Abcam: Growth Has Come At A Cost To Equity Holders

Investment Summary

There’s numerous selective opportunities trading at respectable multiples within the life sciences space. Moreover, we are happy to pay a high multiple if a company can generate high degrees of free cash to equity holders after reinvesting for future growth. We performed a deep dive presented here on Abcam plc (NASDAQ:ABCM) to see if it justified trading at 43x forward earnings, and to understand why investors have been sellers of this stock since it listed in FY20.

Recently, the company announced it would expand its ties with NanoString Technologies (NSTG) to push ahead with its spatial multiomics research collaboration. Pursuant, the ABCM’s RabMAb recombinant antibodies will be utilized to introduce a 64-component protein panel for the CosMx Spatial Molecular Imager (“SMI”). Both companies joined forces to develop and validate the human immuno-oncology panel, that was designed to integrate high-multiplex spatial proteomic and transcriptomic analysis at the single and subcellular level. In our research, however, we noted the fundamentals of ABCM’s growth don’t stack up to create value for equity holders. Growth over the last few years has come at a high cost to shareholders, and the firm has failed to generate a meaningful economic profit. Consequently, growth has actually been destructive to value and this is reflected in the stock price decline since FY20. In other words, the FY22 selloff wasn’t the catalyst for this broad repricing, and the surging cost of capital severely dampened its ROIC profile. Net-net, based on the culmination of points discussed here, we rate ABCM a hold.

Exhibit 1. ABCM price evolution

Growth not beneficial to equity holders

In terms of accounting growth and profits, it’s been double-digits for the company over the 24-months to date. During the initial half of FY22 it reported a total revenue of GBP 185.2mm [$225mm USD], depicting a YoY increase of 20% on a constant currency basis and a reported increase of 23%. Unlike most foreign nationals, ABCM recognized a ~300bps tailwind from USD strength, also from the GBP’s strength against the CNY. In-house revenues were the primary contributor to revenue growth, with a YoY growth of 37% on a constant currency basis, representing 67% of the total sales. We noted strength in its BioVision, custom products and licensing (“CP&L”), and in-house produced catalog products.

Exhibit 2. ABCM Revenue ramp, actual and consensus

Speaking of catalog sales, [which exclude revenue from custom products and licensing], are comprised of both in-house and third-party sales.

With respect to geographical highlights, the Americas region accounted for ~43% of catalog sales, and reported a YoY growth of 31%. EMEA contributed 26% of catalog sales on a YoY growth of 13%, whereas China, representing 17% of sales, reported a YoY growth. As a reminder, catalog sales exclude revenue from custom products and licensing and are comprised of both in-house and 3rd-party sales.

It pulled this to gross margin decompression of 420 basis points, settling at 75.6%, in comparison to 71.4% in the preceding period on operating margins of 23%, also a 540bps lift. The margin growth was owing to the favourable in-house product mix, the inclusion of BioVision, and ongoing commercial activities.

The YoY growth percentages are well received, yet this hasn’t translated into value creation for shareholders since listing. There’s a good explanation for this, in our opinion. As a reminder, a firm creates value for its shareholders when its ROIC exceeds the cost of capital. If it doesn’t, even a high ROIC and/or growth rates won’t add to value – instead, it will erode corporate and equity value.

We’d point investors to Exhibit 3, outlining ABCM’s NOPAT growth and capital investment from Q1 FY20-H2 FY22. Here, we had to run through the firm’s half-yearly accounts over this period, from just prior to its listing in Q2 FY20. We included goodwill into the calculus, seeing it is a premium paid on acquisitions, and represents a transfer of wealth from shareholders to the target firm. Note, all figures are represented in USD.

Exhibit 3.

You’ll note that over this time, it generated $553mm in post-tax earnings, for an additional growth of $14mm in NOPAT. It allocated an additional $247mm in capital investment to achieve this run-rate. Net-net, the incremental ROIC was ~6%, behind the historical ROIC above.

Exhibit 4. ABCM incremental ROIC

Yet, the stock price has fallen ~10% geometrically since it listed in FY20. Sure, there was the broad-market selloff last year, however, defensive, high-margin, profitable names typically outperformed. Second, the selloff has been in situ since FY20. To explain this, we point readers to these inferences from the above data:

1. The required reinvestment for this growth was 44% of post-tax earnings
2. Thus, the growth rate after this reinvestment was just 2.6%
3. Subsequently, only ~55% of post-tax earnings was distributable to equity holders.

Added to that, the periodic ROIC has been below ABCM’s cost of capital across the testing period, effectively eroding equity value, regardless of the YoY growth percentages stated above. In this vein, coupled with the points raised above, we’ve not seen ABCM’s growth profile accretive to shareholders to date.

Exhibit 5.

Valuation and conclusion

We’d also point investors to the fact ABCM is priced at >43x forward earnings [non-GAAP]. We still believe this is heavily overvalued. We believe the stock is more appropriately rated at 18.5x earnings. Key supportive factors to this thesis are listed in this report, namely:

• Thinning incremental ROIC, less than historical ROIC’s
• Rising cost of capital, where ABCM hasn’t generated an economic profit
• Stock trading at >120% above sector P/E, providing further scope for valuation downside
• Quantitative grading supporting the same [Exhibit 7].

Exhibit 6.

Exhibit 7. ABCM Seeking Alpha Factor Grades – F for valuation

We need to see ABCM come in with a strong earnings print with a hopeful surprise to the upside in order to justify a buy rating at this stage. Whilst YoY growth percentages have been welcomed to date, this has come at a large cost to equity holders since FY20. The FY22 selloff doesn’t explain the downside in this stock over that time, but its ROIC profile does. Net-net, we rate AMCM a hold until it can show the market these characteristics.