Description

ATR is a high-quality healthcare company with durable revenue streams and best in class margins. Negative impacts from COVID have temporarily suppressed earnings, but I expect a rebound over the next year. On a standalone basis the stock is attractive here, but there’s also a lot of optionality from some type of corporate transaction to reduce the sizable sum of the parts discount. The stock would be a great activist target IMO. Additionally, there’s a ton of PE and strategic M&A in the space. Despite the fact that the overwhelming majority of Aptar’s value comes from its Pharma segment, the company is primarily covered by packaging analysts.

The business

Aptar operates three segments: Pharma, Food + Beverage, and Beauty + Home.

Pharma

The Pharma segment is the dominant manufacturer of nasal drug delivery spray pumps (60-70% market share) and metered dose inhalers (40-50% market share). It’s also the third largest injectable component manufacturer (~10% market share) behind West Pharma and Daetwyler. Apart from these drug delivery device divisions, the Pharma segment contains an ‘active packaging’ division that sells packaging with an embedded desiccant.

The Pharma segment is a fantastic business that earns ~35% EBITDA margins with low capital requirements and grows organically at an upper single digit rate. The drug delivery divisions of the Pharma segment are good businesses because:

• A drug’s delivery device is part of the ‘drug master file’ submitted to and approved by the FDA. Replacing an Aptar delivery mechanism requires a refiling of approval, which is costly, time consuming, and risky as the FDA can rescind its original approval for the drug itself. Once Aptar makes the delivery device for a drug, it’s typically there for the remainder of the drug’s existence, including when the drug goes generic.

• New customers usually take 5-10 years to start generating manufacturing revenue for ATR as the company is involved in the drug development process from the beginning. This investment period acts as a barrier to entry for new competitors, in part because it raises the hurdle for competitors, but also because customers want to go with a provider they know will be in business in 5-10 years.

• The highly regulated nature of drugs and the low cost per unit of ATR’s delivery mechanisms create an environment where price is not a big consideration for the customer. Most of a drug’s cost occurs in the development phase, and once the drug is in production, it has high gross margins. 

• ATR’s ability to deal with the regulatory process rapidly and reliably is important to the customer since a delay can impact development costs (ATR has to track every component through its manufacturing process and submit info on every component’s chemical makeup, among other things). This capability is more important than the price of the delivery device, which is small compared to the price of most drugs.

• The developer’s high margin annuity stream from its drug relies on a manufacturer that has a super-low defect rate since defects can trigger recalls and cause other problems. A complex delivery system might cost only $2-$3 dollars per unit on the high end, which means that it is a low cost but highly essential piece of the puzzle. Developers aren’t looking to pinch pennies here.

• Drug developers prefer to use a manufacturer with a global footprint that can serve multiple markets, each of which has its own idiosyncratic regulatory requirements. The manufacturing footprint creates a network effect for the business, which is something that West Pharmaceuticals talks about frequently as a factor for the injectables market.

The active packaging division makes up the remainder of the Pharma segment revenue and is from the company’s 2018 acquisition of CSP Technologies. This division makes packaging that absorbs particular chemicals that a drug is sensitive to. Active Packaging is providing the packaging for Quidel’s QuickVue at home COVID test, which is ramping up to 50 million units a month on the back of the federal government’s free at home testing initiative. This should be a material bump to division results.

The Pharma segment only contributes ~40% of company revenue which drives the narrative that ATR is primarily a packaging company. However, this understates the proportion of company value from the segment as higher segment margins mean that Pharma is responsible for 2/3 of company adjusted EBITDA and 75% of company EBIT. Pharma deserves a much higher multiple than the other segments, implying that the overwhelming majority of Aptar’s value lies in its Pharma segment. Yet the company is considered by most to be a packaging company and followed primarily by packaging analysts.

Beauty + Home

The Beauty + Home segment is a junky business- it’s a commodity manufacturer of pumps/valves/closures for the beauty, personal care, and home care markets. The segment has been stuck in restructuring limbo since the end of 2017. It achieved impressive top line growth in 2018 but was unable to translate that into EBITDA due to operational issues and higher resin prices. Softer demand negatively impacted the segment in 2019 and then COVID kicked it while it was down.

Despite evidence to the contrary, management continues to insist this segment is a 3-6% topline grower and targets 15-17% adjusted EBITDA margins (it’s sub 11% in 2021…). In a normal environment I’m skeptical they could get to such margins, but in the current inflationary environment it’s simply not going to happen.

Food + Beverage

Food + Beverage is a better business than Beauty + Home but still not fantastic- it makes plastic dispensing closures for food and beverage products. This segment is responsible for innovations like the upside-down ketchup tops and sports caps on water bottles. Management guides this segment to a 6-10% long-term organic growth target and 18-21% EBITDA margin. 

Standalone value

The Pharma segment’s exposure to nasally administered drugs has worked against it during COVID as instances of cold/flu/allergies plummeted due to lockdowns, social distancing, and masks. The timeline of Pharma end market recovery has been drawn out by the introduction of new variants and destocking among customers.

Management’s guidance on the timing of a recovery in Pharma has been poor and investors are fatigued. The stock is down >25% since its peak in May of ‘21. I have $4.35 for 2022 EPS, which puts the stock at 26x. When Pharma gets back to its historical growth rates, I expect the stock to recovery to its three-year average forward multiple of 30x. 

SOTP opportunity

The real juice for shareholders is in the optionality from a corporate transaction. It’s easy to make the case that ATR is undervalued on a sum of the parts basis. 

Based on comps I put Beauty + Home’s value around $1.3B, or ~8x ’22 EBITDA of $160 million. I’m using an 11% EBITDA margin on my ’22 est. revenue, which is well below management’s long-term target of 15-17% margins, below the segment’s pre-COVID margins of ~13%, and below pretty much the entire packaging peer group too. 

I put Food + Beverage’s value at $1B, or 11x ’22 EBITDA of $90 million. I’m using a 16.5% EBITDA margin on my ’22 est. revenue.

Combined, that puts the non-Pharma segments at $2.3B, or ~9x EBITDA. There’s upside to this if the company can get B+H back to reasonable performance.

The Pharma segment is usually comped to West Pharma, which trades at ~31x ’22 EBITDA. Daetwyler is #2 in injectables and trades for ~22x despite half the company’s revenue being from its lower margin industrial segment. Aptar’s Pharma segment probably doesn’t deserve West’s multiple since only a minority of its revenue is from injectables, and the pump/inhaler market doesn’t have as clean of a growth story as the injectable market. I use a wide range of multiples on my ’22 EBITDA estimate of $480 million, but you have to have a pretty punitive view of Pharma’s value to arrive at today’s price.

Aptar’s problems are something that a financially focused activist can actually fix- namely that the stock trades at a huge sum of the parts discount, and capital allocation has suffered from the Pharma segment competing with the other segments for capital.

Unbelievably, Aptar spent $94 million on restructuring for the B+H business in ’18, ’19, and ’20 combined, plus an additional $164 million for an acquisition in ’20. And what have shareholders received for this capital outlay? Beauty + Home revenue in 2021 is going to be lower than it was 10 years ago. 

What’s particularly attractive about ATR from an activist perspective is that an activist wouldn’t be fighting the clock. This isn’t a situation where management is destroying the business and an activist needs to get control before additional damage is done. Rather, ATR’s value continues to grow along with its Pharma division, which is why I think it’s attractive here despite the lack of a catalyst.

Unfortunately, management is in denial about the sum of the parts discount, going so far as to roll out their ‘One Aptar’ schtick at their analyst day. The CEO claims there’s overlap in technology and capabilities between segments that justify the logic of remaining as ‘One Aptar’. Innovation that comes from one segment is used in the other segments. IMO this is a silly argument- there’s a reason that the segments have wildly different financial profiles despite using the same technologies. And to the extent that Pharma needs tech from the F+B & B+H segments, it can license it (guess which segment will retain the superior economics in such a circumstance).

Finally, the board composition is ridiculous. Despite the overwhelming importance of the Pharma segment, only one of the nine independent directors has a background in healthcare. There was a second independent director with healthcare experience, but sadly she passed away and was replaced by the former chief reputation officer of Amway (?). It would be easy for an activist to make the argument that the board is inadequate.

There’s been a ton of CDMO M&A over the years, with both strategic and PE involvement. Given the strength and uniqueness of ATR’s franchise I doubt the company would have a problem getting a reasonable bid if it were pushed to run a process.

Catalyst

Pharma recovery or an activist