Description

Ibex Technologies is a provider of proprietary enzymes for use as reagents in hemostasis monitoring devices.  The company is asset-rich with $0.17 per share in cash and excess real estate providing substantial downside protection, and has a small but dominant operating business with high barriers to entry that has been overlooked by the market and allows for significant upside potential as well.  

Net of cash and real estate, shares currently trade at a TTM valuation of only 0.3x revenues and 5.5x adj EBITDA (capex is negligible).  More importantly, however, earnings have been masked over the last 18 months or so from expenses incurred to establish a fermentation facility in Montreal that is not yet selling commercial product; on a normalized basis I believe that the valuation is closer to 1.5x adj EBITDA, and thus represents a very attractive investment opportunity.

The company’s size and liquidity make it more suitable for personal accounts.  Shares trade as IBT on the TSX Venture Exchange in Canada and IBXNF on OTC Markets in the US.  Dollar amounts are in Canadian dollars unless otherwise specified.

Business Overview

Ibex’s core business is manufacturing and purifying proprietary enzymes (heparinases, chondroitinases, etc) that are used as reagents in hemostasis monitoring devices sold by a number of leading diagnostics companies.  The major providers of these diagnostic devices include Abbott, Medtronic, Siemens, and Haemonetics, among others.

The principal application of the diagnostic tests that Ibex’s enzymes are used in are to determine the clotting potential of blood pre-operation and post-operation.  This is a particularly important consideration in the bypass and vascular surgery markets, and it allows hospitals to better manage their blood usage -- which is obviously a significant cost -- in particular.

The market for these diagnostic tests has generally expanded over time.  Apparently post-operation usage has grown as hospitals have become more savvy with using data to better manage their blood.  The diagnostics companies have also expanded the market for the tests by making them easier to do at point-of-care.

Dominant Position, High Barriers to Entry

While Ibex is a relatively small company with only $5 million in revenues, I believe the quality of the business is unusually high, and this has been overlooked by the market.

First of all, my understanding is that the company has no competitors in diagnostic heparinases (over 50% of revenues); all of the major global diagnostics companies purchase exclusively from Ibex.  Apparently no one is able to match their capabilities on either price or purity, both of which are challenging. Management has said that a Chinese company tried to enter the Chinese market 4 or 5 years ago but it does not appear that they were successful.  Ibex apparently has many trade secrets that support what has been an insurmountable competitive advantage, particularly in the area of purification.

In addition to the strong intellectual property, the company also benefits from significant switching costs which further protect the business from potential competitors.  If a diagnostic company ever wanted to stop using Ibex enzymes in one of their tests, they would need to re-register those tests in each region where they are sold. Considering the cost and risks associated with re-registration, it goes without saying that test providers have a huge reluctance to change the composition of any of their tests to try to save money.

Bio-Research Products

Around 20% of revenues come from Bio-Research Products (BRP), a US business that Ibex bought at the end of 2012 for $2 million USD.  BRP is a fairly similar business -- they specialize in the production of enzymes, lectins, protease inhibitors, substrates, and assays.  In particular, they were the leading provider of wheat germ phosphoenolpyruvate carboxylase (PEPC), an enzyme used in diagnostic reagents.

To make a long story short, the Bio-Research Products acquisition was not a success, but it also wasn’t a disaster either.  First of all, they paid a very low price for the business and the real estate they acquired alone is probably worth the $2 million USD that they paid.  Secondly, the business has never really burned cash and has generally been cash flow neutral. They had hoped to do custom manufacturing from the facility but it never really took off.  And certain other sales increases that they hoped for ultimately didn’t materialize.

Montreal Fermentation Facility

Around 1.5 - 2 years ago, management started to build a new fermentation facility in Montreal.  They said that this new facility would allow them to internalize the upstream production on heparinases (certain enzymes are currently produced at 3rd party facilities monitored by Ibex personnel).  In a November 2016 earnings press release they specifically stated: “Next year’s results will also be affected by a significant capital investment in our Montreal product development and production capabilities, an investment we expect will benefit the longer-term profitability of IBEX.”

While management hasn’t spelled out the magnitude of expected cost savings from this new fermentation facility, we can at least get a rough idea looking at the size of the project.  The cost of building the new facility was $600k, so I would expect that management would’ve required at a minimum a $150k benefit (25% ROI) from internalizing this production."

More importantly, however, this new fermentation facility should allow the company to unlock significant value from the BRP business, which thus far has not been contributing to EBITDA.  When the company acquired BRP, one of the main attractions was their 10k square foot facility with 300 L of fermentation capability. With this additional capacity in Montreal (my understanding is that it can handle ~90% of the fermentation done by BRP), barring a significant increase in sales volume the BRP capacity in Iowa now appears to be redundant.

Management has not said yet what they will be doing with BRP once Montreal’s new facility has had its production qualified, but I think the writing is on the wall.  There are a few options that I can see management taking, but barring a huge growth in demand over the next six months, keeping the existing BRP facility operational seems unlikely to me.  Management could explore selling all or parts of BRP, or moving all or parts of BRP into Montreal; theoretically there should be meaningful cost savings from centralizing all of the production in Montreal.  I haven’t incorporated any EBITDA or value from BRP beyond its real estate in my analysis, but I would not be surprised to see that they are able to either sell the business or retain it and start generating positive cash flows from it.

If Ibex management does indeed decide to either shut down, sell, or move BRP’s business -- that will finally unlock the value of their Iowa real estate, which I believe is significant relative to the current market cap -- around $2.6 million in real estate vs. a $5.8 million market cap.

Real Estate

When Ibex acquired BRP, included in the purchase was two buildings that comprise 10k square feet sitting on around 5.4 acres of land in North Liberty, Iowa.  What’s most interesting about this property is that while it is currently industrial, it is very well located in a quasi-residential area. Furthermore, North Liberty as a whole appears to have had very healthy economic trends over the last 5 years with strong population growth and presumably rising property values.  From 2010 to 2015 the population grew 36% according to the US Census Bureau (https://www.northlibertyiowa.org/2016/01/11/north-liberty-population-18228/).  And since BRP was purchased in 2012, the population of North Liberty has grown by over 20%.

The first clue as to the value of the property comes in the form of a mortgage.  When BRP was purchased in 2012, half of the $2 M USD purchase price was financed by taking out a $1 M USD mortgage on the property.  Considering that the vast majority of the value of this particular property is derived from land, presumably the bank would have been confident the property was worth at least $1.5 M USD in 2012 to justify a mortgage of that size, especially considering the more volatile nature of land values.

Secondly, you can look at the assessed values of the two parcels here, which total $1.1 M USD:

• https://beacon.schneidercorp.com/Application.aspx?AppID=86&LayerID=841&PageTypeID=4&PageID=572&KeyValue=0612451010
• https://beacon.schneidercorp.com/Application.aspx?AppID=86&LayerID=841&PageTypeID=4&PageID=572&Q=1072151881&KeyValue=0612451012

Finally, and most importantly, there is fortunately an almost identical plot of land that is currently being marketed almost directly adjacent to BRP’s land.  This listing obviously provides the clearest indication of value. It is a smaller plot at only 4 acres vs BRP’s 5.4 acres and it has been listed for sale at $2.1 M USD, as seen here:

https://www.kalonarealty.com/-/listing/IA-ICAR/20181334/250-N-Highway-965-North-Liberty-IA-52317

If you look at the satellite maps provided on that listing, you can actually see BRP’s land just south-east of this adjacent property that is for sale.

Given all of the data available, I feel comfortable putting a present value of $2 M USD on BRP’s land.

Valuation

Adding up all of the pieces, Ibex currently has $2.7 million in cash.  I think this figure is actually a little depressed right now due to the timing of certain working capital accounts and was over $3.0 million in recent quarters, but I haven’t made any adjustments to normalize for the working capital levels.  That works out to $0.11 per share.

Next we have the Iowa real estate.  As stated above, I have valued that at $2 M USD, or $2.6 M CAD.  There’s a $1 M mortgage against the property, so Ibex’s equity in the property is $1.6 M.  That works out to $0.06 per share. So cash and excess real estate amounts to $0.17 per share.

As for the core business, financials have been as follows:

Aside from the Montreal fermentation expansion project, capex has been negligible over the last five years.  And the company has substantial deferred tax assets that will shield taxes for a very long time due to its former history when the company was significantly larger and spent heavily on R&D of molecular biomarkers for the management of cancer and arthritis.

The company has extremely high contribution margins (80%+) and this has caused EBITDA to be a lot more volatile than revenues.  You can see in FY16 that a $600k increase in EBITDA fell right to the bottom line. In FY17 the contribution margin was unusually low at 40-50%, partly due IMO to the company starting to incur costs associated with the fermentation expansion project, and partly due to unusually high bonuses that were fully incurred in Q4 after a strong year.

Normalizing for some of these one-time costs that I believe have been obscuring the earnings power, the core business appears to be running around $5 M in revenues and $1 M in EBITDA.  I think that normalized EBITDA might actually be a bit higher than this due to a) the cost savings from internalizing upstream production of heparinases, and b) potential cost savings depending on what they do with BRP, but there’s enough uncertainty and volatility in EBITDA that I feel it’s prudent to only count on around $1 M in EBITDA for now.  

It’s also worth noting that this level of EBITDA is not out of line with history.  The company actually generally $1.2 M in EBITDA back in 2009 on only $3.5 M in revenues.  Although this was some time ago now, other than the acquisition of BRP I don’t believe that the underlying business has changed materially since then.

I believe that the operating business is worth at least $10 million, which works out to around 2x normalized revenues and 10x normalized FCF.  I think it’s also important to note that the company has generally been on a growth trend, and it would not take very much additional revenues to materially increase FCF due to the extremely high contribution margins.  If the business continues to grow and gets to just $6 - 6.5 million in annual revenues (only 20-30% revenue growth), I think that normalized EBITDA could even get to the $2 million level, which is more than double what I have modelled.

This $10 million in value for the operating business works out to $0.40 per share, and so adding this to the cash and real estate I believe the combined value of the company is around $0.57 per share.

What is the market missing?

First of all, I think the market has overlooked the value of the real estate.  The company has never spelled out its value, and so investors have had to do their own research to realize that it is very material -- with an estimated value of 45% of the market cap.

Secondly, I think the market has failed to appreciate the unusual costs that have depressed earnings over the last few years, nor the potential earnings improvement from the new fermentation facility, nor the potential to unlock value from BRP through either a sale or restructuring of operations.

Finally, I think the market has failed to appreciate the high quality of the business.

It’s important to understand that EBITDA is very volatile from quarter-to-quarter.  While the end market demand for the enzymes is relatively stable and driven by the volume of diagnostic tests performed, quarter-to-quarter revenues can be quite volatile as there is a relatively limited number of customers and their purchases can be lumpy -- maintaining either high or low inventory levels at any given time.  The quarter-to-quarter revenue volatility is further exacerbated by the extremely high contribution margins, which are at least 80%. The end result is that in quarters where purchases are healthy the company can generate $400-600k in EBITDA, but in quarters where they are light it’s not unusual for them to have a $100-200k EBITDA loss.  

I believe that this quarterly volatility is one of the main reasons why the market has failed to appreciate the quality of the business; at a glance the company appears to be very unpredictable and unstable.  It’s only by understanding the company’s dominant market position and relatively stable end market demand that one can appreciate that the company has a high quality, enduring franchise in producing diagnostic reagents.

The company has been undervalued by the market for a long time.  Why now?

First of all, I believe that the impending commercialization of the Montreal fermentation facility represents an important inflection point.  The facility is now operational, but my understanding is that it will take the next six months for the company to qualify its production. By next year, however, it should finally be commercialized and should start driving improved profitability in the business, instead of just incurring costs with no benefit.

Secondly, the commercialization of the Montreal fermentation facility will finally open up some options for them to unlock value within BRP.  They have not decided yet what they will do, but as I’ve laid out in this report, I believe it’s inevitable that they will either sell BRP or restructuring its operations out of Iowa, and monetize the valuable real estate in North Liberty.

Finally, I would note that the CEO has been with the company since 1994 and is now 75 years old.  If you go back to the 1990s, this was actually once a $100+ million market cap company. If you asked him 20 years ago where he’d be in 2018, I highly doubt it would sound anything like “still working, managing a $6 million market cap business.”  I believe it’s highly likely that the CEO has stayed on board with the company to bring it to a happy conclusion for shareholders (he owns around 2.5 million shares himself, second only to the estate of the late Lloyd Miller III, which owns around 4.1 million shares).  I believe it’s high likely that once the new fermentation facility has been fully commercialized, he will seek to unlock value from assets currently not generating any value (BRP, Iowa real estate) and to explore a sale of the now more profitable business operations (which would have very significant strategic value to any of Ibex’s customers IMO).  It’s possible that he could also explore an acquisition or merger with a similar business, and that could certainly be good or bad depending on the target and terms, but I feel that the path of least resistance in this case is probably an outright sale of the company.

Risks

Potential risks include:

• Management spends the company’s cash on a poor acquisition.
• The company does not, or is otherwise unable to, sell the Iowa real estate at an attractive price.
• Customers re-engineer their tests to use less of Ibex’s enzymes. In the past when this has happened though, it has driven more test volume which has at least partially offset any weakness.
• Another company successfully enters the market and undercuts Ibex on price.
  
  

Catalyst

• Commercializing the new fermentation facility should drive earnings improvements.
• Unlocking value from BRP by either selling or restructuring the business.
• A sale of the North Liberty, Iowa real estate.
• A sale of the entire business, or entering into a business combination that results in a larger entity that is more attractive to public market investors.