Expert Financial Analysis and Reporting

The Bioprocessing Business of Refine Technology

Repligen (RGEN) has just announced the acquisition of Refine Technology. The primary reason for the acquisition was to acquire its Alternating Tangential Flow System. This is a filtration device used to continuously remove waste from fermenters during biomanufacturing. This system can increase cell densities in the fermenters by 2 or 3-times the levels achieved by standard batch fermentation. This increases product yield and can reduce the size of a bioreactor required to manufacture a given volume of product.

Repligen describes Refine a diamond in the rough and believes that its Tangential Flow System is the gold standard in this application. There are competitive technologies but Repligen believes that Refine’s technology is much more widely used and accepted and has competitive advantages over others. It is protected by a patent through 2020.

Production will be moved to Repligen’s facility in Massachusetts and commercial operations will be folded in so that US operations will be conducted out of Repligen’s existing facilities. This appears to be a very good fit for Repligen and will be strategically important in increasing critical mass.

Where Refine Fits Into Repligen

Protein A, which is by far the largest product in Repligen’s product line, is used to separate a desired drug product from fermentation waste in chromatography columns that are downstream of fermenters. This is also true of the OPUS disposable chromatography columns thhat are used in the same setting. OPUS currently has much smaller sales than Protein A, but is growing much faster and management believes that its sales can ultimately be as large as protein A. The second largest product group after protein A currently is growth factors used during the fermentation process. Refine is about the same size as growth factors and adds a meaningful new leg to the business.

The bulk of Repligen’s current business-protein A and OPUS- is used in purification which is downstream of fermentation in the manufacturing process. This acquisition when combined with growth factors creates more critical mass in the upstream fermentation process. The ATF System is available in a range of sizes from lab scale to clinical to commercial manufacturing and is used in the production of several FDA-approved drugs. Repligen plans to develop a single-use, consumable version of the ATF System for customers who are building or employing manufacturing facilities with single-use bioreactors. This fits very nicely into Repligen’s strategy and should be available in 1H, 2015.

This is another step in Repligen’s plan to be able to build cheaper and more efficient factories of the future for biotechnology products. Its vision is to employ smaller and more flexible disposable systems as opposed to the large, dedicated costly, inflexible stainless steel factories that have been the norm. This is a bold plan that could make Repligen a very unique high growth company in the biotechnology business. Its business model allows the Company to benefit from successes in drug development by others without incurring the significant binary risk of drug development. There are many companies trying to develop new drugs and some will succeed and some will fail. Many of these companies will turn to Repligen to help them produce their products in both the development and commercial stages so that it can benefit from their efforts and success and perhaps even failures.

Terms of the Deal

Repligen will pay $20.5 million of cash and issue 215,285 shares for Refine Technology so that the total consideration at the current price is about $24.5 million. The agreement also includes potential milestone payments of up to $8.75 million if specified revenue targets are met. If revenue targets are exceeded, there could be up to an additional $2.15 million (no more) of royalties. Hence, this acquisition could cost as much as $35 million. Repligen expects the acquisition to add $3.5-4.0 million in revenue for the remainder of the year 2014 and perhaps $8.5 million in 2015.

This suggests that current annual revenues are on the order of $7 million. Ignoring contingent payments for performance goals, Repligen is paying a little over three times sales. Profit margins were not disclosed but for the purpose of illustration, if after-tax margins were 10%, they would be paying 30 times earnings.

Guidance for 2014 is Revised

As a result of this acquisition, 2014 guidance is being revised as follows:

• Sales are expected to increase to $56 to $59 million versus previous guidance of $52 to $55 million. The new guidance would represent an 18% to 24% increase in bioprocessing revenues.
• Product gross margins are expected to be 51% to 53%. This compares to prior guidance of 53.0%
• Operating income is expected to be $10 to $12 million which is a decrease from prior guidance of $11 to $13 million. This decrease is primarily the result of one-time transaction and inventory related expenses and increased expenses related to the expansion of the Company's commercial operations.
• Net income is expected to be $8 to $9 million as compared to previous guidance of $8 to $10 million,
• Yearend cash is expected to be $62 to $66 million which compares to prior year guidance of $84 to $87 million.
• The previous guidance on the tax rate was 20% to 22%. This remains unchanged.

Sales and Earnings Model

I am estimating fully diluted EPS of $0.27 in 2014. I also estimate that core the bioprocessing business will earn $0.21. The difference is due to a milestone payment received from Bio Marin. I think that this acquisition will be accretive in 2015 and I am raising my fully diluted EPS estimate from $0.27 to $0.30. The complete sales and earnings model is shown below:

Investment Thesis

I think that this is a very sound acquisition and I give it thumbs up.

Repligen is now being valued at about 95 times 2014 bioprocessing EPS and 63 times 2015 EPS. This is an obviously a very high multiple on current earnings. Based on current operations (which includes Refine), my five year growth rate estimate for sales is 11% and EPS is 20%.

I believe that this high P/E reflects several factors:

• Repligen has partnered potentially valuable biotechnology assets to Pfizer and Bio Marin. These are difficult to value as they are in early stage of development,
• Investors see a company that is cash rich and cash flow positive. It should be able to make a string of accretive acquisitions similar to Refine Technology that are accretive sales and earnings.
• The Company has a unique business model that allows for investors to participate in the growth of biotechnology without the binary risk associated with product development. It is highly predictable and sustainable.
• There is scarcity value as there just aren’t any comparable companies for investors to invest in.
• Repligen could be acquired at some point.

I initially recommended RGEN on December 4, 2012 at a price of about $6.13. I have not been aggressive in recommending purchase of the stock at current levels because a meaningful amount of the valuation is based on issues (as just described) that are difficult to quantify. My mantra however is that you couldn’t pry this stock out of my portfolio with a crow bar. It may or may not be appropriately valued at the current price; I obviously am finding the stock hard to value. However, when I look at the uniqueness and opportunity for Repligen, I think that there is the potential for explosive growth in the next decade that could take make the company several times as large as today if the Company can continue to find good acquisitions and develop new products for its factory of the future. The biotechnology partnerships are an additional wildcard.