Description

Emergent Life Sciences Platform Accelerated by Sale of Semiconductor Division

1) Thesis Description

Azenta Life Sciences (AZTA) is a cold-chain biological sample storage/management solutions and genomic services company, previously the Life Sciences segment of Brooks Automation (BRKS). The life science industry’s next evolutionary step is towards more individual-based biologic, cell and gene therapies (CGT) as well as mRNA vaccines. Increasing use of live samples for research and treatment with these newer therapies, necessitates the use of large-scale cold storage and detailed chain-of-custody logistics, which is driving research organizations, biotech’s, and large pharma companies to increase use of automated equipment and outsource sample storage as well as related services, to focus on scientific breakthroughs. Following the success of several gene therapies and now mRNA vaccines during the pandemic, an acceleration has occurred in both the research funding and regulatory environment for these therapies which should result in a rapidly growing and less-risky industry environment going forward. Azenta, which has sold its semiconductor segment at an advantageous time, is poised to claim a critical position at the leading edge of the life sciences industry as it not only stores/manages more biological sample sets but also provides sample-related services such as gene sequencing, generating insights for customers while freeing up researcher capacity/capital.

The thesis is as follows:

1)      At the current price of $94.81/share, the market assumes ~9% revenue growth per annum (~50% below its three-year average), and no margin improvements at the current valuation multiple of ~25x EV/EBITDA. Valuation ranges from $89/share to $481.75/share over five years, with scenarios ranging from little growth/no margin improvement to ~25% market share of the life science sample storage/genomics services markets.

2)      An opportunity is available due to several reasons:

a.       Sale of Azenta’s Semiconductor division removes mature but growing business and reveals the emerging strength of the Life Sciences division, while triggering a modest shift in the investor base. Brooks’ expansion outside of the semiconductor market started in the early ’10s as the company sought industry exposure exhibiting more favorable dynamics and yet an overlap with its existing capabilities, ultimately landing on the life sciences industry. As of today, the Life Sciences segment is of equivalent size to the semiconductor segment (~$500M revenue). The Semiconductor division supplies fab equipment manufacturers, and while exposed to favorable trends, has a lower return/valuation profile (8%-12% per annum revenue growth, 50% gross margin, 20% operating margin, normalized 15x-20x EV/EBITDA) than the Life Sciences division (20%+ per annum revenue growth, 55%-60% gross margins, 30%+ operating margins, normalized ~30x EV/EBITDA). Additionally, the combination of semiconductor and life science exposure naturally led to a split of the investor base with either side likely not properly valuing the other division. With management’s capital allocation priorities towards life sciences, the sale of the semi business for ~$3B (~19x ’21 EBITDA, closing 1H/22), yields the best possible outcome as opposed to the previously announced semiconductor spin-off. The ~$2.4B in after-tax cash from the sale should not only accelerate Azenta’s growth in the life sciences market as management continues to add to its exemplary M&A track record, but also reveal the full strength of the remaining business necessitating an upward reassessment in its valuation. This revaluation is further amplified by the shift in the investor base to those more familiar with a life science pure play.

b.      Market participants underestimate management’s ability to affect a transformative Life Sciences acquisition with almost $3B in cash largely from the Semi division sale. Since ’11, the leadership team at Brooks has allocated ~$840M towards the Life Sciences division (plus ~$160M in total R&D over nine years), and at the current market price implies a ~5x return on investment (~17.5% IRR over 10 years). The 14 life sciences acquisitions to-date have combined to offer sample storage management/services under one roof, a value proposition highly sought after by customers. However, the company’s latest acquisitions, Genewiz, one of the top 10 genomics servicing businesses, point to an evolution towards CGT, mRNA-related services as opposed to simply just storage management equipment/services. Going forward, we anticipate Azenta to affect a large-scale or multiple mid-sized transactions targeting service providers to researchers and clinicians utilizing these leading-edge therapies, which are exhibiting growth trajectories (20%-40% per annum) even more superior than the base sample management business (15%-20%). Further, we anticipate that any acquisitions toward their sample storage business would be small in nature and only incrementally strengthen its existing advantages. Pro forma, cash represents 35%-40% of the company’s ~$7B market cap, and with less than $50M in debt the company’s balance sheet is substantively underlevered. With just short of $3B in total cash (plus potential leverage) to allocate towards the leading edge of the life sciences industry and a long track record of accretive M&A amounting to a ~5x ROI, Azenta can massively expand on its newly emerged business, a high probability outcome that appears only minimally priced into the name.

c.       True earnings power and long-term growth potential obscured by divestiture costs and exit of low value storage contracts. As a consequence of the semi segment divestiture, Azenta’s margins should be impacted by over 500 bps, lowering EBITDA margins from 20%+ to ~15%, driven by transactions costs and reallocation of expenses that were spread out by both divisions. The company’s EBITDA margins should inflect upwards to ~22% in the next 12 months as the one-time costs go away and the Life Science division continues its ramp in scale. From there a reasonable margin expansion of 200+ bps per annum is expected with Azenta reaching a normalized 30%+ operating margin in several years. Additionally, Azenta dissolved its alliance with Rutgers University Cell and DNA Repository (RUCDR) last September resulting in a drag on near-term sample repository solutions (SRS) segment growth of ~10% y/y, though improving margins of 500+ bps given the low value nature of the contracts. The impacts to revenues and margins should be alleviated as the semi divestiture closes and the contracts with RUCDR lap into easy comparables with annual growth/margins inflecting upwards to a firm-wide ~20% annual growth and 30%+ EBITDA margins.

d.      Evolution of the Life Sciences division misunderstood as offering expands deeper into customer workflows and product/service segments create self-reinforcing competitive advantage. Brooks’ first endeavor into the life sciences market leveraged their automation IP to create an automated freezer for biological sample storage. The product resulted in a life science business with low margins, lumpy sales, and minimal consumables, though was well received by customers leading to solid growth. Over time the company expanded its offerings to include off-site storage services, consumables, and software. This comprehensive storage solution exhibits high barriers to entry and considerable customer stickiness, as moving samples is inordinately risky and costly, which allows Azenta a high degree of pricing power (3%-5% annual cost increases). As such, Azenta is now deeply embedded in its customer’s research workflow for samples, from discovery up to clinical trial. Further, the comprehensive capabilities of Azenta have become an enabling feature for their customers, who are increasingly outsourcing components of their process to focus on their core competencies to accelerate insights and positive outcomes. As mentioned earlier, the acquisition of Genewiz marked a turning point in the development of the Azenta, providing outsourced science services that are more recurring in nature, but which also require sample storage then provided by the company. Unique to Azenta in the life sciences market, the storage business bolsters the services segment’s competitive advantage by having secure/faster/lower cost access to samples and the services business strengthens the storage segment as they can offer customers more outsourced functions/insights further expanding the advantages of being a one-stop-shop. The company currently has ~20% per annum revenue growth, of which almost 75% is recurring with 20%+ operating margins. With the focus of capital allocation being the services business, we anticipate higher growth, greater recurring revenue and superior margins going forward.

e.       Pace of pharmaceutical R&D efforts toward gene/cell therapy and mRNA likely to accelerate following the pandemic. With the invention of CRISPR gene editing in ’12, research into cell/gene editing rapidly expanded, though actual therapies were not developed/approved for use. The first gene-editing therapy approved by the FDA was for sickle-cell disease in ’20 after six years of work. Coinciding with this and other biological breakthroughs, the annual pace of FDA approval has doubled to over 40 approvals per annum compared to ’00-’15. This year the FDA should approve ~45 novel therapies of which CGT comprised nine approvals. Notably, the FDA’s guidance for CGT approvals is 20-25 per annum by ’23-’25, and importantly, Phase 3 CGT trials grew 60% y/y to ~150 in ’21. Further, with the success of the mRNA coronavirus vaccines, mRNA-based therapies are being aggressively researched. Approximately 50 mRNA candidates are already in contract negotiations for mRNA supply, almost 2x the level from ’20. At present there are ~18.5K therapeutics in the biopharma pipeline (up 6% y/y) of which ~45% are biologics including ~2.5K, ~1.5K and 100+ trials for antibodies, CGT, and mRNA, respectively. With such a large pipeline, FDA approvals are expected to double again to 75-95 approvals per annum by ’25. This accelerated level of research and approval for therapies at the single cell/DNA scale should generate a large tailwind to a supplier/enabler like Azenta, likely setting a floor around the firms’ ~20% per annum growth rate for several years.

f.       Systematic mispricing of Azenta as consistent, tactful M&A and disposition of the customer base create multiple value options. Consistent M&A has augmented the company’s organic growth and expanded their life sciences addressable market by over 3x since inception. As it stands today, Azenta’s foundation of sample storage and consumables creates a unique platform for consolidating life science service businesses, further strengthening the initial effects from M&A. By switching an acquisitions’ consumables to Azenta products at cost, the target’s margins improve, and their services can then price at the low end of the market, allowing them to gain share while maintaining a solid economic return. The more samples they process, the greater the benefit from vertical integration and potential for sample storage recurring revenue. Additionally, use of automated sample storage provides another productivity enhancement unavailable to competitors. Further, the overall transaction is substantively derisked as Azenta sells these new services to its existing base of sample customers, who have inordinately high switching costs for their sample storage. Lastly, a portion of the company’s customer base, small/embryonic biotech’s, aggregate to produce a payoff structure similar to an option, should a firm exit the market its negative impact to Azenta would be minimal but if a firm becomes successful, massively increasing in size it would disproportionately benefit the firm. In sum, Azenta has several value creation avenues that exhibit option-like behavior and which by their inherent nature are mispriced by the majority of the investment community.

3)      The largest micro risks in the name are execution issues with sample storage expansion, M&A execution, and technological obsolescence. The largest macro risks are the levels of pharma R&D funding/activity, outsourcing of research services trend, FDA approval rates, and regulatory controls on CGT.

2) Business Analysis

A Brief History – Semiconductor Company Utilized Automation IP to Expand into Life Sciences, Now Azenta

Brooks Automation, headquartered in Chelmsford, MA, began as a semiconductor equipment supplier in 1978. Through the ’00s, the company acquired entities to build out capabilities in vacuum automation, contamination control and advanced packaging/wafer transport. In the early ’10s, the company sought industry exposure exhibiting more favorable dynamics and yet an overlap with its existing capabilities, ultimately making inroads in the life sciences market.

Brooks’ first endeavor into the life sciences market leveraged their automation IP to create an automated freezer for biological sample storage. Since then, the firm has made 14 life sciences acquisitions, amounting to ~$840M, which have combined to offer comprehensive sample storage management/services under one roof. To fund this build out, BRKS exited lower performing or non-core verticals such as semiconductor contract manufacturing, instrumentation, and cryogenics for a total of ~$840M.

Two particular life science transactions display both management’s ability to allocate capital and evolve the business to provide a unique solution to the marketplace.

Brooks purchased BioStorage for ~$125M in late ’15 at a ~3x EV/Revenue or roughly ~16x EV/EBITDA valuation. BioStorage was a comprehensive sample management and cold chain solutions for the bioscience industry. In effect, this transaction accelerated Brooks’ budding automated sample storage system by giving the Life Sciences division a wide product offering/customer base in sample storage and scale that would have taken years to build out. From there, management continued acquiring key competencies including software and consumables for sample storage/shipment.

In late ’18, Brooks acquired Genewiz for ~$450M at a ~3.2x EV/Revenue or roughly ~16x EV/EBITDA. Genewiz is one of the largest independent genomic servicing companies, providing Sanger sequencing, Next-Gen sequencing, and gene synthesis. With a product-oriented company like Brooks, the purchase of a servicing company like Genewiz marked a new era for the combined entity. Brooks was able to provide ample capital to accelerate growth, vertically integrate resulting in expanding margins by having Genewiz use Brooks’ consumables, and cross-sell to a captured customer base via the storage business. Integration took several years as a cultural change in operations, marketing and sales occurred due to the intrinsic differences in the product and service-oriented businesses.

Azenta has facilities in the U.S, U.K, Germany, China, and Japan with 14 labs and eight sample repository solution locations. A new Chinese facility should begin operation in March ’22.

Azenta has two main segments: Products and Services.

In ’21, Azenta revenue consisted of ~60% from Services and ~40% from Products. Approximately 75% of revenue is recurring (consumables, outsourced sample storage, genomics services). Approximately 45% of revenue is from Genomic Services, ~25% from Consumables/Instrumentation, ~15% from Automated Storage/Service and ~15% Sample and Repository Solutions (SRS). Importantly, ~10% of revenue is tied to CGT.

Approximately 60% of revenue is derived from biopharma (top 20 firms ~15%), ~35% from academic/research institutions and less than 5% from other healthcare entities.

Products Segment

The company’s Products segment provides Automated Storage Systems (-20 to -190 Celsius), service of storage systems, tube consumables/instruments, and PCR/assay microplate consumables/instruments.

Services Segment

Azenta’s Services include sample/material management and storage (SRS), clinical trial management, lab/biologic transport, IT solutions, business continuity/risk mitigation and quality management. Additionally, the company provides genomic services via Genewiz including Sanger, NGS sequencing and gene synthesis.

At present, the company’s SRS business stores over 60M samples and the business has over 500M samples in Azenta freezers.

Genewiz has processed over 16M samples, generated 4,700 TB of NGS data and synthesized over 200M nucleotides

Management History – Minimal Insider Ownership (~2%), Impressive Management and M&A Track Record

Dr. Stephen Schwartz joined Brooks in ’10 as CEO. Previously, Mr. Schwartz was CEO of Asyst Technology, a semiconductor automation system firm from ’02. Schwartz’s compensation comprises a ~$675K base salary, a cash bonus of ~$725M and a stock bonus of ~$2.5M or ~65% of total compensation. The stock compensation consists of ~75% performance RSUs and ~25% time-based RSUs. He is required to own 6x his base salary in shares, owning ~0.45% of shares outstanding.

Dr. Schwartz’s ability to understand customer needs as well as a desire to reach more profitable markets has led Brooks, and now Azenta, to expand into the life sciences markets. Since ’11, Brooks expanded their addressable market in life sciences to ~$10B (5%-10% share), while investing $1B ($840M in 14 acquisitions, $160M in R&D) to reach a Life Science division valuation of ~$5B, equating to a ~5x ROI (~17.5% IRR over 10 years). The company adheres to a strict ROIC framework.

Lindon Robertson became Brooks’ CFO in ’13. Prior to that, he was a CFO of Graftech from ’11-’13 and CFO of IBM’s Japan/China divisions. Mr. Robertson’s compensation comprises a ~$500K base salary, a cash bonus of ~$490K and a stock bonus of ~$1.05M or ~50% of total compensation (part long-term compensation plan). He is required to own 3x his base salary in shares, holding ~0.05% of shares outstanding.

The remainder of the executive team is required to hold 2x their salary in shares.

Performance RSUs are based on revenue (~50%), adjusted gross margins and adjusted EPS (25% each).

Time-based RSUs are based on 3 year adjusted operating profit, free cash flow, and ROIC (equally weighted).

The executive team and insiders own ~1.75% of AZTA.

Customer Dynamics – Biopharma Increasingly Outsourcing Functions as Complex CG&T, mRNA, et al Increase Research Costs; Captured Customer Base Given Costs/Complexity of Sample Storage and Management

Azenta sells sample storage products/services as well as genomic services to biotech/pharma firms, academic research facilities and healthcare/clinical systems, over 8,500 clients in total. In automated storage the company believes they have a 5% market share. In genomic services and biosample storage, AZTA believes they have ~10% market share.

As the scale of therapies within biopharma have shrunk from the small molecule to DNA level, R&D complexity and costs have increased, leading to a declining ROI. In ’13, the average cost to bring a drug to market amounted to ~$1.3B over 6 years from development to approval with an ROI of ~6.5%, according to Deloitte. In ’20, the average cost increased to ~$2.4B with a 7-year development-approval cycle and a diminutive R&D ROI of only ~2.5%. This as well as consumer/government pressures to reduce healthcare costs have resulted in biopharma firms outsourcing an increasing number of functions. In R&D specifically those functions include, sample storage/management, basic research, late-stage development, genetic engineering, target validation, assay development, and safety/clinical trials.

Azenta’s ability to offer multiple research functions, logistics and sample storage under one roof appeals to biopharma firms, enabling an increase in R&D ROI. Azenta defines their exposure to client’s research workflow starting at kitting (consumables), to transport, process (analysis of samples), store, retrieve and informatics. For smaller biotech’s, the company’s ability to provide these products/services is crucial as they have acute pressure on cash burn until a therapy reaches approval.

In sample storage, research firms have an increasingly difficult time managing millions of samples and do not want to devote internal resources to such activities. Appropriate samples for research applications can take months to years to acquire and storage of samples can range from 3 years up to 25. Concurrently, research at the DNA level requires a greater number of samples for assay and chain of custody for each sample since these therapies are targeted to individuals, all of which is intensifying storage volume levels, difficulties, and costs.

Further, biologic and DNA storage necessitates colder temperatures down to -190 Celsius, making transport and manual handling a risky proposition, emphasizing a need for automation. Additionally, as storage temperature requirements get colder the energy costs for in-house sample storage also increases.

These dynamics result in a customer base that not only desires offshoring their sample base but once moved firms are unlikely to transport the samples again as the economic payoff to a cheaper service is not outweighed by the risks. This customer stickiness can be observed in Azenta’s ability to increase storage contract prices 3%-5% annually for the preponderance of their customer base. A benefit of this captured customer base goes beyond simple pricing power, as adding on services for those captured samples significantly de-risks any M&A via cross-selling and adds to the recurring revenue base.

At present, Azenta has ~60M managed samples under their service and a total of ~500M samples in Azenta freezers worldwide, equating to a customer base that is outsourcing ~12%. Over 60% of Azenta’s managed samples are expected to be stored up to 25 years, with ~20% stored up to 7 years (regulatory requirement driven) and ~20% stored up to 3 years (those used in active trials)

Further, with decreasing temperatures to store biologics and now DNA samples, Azenta’s storage products and services are expanding into mRNA vaccine distribution and clinical trials, beyond their current research-only customer base.

Add-on sample services, starting with Genewiz DNA sequencing and synthesis, creates a unique vector for the company in-step with the main outsourcing trend described above for sample storage. Customers are outsourcing services on these samples and having to transport to multiple locations for differing services, which increases risks, costs, and time delays for results. Further, the critical mass of over 400 scientists at Genewiz creates an outsourced genomics division for customers who typically do not have similar scale for genomics services/expertise. In total, Azenta is creating a much sought one-stop service business on top of their storage concern, with latent customer demand.

Azenta is in a unique place to provide sample storage and bolt-on services to a captured customer base, who are increasingly outsourcing research functions, expanding both market share and addressable markets with a lower risk profile.

Supplier Dynamics – Most Materials Widely Available; Genomics Suppliers View Azenta as Third-Party Seller

Azenta’s inputs consist of raw materials and some finished components from third parties. Supplier pressures are minimal. Input pricing pressure hasn’t been observed thus far at the company.

For genomics services, the company purchases sequencing equipment from a select few such as Illumina, 10x Genomics, Thermo Fisher and PacBio. However, by utilizing internally developed consumables, pricing pressure from these suppliers is mitigated. Additionally, these suppliers view Azenta as a customer and third-party seller in a sense, a large customer to sell equipment to and expand the market for DNA services.

Competitor Dynamics – Comprehensive Offering/Automation IP Sets Azenta Apart from Larger, Less Nimble Firms

Across all aspects of Azenta’s business, their biggest competitors are client’s in-house operations. Increasing complexity and cost for sample management as well as a shift in operational philosophy at biopharma/research organizations towards higher ROI is driving outsourcing of non-core in-house functions.

Azenta competes against life science tools competitors (Thermo Fisher, Agilent), large central labs (Quest, LabCorp) and other distributors. Use case expansion into clinical trial providers and vaccine storage has the company competing with Charles River, Covance etc.

Notably, none of their competitors provide complete end-to-end solutions for sample management, which allows a one-stop-shop competitive advantage to customers seeking simplicity in their outsourcing. Importantly, the captured customer base with the sample storage base business creates a platform for add-on services that is difficult for others to displace and introduces a self-reinforcing competitive advantage.

By being vertically integrated (services with internally manufactured equipment and consumables) the company can utilize lower cost consumables as a lead-loss product, getting a toehold into customer workflows. When this vertical integration is applied to service businesses with high sample throughput, like Genewiz, the acquired entity then can operate with a substantive portion of their variable costs (consumables) at cost, allowing them to become the lowest cost provider in the market. This cost advantage allows the acquired entity to take share while maintaining superior margins, and gives Azenta services to sell into the customers using their lower cost consumables or sample storage. This platform creates substantive cost and revenue synergies for M&A targets. As such, we anticipate Azenta to consolidate C&GT etc. sample servicing businesses, which would receive at-cost consumables and automated freezer storage advantages at the outset.

For genomics services, the company competes against Illumina, Qiagen, BGI Genomics, PerkerElkin and Eurofins. The service business outcompetes based on superior accuracy of branded sequencing equipment by using internally developed consumables and techniques, as well as faster turnaround time and effective management for samples. As such, Genewiz can offer substantial cost saving advice/services, for example the ability to sequence a particular gene once in 24 hours versus their customers cycling the same sample internally 15x-20x over several days/weeks.

For freezer/storage equipment, the company’s automation technology for sample movement within the freezer is a capability that others simply do not have. As storage temperature requirements decrease this capability should become an increasingly important differentiator. Further, with CGT research and treatment necessitating accurate sample storage, management and analysis, automation is increasingly a critical element for customers and competitive differentiation.

Market Trends – Biologics, Cell and Gene Therapy and mRNA Vaccine Development Accelerating, Large FDA Pipeline

R&D Outsourcing

Given the ROI pressures on the biopharma industry, outsourcing of R&D costs/functions has increased from ~30% of total operating costs to ~50% in ’21. According to the CBO, pharma R&D costs have increased ~8.5% per annum for the last 10 years and less than 12% of drugs entered Phase I clinical trials. These trends could intensify given the rising complexity/costs of drug development as well as organization’s increased comfort with remote work due to the pandemic.

The outsourcing market for biopharma reached ~$60B in ’20 and should grow ~5% per annum to ~$90B by ’28.

At present, Azenta’s customers only outsource ~12% of their sample storage.

According to industry insiders, only ~25% of gene sequencing is outsourced.

Given the costs of gene sequencing and the increasing costs of sample storage, we believe Azenta’s customers should outsource both functions to equivalent levels as their other operational functions.

Azenta’s Current End Markets

Automated storage hardware markets are expected to grow 5%-10% per annum to ~$5B market in ’25.

Genomic service and biosample storage markets Azenta directly addresses are expected to grow 10%-15% per annum to ~$5B market in ’25. The entire genomics market (80%/20% products/services) amounts to ~$25B in ’20 and is expected to grow almost 19% per annum to $90B by ’28, according to BCC Research.

The sample market is expected to grow ~25% per annum to ~5B samples by ’25, with ~10% outsourced.

Advanced Therapies/FDA Approval

The biopharma pipeline has increased from ~9.5K therapeutics to ~18.5K in ’21, ~7% growth per annum.

Biologics have increased from less than 25% of the pipeline in ’11 to almost 45% in ’21. Further, monoclonal antibody biologic prescriptions have increased ~25% per annum since ’13 reaching 16M+ prescriptions this year according to the FDA.

Importantly, within the biopharma pipeline ~20% are antibody, CGT, and mRNA therapeutics (leading edge). Trials for CGT therapies have increased from ~200 in ’07 to ~1,320 this year, ~14.5% growth per annum. Presently, there are only nine approved CGT therapies. Phase III trials for CGT should reach ~160 this year. Competitors estimate the entire CGT market to grow between 30%-40% for the next ten years to ~$250B, after reaching over $20B this year.

Lastly, ~100 mRNA programs are ongoing, and ~50 at the development stage are already reaching out to suppliers to start scaling production. This modality is the newest with the possibility to displace traditional vaccines/other therapeutics, having only truly emerged in ’20. mRNA development is expected to follow suit compared to biologics/CGT with 20%+ growth in the number of therapies being researched/approved going forward.

The annual pace of FDA approval has doubled to over 40 approvals per annum compared to ’00-’15. This year the FDA should approve ~45 novel therapies of which CGT comprised nine approvals. FDA approvals of CGT therapies are expected to increase to 20-25 per annum. Further, FDA approval of biologics has increased to ~30% of approvals.

3) Why now?

Azenta’s core platform growth has only just begun as new add-on services (starting with genomics) amplify the strategic benefits of the sample storage business and vice versa, creating a self-reinforcing dynamic. With the sale of the Semiconductor division, AZTA should have just short of $3B in cash in early ’22 to effect a transformative or set of acquisitions that strengthen the business beyond what is expected today. Pro forma the $2.4B in after-tax cash from the semi divestiture, the name trades at ~6.25 EV/FY’23 Revenue assuming consistent revenue growth of ~19% through FY’24. If the company can purchase ~$575M revenue with ~25% EBITDA margins for ~$2.8B or ~20x EBITDA in FY’23, Azenta would trade at ~3.5x EV/Revenue and ~14.5x EV/EBITDA, well below the low end of the valuation range for a genomics service and leading-edge life science firm. We advocate entering into a position as the company’s core business continues its secular growth trajectory, management executes an accretive, possibly transformative acquisition (or set of acquisitions) early next year and the market lags in catching up to the accelerating story.  

A few key points below illustrate the company’s value potential at this point in time:

1)      Strong End Markets and Self-Reinforcing Competitive Advantages Drive Growth, Potential for Acceleration from CGT, mRNA: With increasing R&D efforts into biologic, CGT and mRNA therapies, the sample storage and genomics market are expected to grow ~25% and ~20% per annum through ’28, respectively. Some genomics/CGT-specific servicers are exhibiting 30%-40% annual growth. Approximately 10% of AZTA’s revenue is derived from CGT. At present, sample storage and genomics services are outsourced by ~12% and ~25% of Azenta’s customer base respectively. Outsourcing in biopharma has reached ~50% of operating costs, and AZTA’s services are expected to displace in-house operations similarly over the coming years. Additionally, near zero temperature requirements for R&D, and now clinical trials and manufacturing/distribution for CGT/mRNA therapies, open Azenta to these adjacent addressable markets and an improved strategic position going forward. Amplifying strong end market growth is the inherent structure of Azenta, a sample storage base business with add-on services applied to the captured customer base. Customer’s desire to outsource to as few vendors as possible creates a self-reinforcing competitive advantage for Azenta. The sample business benefits from having more services to cross-sell to their captured customers, strengthening the company’s value proposition as a one stop shop. Vice versa, the services business benefits from the storage segments quick, safe, and affordable sample access and lower consumable costs via vertical integration. AZTA has evolved from a hardware-centric organization growing in the mid-teens to a predominately genomics service business (~45% of revenue) with a sample storage concern, the total entity exhibiting closer to 20%+ revenue growth per annum. Further, pandemic-related consumables for PCR testing peaked earlier in ’20, and now amount to less than ~10% of revenue, though are expected to stay elevated given the necessary surveillance for new variants. Synthesizing all these dynamics, we anticipate Azenta grows organically ~19% per annum through FY’27, with modest upside should the company continue to expand via M&A directed towards genomics, CGT and mRNA servicing businesses, even assuming a slowdown in pandemic-related sales.

2)      Potential for Transformative M&A with Almost $3B in Cash and Unlevered Balance Sheet: Pro forma the Semiconductor division sale, Azenta’s cash balance should equate to ~$2.8B (35%-40% of a ~$7B market cap), and with total debt of ~$50M, the balance sheet is substantively unlevered. Since ’11, the leadership team at Brooks has allocated ~$840M towards the Life Sciences division (plus ~$160M in total R&D over nine years), and at the current market price implies a ~5x return on investment (~17.5% IRR per annum over 10 years). Within a fractured private market, Azenta management has successfully purchased firms for less than 20x EBITDA, while generating both revenue and cost synergies with reduced execution risk by cross-selling to their captured customer base and using Azenta consumables at cost. Going forward, we anticipate Azenta to affect a large-scale or multiple mid-sized transactions targeting service providers to researchers and clinicians developing biologic, CGT, and mRNA therapies, which are exhibiting growth trajectories of 20%-40% per annum and operating margins in the 30%’s at scale. At a high level, should the company continue its track record of delivering a ~17.5% IRR per annum on invested capital over the next ten years, the ~$3B in cash alone could compound to ~$15B in equity value. A plausible and more conservative scenario has Azenta purchasing a larger service-oriented firm (~$575M revenue) for ~$2.8B at ~20x EBITDA, increasing firm value by a total ~$5.25B over five years. Should a large deal not occur, Azenta can utilize the cash to acquire smaller firms with lower multiples/margins amounting to ~10% of incremental revenue growth per annum ($100M-$150M) over the next five years and still generate equivalent value creation.

3)      Scale and Greater Focus on Value-Add Services Expand Margins: Azenta’s freezer/hardware centric business generates revenue growth of 15%-20%, gross margins of ~50% and has normalized EBITDA margins in the mid-20%’s. Meanwhile, the genomics and storage service business have revenue growth of 20%-40% (depending on the sub-segment), gross margins in the mid to upper 50%’s and EBITDA margins in the mid to upper 30%’s. Notably, gene synthesis, the stickiest service provided by Azenta, has gross margins in the 70%’s. In light of these dynamics, over time, we anticipate the services segment naturally expands from ~60% to ~75% of revenue over the next five years. However, given the economic and strategic benefits to adding on services, we anticipate Azenta’s new acquisitions to be predominantly higher growth/margin service-oriented firms, with services then amounting to over 80% of revenue going forward. Additionally, this would result in recurring revenue amounting to ~95% of total revenue. Historically, Azenta has grown operating margins over 200 bps per annum even with the more mature Semiconductor division. Pro forma the semi sale and the highly likely services portfolio shift afterwards, we anticipate EBITDA/operating margins inflect upward from ~22% at YE FY’22 to ~33% by FY’27, with further upside contingent on the ability of the company to scale service gross margins into the 60%’s.

4)      Top-Tier Management Team Should Continue Expanding Azenta’s Opportunity Set: At the beginning of Dr. Schwartz’s tenure at Brooks, the legacy semiconductor business underwent a shift in priorities to address emerging opportunities within its existing markets, resulting in an over 3x expansion in the semi segment’s addressable market while improving its economics/industry position. During this evolution in the semi business, management also followed a similar playbook in the life sciences market, albeit at a smaller scale. With the sale of the Semiconductor division, management is now fully focused on the life sciences market, with a modestly scaled business and a tried-and-true playbook for growth. This is evident with the company expanding beyond R&D services and into clinical trial and manufacturing/distribution markets. While Azenta addresses ~$10B markets today, the outsourced life science market as a whole is in excess of $100B, with smaller niches tied to CGT et al growing at an accelerating rate. Over time we expect AZTA to extend their leadership position in the key markets it serves today and continue expanding into adjacencies that should only improve its industry standing and economic potential.

5)      Strategic Position within Industry and a Unique Platform Create Possible Acquisition Target: Despite having a plethora of competitors, Azenta’s combined sample storage and genomic services structure makes it unique within the marketplace. Those with similar biostorage enterprises do not layer on additional sample services. Large scale players such as Thermo Fisher, PerkerElkin and LabCorp only provide certain functions of the research/clinical process with little or no expertise on handling samples in an automated efficient fashion. Smaller firms provide only one or two outsourced functions. These dynamics have resulted in Azenta filling an outsourcing niche, while consistently improving its industry position by acquiring the smaller players within its ecosystem where one plus one equals three. With a captured customer sample base and multiple services built on top at scale, Azenta could be highly valuable to a strategic consolidator with complementary products/services looking to take advantage of its inherent characteristics at an even larger scale.

4) Concerns/Thesis Pressure Points

Outsourcing Risk

Azenta’s strategic positioning pays off when their customer base outsources as many functions/costs as possible. Additionally, the growth in outsourcing is a key component of growth for AZTA. Should customers decide to in-house more of their research, clinical trials, and manufacturing/distribution, Azenta would be detrimentally impacted strategically and on growth.

Regulatory/New Modality Risk

An emerging growth driver for the company is CGT, mRNA, and other biologic drug development, should there be regulation on DNA-level research it would directly hurt the company as the industry pulls funding. Further, if any of the new modalities increase patient risks or address only narrow uses, the size and economic viability of these emerging markets could be negatively impacted.

Competition Risk

The company’s competitive environment is split between the large players such as Thermo Fisher, LabCorp, and many smaller private entities. Should the larger firms decide to encroach on Azenta’s business, their outsized capital and customer base could present a threat that would displace AZTA.

Customer Country Risk

Roughly a quarter of Azenta’s revenue is from China, and the majority of the revenue is derived from the genomics services segment. Given the regulatory environment in China and the increasing animosity towards western firms/countries, this exposure presents a risk.

Computer Simulation Risk

Underpinning the need to store and utilize biological samples is the importance of generating statistically significant numbers of relevant simulations/tests for drug development. The human body is complex and cellular interaction varies from person to person, which is why the acceleration of individual-based therapies is so beneficial to Azenta. However, should a computer model of the human body at the cellular level be developed, it would reduce the need for vast amounts of samples.

Pandemic PCR Testing Risk

During the pandemic, PCR consumables climbed to ~$20M/quarter, which if annualized would have amounted to ~20% of revenue. With PCR testing consumables now accounting for less than 10% of revenue (~$10M/quarter), the risks of a material slowdown in revenue should be mitigated. However, if the pandemic ends abruptly, so would the level of testing currently ongoing to surveil the population for cases and new variants. The emergence of the omicron variant shows that a base level of testing is likely to continue with a longer tail than anticipated as the virus continues to evolve.

5) Business Valuation

Azenta should exhibit high teens to 20% organic growth over several years as the life sciences industry evolves with more complexity and sample storage driven by increasing development/approval of biologic, CGT, and mRNA therapies. The company’s ~$3B cash balance by mid-’22 and unlevered balance sheet provide additional upside not priced into the stock. The firm generates revenue through the manufacture and sale of automated sample storage systems, outsourced biostorage services, related consumables/instruments, and genomics services.

A summary of the Base Case assumptions for the company is below:

1)      Short-Term Guidance: 1Q/FY’22 Revenue Growth: $130M-$140M, Capex: ~10% of revenue (4% due to genomics facility buildout).

2)      Long-Term Guidance: Organic Revenue Growth through FY’24: 18%-20% y/y ($860M-$880M), EBITDA margin FY’24: ~26% (300 bps expansion per annum), Opex FY’24 (incl. R&D):  ~32% of revenue. Capex: ~5% of revenue.

3)      Total revenue should grow ~18.5% to ~$610M in FY’22 and average ~19% growth per annum to ~$1,450M by FY’27, assuming no M&A.

4)      In FY’23, we anticipate Azenta purchases a firm with ~$575M in revenue with ~25% EBITDA margins and an acquisition multiple of ~20x EBITDA (assumes no synergies for conservativeness), a total purchase price of ~$2.8B.

5)      EBITDA margin of ~19% in FY‘22 should improve to ~33% by FY’27, a ~250 bps expansion per annum, slightly below the company’s historical rate. Effective tax rate of 22% in FY’22 and beyond.

6)      Capex: ~10% of revenue in FY’22 scaling down to ~5% thereafter.

7)      ~25x normalized EV/EBITDA or ~8.5x EV/Revenue multiple for Azenta. Reasoning behind the multiple is in the Peer Analysis section below.

8)      Discount rate at ~10% (large-cap).

Five-Year Operating Model

A simple five-year operating model is utilized to determine value.

Base Case:

Base Case assumes the company grows organically at ~19% per annum, purchases a $575M revenue firm for ~$2.8B ($35.75/share of incremental value), expands EBITDA margins to ~33%.

-         Base Case Valuation: $202.50/share.

Upside Case:

Upside Case assumes the company grows organically at ~25% per annum, purchases a $575M revenue firm for ~$2.8B ($35.75/share of incremental value), expands its market by 3x (~$45B) and captures 25% market share with ~35% EBITDA margins.

-         Upside Case Valuation: $481.75/share.

Downside Case:

Downside Case assumes the company grows organically at ~10% per annum, fails to use its ~$3B in excess capital, does not increase EBITDA margins beyond ~25% and is valued at a ~20% discount to our expected normalized valuation at ~20x EV/EBITDA.

-         Downside Case Valuation: $89/share.

A summary of the valuation in each of the three cases is below ($):

Peer Analysis – Trading Comps

Azenta has no direct public comparables, given its unique structure. However, ~45% of its revenue is derived from genomics services, like Genscript Biotech (1548.HK). The remainder of the business is in the sample storage services/equipment most similar to Biolife Solutions (BLFS) and Cryoport (CYRX). The list of comparables below consider these firms as well as Danaher (DHR) to blend an element of a scaled consolidator with exceptional management. Analysis below utilizes a normalized EV/Revenue metric to account for the early stages of growth/development these firms are in, ex. DHR.

Public Comparables – EV/Revenue

1)      Genscript Biotech (1548.HK) – ~12x normalized EV/S; currently at ~19x FTM.

2)      Twist Bioscience (TWST) – ~10x normalized EV/S; currently at ~20x FTM.

3)      Biolife Solutions (BLFS) – ~11.5x normalized EV/S; currently at ~11.5x FTM

4)      Cryoport (CYRX) – ~13x normalized EV/S; currently at ~13.5x FTM.

5)      Danaher (DHR) – ~6.5x normalized EV/S; currently at ~8.5x FTM. 

Genscript is a life sciences research and application service provider focused on leveraging their gene synthesis platform for CRO’s, CDMOs and CGT therapies. The firm provides a range of applications from gene synthesis to other protein synthesis as well as associated equipment and consumables. Approximately 65% of revenue is from life sciences services that most closely align with Azenta’s genomics business. The remaining business is more traditional biotech with outsourced scientific discovery in the biologic and CGT space. This is the most direct competitor utilized for our comparison analysis for Azenta’s genomics business, as they have a comprehensive genomics service, sequencing and synthesis and have a trajectory to solid cash flow generation. Revenue growth should average ~35% per annum over the next five years, scaling down from 50% y/y to upper 20%’s.

Twist is a DNA synthesis company attempting to create an industrial tools platform for synthesized DNA products/applications. The firm is quite different from Genscript and Azenta’s genomics services, but was included in this analysis, though with a large discount on the multiple to pre-COVID levels, to provide another data point to show how highly genomics-first businesses are valued. Growth should average ~30% per annum over the next five years.

Biolife is a manufacturer of bioproduction tools and services for CGT as well as biological storage services. The company’s markets include basic and applied research as well as commercial manufacturing of biological-based therapies. Notably, this is one of the competitors most cited as a comparable by analysts for AZTA’s biostorage business due to their similar focus on biologics and sample storage, though Biolife is ~100% focused on CGT. Growth should average ~30% per annum over the next five years.

Cryoport is a provider of cryogenic logistics products to the life sciences industry as well as proprietary logistics management services for biological samples. The company’s markets include researchers, CRO’s and CDMO’s. This is one of the competitors most cited as a comparable by analysts for AZTA’s sample cold-chain logistics business due to their similar focus, though Cryoport is more focused on CGT. Growth should average 20%+ per annum over the next five years.

Danaher is a science/technology firm of 20 operating companies focused on life sciences, diagnostics, environmental, and applied science sectors. The company is in mature sectors though has 50% of its revenue tied to life sciences with recent acquisitions in the CGT/biologics markets. Growth should average 8%-10% per annum over the next three-to-five years.

The group’s normalized EV/Revenue multiple equates to ~10.5x and has ranged between 6x-35x from ’16 to ’21 and currently trades at ~14.5x FTM assuming ~25% per annum revenue growth. Azenta currently trades at ~6.25x FY’23 EV/Revenue, excluding any possible large-scale deal and should generate revenue growth of ~20% per annum.

Peer Analysis – EBITDA Margins

EBITDA Margins

1)      Genscript Biotech (1548.HK) – ~45% normalized EBITDA margin; currently at ~5% FTM.

2)      Twist Bioscience (TWST) – N/M.

3)      Biolife Solutions (BLFS) – ~35% normalized EBITDA margin; currently at ~10% FTM

4)      Cryoport (CYRX) – ~20% normalized EBITDA margin; currently at ~10% FTM.

5)      Danaher (DHR) – ~37.5% normalized EBITDA margin; currently at ~35% FTM.

Genscript’s operating margins are expected to increase from breakeven to its normalized level over the next five years as the company achieves scale with its core technology. Capital expenditures should average ~9% of revenue.

Twist’s operating margins are negative, and the business model is unproven at scale, thus we do not include its margins in our analysis.

Biolife’s operating margins have increased to breakeven this year and should scale ~500 bps per annum going forward as the business reaches critical mass. Capital expenditures have averaged ~3% of revenue.

Cryoport’s operating margins have increased to breakeven this year and are expected to expand ~250 bps per annum for the next five years. Capital expenditures have averaged ~4% of revenue.

Danaher’s operating margins have increased ~250 bps per annum since ’16, though are expected to expand less than 50 bps per annum for the next five years. Capital expenditures have averaged ~4% of revenue.

Azenta’s comparable group generates ~35% normalized EBITDA margins, underpinned by operating margin expansion of ~250 bps per annum. Azenta generates ~20% EBITDA margins and should expand margins almost 300 bps per annum.

Peer Analysis – Conclusion

For Azenta, a ~8.5x EV/Revenue normalized valuation appears reasonable based on the representative comparable group of genomics service firms and biostorage specialists with CGT exposure. Further, this valuation multiple equates to a 20%+ discount to comparables as we attempt to apply conservatism into our valuation.

Azenta’s uniqueness extends from its business structure to its financials, being one of the only companies in this cohort with the ability to generate free cash flow today. As such, when applying our EV/Revenue multiple of 8.5x against a normalized margin structure of ~35%, AZTA’s normalized EV/EBITDA multiple equates to ~25x, not far off the low-to-mid-20x’s valuations of larger and slower growing mixed service/product life sciences companies deeply embedded in customer workflows (A, BIO, OMCL, TMO).

6) Market Expectations/Perceptions

Azenta is covered by five analysts with an average price target of ~$145/share, all with Buy ratings. Not one analyst gives credit to the value creation that would occur if the ~$3B in capital was used for M&A. Beyond that there is strong belief in the company’s growth trajectory and the ability of management. Management is known for being great capital allocators, highly focused on operations/returns and realistic on forecasts, typically beating expectations.

Consensus forecasts in the near-term are convoluted as some estimates include the semiconductor segment and some do not. Ultimately, consensus for FY’24 revenue and EBITDA is ~5% and ~10% below company guidance, which has historically been conservative. The largest underlying disconnects are likely the lack of recognition for the excess cash/potential M&A and the lagging recognition that the business is ~45% genomics services with CGT exposure at ~10% of revenue, which is growing 30%-40% per annum.

7) Downside Protection – Where’s the Margin of Safety?

The company’s downside is well protected as Azenta provides crucial storage services for the biggest biopharma companies in the world and its cash balance pro forma the semi sale is 35%-40% of its market cap. We assume the capital gets put to productive use creating more value than sitting on the balance sheet. However, should there be a lack of M&A targets, the company could reverse course and repurchase over 35% of its shares outstanding.

Further emphasizing the margin of safety is the ratio of excess cash on the balance sheet today plus cumulative 5-year free cash flow divided by current market cap, which comes to over 50%. I.e. roughly half the company’s market cap is ‘covered’ by cash and free cash generation.

Should the company fail to grow beyond its FY’24 targets (~$870M revenue, ~$230M EBITDA, no M&A), the company would be worth ~$112.75/share, ~20% above today’s share price.

Adjusting growth and margins to consensus estimates implies a normalized ~10.5 EV/EBITDA or ~3.25x EV/Revenue valuation for the business based on the current market price of ~$95/share. Which highlights the market's lagging recognition of the base business’s competitive advantages, even before addressing the potential options with the large cash balance.

Notably, while our normalized valuation multiple appears elevated compared to the firms’ historical average, we believe it may be justified given the industry/company’s strong secular growth and the emerging CGT growth opportunity.

8) Conclusion

Azenta is an emerging life sciences company with unique characteristics led by smart capital allocators. The company’s strategy and market positioning enable it to leverage a unique platform unlike any in the life sciences industry, which generally makes it more difficult for financial participants to ascertain its intrinsic value. Additionally, the company’s divestiture of its semiconductor business should amount to almost $3B in cash, which the management team should put to productive ends, generating substantive value that is currently not priced in by the market.

The company’s valuation should inflect upward from strong growth, accretive M&A and expanding competitive/financial advantages as the biopharma industry accelerates funding/research towards biologic, CGT and mRNA therapies.

As of December 17, 2021, the name is trading at $94.81/share. With a Base Case valuation of $202.50/share, we believe there is ~115% upside, equating to ~16.5% annualized IRR over five years.

Catalyst

·        Revenue growth in excess of historical norms/expectations

·        Transformational M&A

·        Share buybacks in the absence of M&A targets

·        Increased industry spending towards CGT, mRNA et al

·        Accelerating pace of FDA approvals for CGT, mRNA other biologics