs have been made by chemical synthesis, and the result has simply been molecules such as aspirin. These drugs act systemically, i.e. they act over the whole organism to achieve their goal. Undesirable side effects are inevitable. To stay with the example of aspirin: You fight the pain but risk a strain on the stomach mucous membranes.
For producers, the approach is fraught with risks. Many new drug candidates fail during clinical trials because, for example, the side effects are too harsh.
The next generation of drug production
In contrast to synthesis, fermentation can be used to produce much more complex molecular compounds. The advantage is that the active ingredient can be targeted much more specifically to the clinical picture, which means that higher dosages are possible. To put it simply, the core of fermentation is genetically modified cells that expel the active ingredient (i.e. the desired active ingredient) as part of the process.
This process has revolutionized drug manufacturing. The first significant successes were achieved in the biotechnological production of insulin in the mid-1990s. Instead of extracting the drug from the pancreas of cattle and pigs, an optimized E.coli bacterial culture has taken over the production in eight-meter-high fermenters with a capacity of 16,000 liters. These had to be cleaned after each production process. This was expensive and labor-intensive.
And that’s where Sartorius comes in. This is because Sartorius produces so-called single-use containers, in which fermentation can take place. This has three advantages: the production process is cheaper, more flexible and even faster.
Single-use container Sartorius Stedim Biotech
The older steel-tank bioreactors had a volume of up to 20,000 liters. Such sizes may be useful for the production of so-called blockbuster drugs such as insulin. But the requirements are changing. Today, an increasing number of small and medium-sized biotechnology companies are developing more and more specific biologics for the different subtypes of diseases. Due to the increasing individualization of therapies, the addressable group of patients is getting smaller and smaller. As a result, the big cauldrons of the “blockbuster” generation are becoming less and less of an option. Instead, small containers, such as the single-use containers with a capacity of up to 5,000 litres, are an advantage.
There is no question that Sartorius CEO Joachim Kreuzburg played a decisive role in this development. Until entering the new segment of single-use containers, Sartorius was primarily active in the field of precision scales. Kreuzburg is a salaried CEO, but he also owns small shares in the company. The ownership structure is about to undergo a major change. Until now, the family’s shares have been held by a lawyer as administrator of the last will and testament of Horst Sartorius, the grandson of the company’s founder. After that, these shares will pass into the hands of the family. Since it is more than 50 percent, it will have a greater significance. It is then quite possible that Sartorius will be taken over by a competitor such as Thermofisher from the USA.
Natural oligopoly protects against new competitors
The bioprocessing market has historically grown at a rate of 12 percent per year. Currently, the growth rate has fallen to just 10 percent. However, many experts believe that the market will return to its historical growth rate.
At the same time, the barriers to market entry in this innovative business area are very high – and protect the existing suppliers in a kind of natural oligopoly. The most important factor is the approval of new drugs. When new drugs come onto the market, manufacturers also look at the production processes from phase III onwards in the development process at the latest. This is where the different filters and membranes come into play. The production method is approved by the regulatory authority and is not changed after a successful approval.
As a rule, these processes are then protected and completely fixed for periods of 10 to 12 years. And this is exactly where pharmaceutical manufacturers rely on the well-known names in the industry such as Sartorius, Thermofisher or Danaher.
“One stop shop” gives pricing power
If a new supplier, for example in the field of filters, has an innovative product, the probability that the major drug manufacturers will use such a product is still low, because there are still many other aids missing. In this respect, the few producers who have been able to position themselves on the market as a “one-stop shop” are very well protected from new competition. Innovative niche providers prefer to be taken over by them rather than look for competition in the long term. This market structure allows the industry leaders to have very good pricing power and forms an economic moat.
Innovations are now driving this sector and the next forms of therapy, cell and gene therapies, are already in the starting blocks. This area has a growth potential of 20 to 30 percent per year. With a recent acquisition of Polyplus, Sartorius Stedim Biotech is already well positioned to be part of this new basic technology.
Victim of success
The company became a bit of a victim of its own success here. During the Corona pandemic, it was a matter of getting the essential consumables at all for a longer period of time, after the vaccine manufacturers had reduced inventories in the market to almost zero. In the tense supply situation, many pharmaceutical companies built up high inventories in order to be able to continue production in any case. From 2021 to mid-2022, there were above-average growth rates and a special boom in the share. After that, the pendulum swung back: less vaccine was produced and at the same time many pharmaceutical producers still had high inventories. Since Sartorius Stedim Biotech has proven to be a particularly reliable supplier during the crisis, the company is more affected by the reduction in inventories than its competitors.
Recovery after sharp price correction
For the 2023 financial year, management now expects a 19% decline in revenue after two profit warnings. In addition, the 2025 targets have been reduced. This has led to a sharp correction in the stock. However, initial data points show that destocking is coming to an end. At the same time, underlying growth remains strong, precisely because of the long-term trends outlined above. We believe that with the new medium-term targets to be released by management in January 2024, the focus will shift back towards the company’s long-term potential. At the same time, order intake should also improve again with each quarter. The low point here was the third quarter of 2023, according to consistent statements by several management teams in the industry. That’s why we’re betting on a recovery of the stock in 2024.
