Short Cambrex Corporation NYSE:CBM Stephen Saroki O’Brien Greene & Co. ssaroki@obriengreene.com Sohn Investment Conference – April 2018
Introduction Investment Thesis Snapshot 1. Cambrex is a smaller player in the highly Capitalization competitive, fragmented, and commodity-like Share Price $55.05 world of small molecule Active Market Cap 1,891 Pharmaceutical Ingredient (API) contract Net Debt (183) manufacturing Enterprise Value 1,708 2. Financials More than a third of its revenue, and likely more than half of its operating earnings come 2018E Revenue 536 from Gilead’s declining HCV franchise 2018E Sales Growth 0.1% 2018E EBITDA 157 3. The hard catalyst of the loss of Gilead’s high 2018E FCF Yield 3.1% margin business (which management already Valuation acknowledges) should lead to sales declines, P/2018E E 19.0x lower capacity utilization and operating P/2019E E 17.8x deleverage, and substantial margin EV/2018E EBITDA 10.4x compression EV/2019E EBITDA 10.0x 4. Figures in millions In addition to reduced earnings, its multiple should compress away from its peers Source: FactSet Page 2
Company Overview Founded in December 1981 and Cambrex’s Charles City, IA Plant based in East Rutherford, NJ Pure-Play Small Molecule API Contract Manufacturer Organization (CMO) An API is the ingredient in the pill that does the beneficial work Niche focus on drugs with <$5 million in sales — the Gilead business excepted Major producer of APIs for Gilead’s hepatitis C virus (HCV) franchise Gilead makes up 35.1% of Cambrex’s revenue Page 3
Contract Manufacturing is a Bad Business “Contract manufacturing is a Small Molecule API CMO difficult , competitive , low- Market Share - 2013 margin business.” – Industry Week (2013) “Regardless of efforts to consolidate the sector, the landscape of the CMO industry remains fragmented . The major players in the sector only command a 2-4% market share each .” – Results Healthcare (2017) Cambrex commands just under 2% of the market Source: Cambrex Presentation Page 4
Small Molecule: A True Commodity Business Small Molecule Large Molecule/Biologic - Small ( single molecule ) - Large ( mixture of related molecules ) Size - Low molecular weight High molecular weight Simple , well defined, independent of manufacturing Complex (heterogeneous), defined by the exact Structure process manufacturing process - Produced by chemical synthesis - Produced in living cell culture Manufacturing - Predictable chemical process - Difficult to control from starting material to final - Identical copy can be made - Impossible to ensure identical copy FDA Approval Process None beyond initial drug approval New, lengthy process with each new manufacturer Because small molecule Barriers to entry are very low, manufacturing involves a simple, hence the fierce competition in predictable chemical process that the space identically replicates the molecule Sufficient capital is the only in question, no additional FDA approval is required substantive requirement for new entrants in the industry For these reasons, small molecule API manufacturing is a commodity business Source: Generics and Biosimilars Initiative Page 5
Why Small Molecule Manufacturing is a Commodity-like Business Easy to Make: Hard to Make: Aspirin, a small molecule Insulin, a large biologic Page 6
The West is Losing Share to the East Asia gained 2011 2016 8% market share in just 5 years, Rest of Rest of virtually all the the from Europe World, World, and the US 10% 11% North America, North America, 27% 32% Asia, 26% Asia, 34% Europe, 29% Europe, 31% China and India have won share due to their fundamentally lower cost structure for manufacturing, labor, equipment, and materials combined with access to a large talent pool of chemical engineers and scientists This uniquely disadvantages Cambrex which manufactures solely in the US and Europe Source: Dr. Reddy’s informEx Presentation, Clarivate.com Page 7
How then has Cambrex been so successful thus far? Cambrex in the Time of Gilead Top Drug Launches in History Gilead’s HCV franchise has “the fastest growth out of the gate of any pharmaceutical ever.” – Forbes One of Gilead’s HCV Since getting Gilead’s HCV business, drugs, manufactured Cambrex’s EBITDA margins have by Cambrex nearly doubled from 18.3% in 2011 (pre-Gilead) to 32.7% in 2017 , which is about 1000 basis points higher than their larger peers In addition to process knowledge, Gilead’s business has allowed Cambrex to experience high capacity utilization, allowing them to leverage fixed costs (production facilities and equipment) more Date: August 2015 effectively Source: Forbes Page 8
What Gilead Giveth, Gilead can Taketh Away Cambrex’s 2017 Financials Cambrex’s Reliance on Gilead Revenue Gilead made up more than a third ( 35.1% ) of Cambrex’s 2017 Revenue Gilead 35% Assuming an ex-Gilead operating The Rest margin of 21.0% (which is better 65% than its pre-Gilead margins of 18.3%), its Gilead operating margin is 54.4% EBITDA This implies that Gilead made up more than half ( 58.4% using conservative estimates, though it is The Rest 42% likely higher) of Cambrex’s 2017 Gilead 58% operating profits Source: Cambrex SEC Filings Page 9
Gilead’s HCV Franchise is in Freefall Gilead's HCV Sales (in millions ) 25,000 19,140 20,000 14,834 15,000 12,410 9,137 10,000 5,350 5,000 139 0 2013 2014 2015 2016 2017 2018E Gilead’s HCV Sales in 2018 are expected to drop 41.4% year-over-year , with a 72.0% drop from its peak in 2015 Page 10
Cures: Good for Humanity, Bad for Business HCV Patient Starts (in thousands) 700 587 600 510 500 185 124 375 365 400 49 75 102 300 116 190 24 103 200 91 32 237 100 208 158 143 2 0 2013 2014 2015 2016 2017 US Europe Japan Rest of the World With its simple 12-week pill Patient starts have dropped regimens, Gilead’s products cure 36.3% since the 2015 peak people of HCV , with Epclusa With every cure, Gilead’s total curing all 6 major strains addressable market shrinks Source: Gilead Earnings Presentations Page 11
With Great Profit Comes Great Competition Gilead's Epclusa AbbVie's Mavyret Number of Types of HCV Cured All 6 All 6 Price per 4 Weeks $24,920 $13,200 Normal Duration of Treatment 12 Weeks 8 Weeks Total Cost of Treatment $74,760 $26,400 Discount to Epclusa NA 64.7% While companies like Merck, Roche, and Bristol-Myers Squibb have HCV drugs, the most prominent competition is AbbVie’s new drug Mavyret Mavyret cures all 6 types of HCV at ~1/3 or less the cost of Gilead’s products As of September 2017 , Mavyret had already “ grabbed 7% of total new subsciptions ” in the HCV space Source: Investor’s Business Daily Page 12
Cambrex hasn’t Felt Gilead’s Pain— Yet Cambrex's Gilead Sales (in millions) 200.0 187.8 181.0 180.0 160.0 149.5 140.0 120.0 89.9 100.0 80.0 58.2 60.0 40.0 20.0 0.0 2013 2014 2015 2016 2017 Cambrex’s Gilead Sales have leveled off, but they’ve still grown, even as Gilead’s HCV Sales have declined. How is this? Source: Cambrex SEC Filings Page 13
How? Gilead has Cut its Other HCV API Suppliers First Gilead has several HCV API suppliers, which is a common practice implemented to mitigate production risk. It has cut production at secondary manufacturers but left primary manufacturers like Cambrex untouched — so far. In this example, unit production Hypothetical HCV API Unit Production drops 20% year-over-year 100 100 Supplier 4, 10 While all of the other suppliers 80 Supplier 3, 10 have experienced unit 80 Supplier 4, 5 Supplier 3, 5 Supplier 2, 20 reductions, Cambrex’s unit Supplier 2, 10 60 volumes remain unchanged 40 To maintain several suppliers, Cambrex, 60 Cambrex, 60 future supply reductions will 20 have to occur across the board 0 T=0 T=1 Cambrex will be next on the chopping block Page 14
Why Now? Cambrex’s CEO Says So Steven M. Klosk, Gilead HCV API Agreement Cambrex Corporation CEO “We have a firm commitment for significantly reduced volumes of this product for 2018 , which is in line with our expectations. We have a 5-year supply agreement ending in December 2020 that now includes a defined minimum volume for 2019 , which represents a further significant decline compared to the volumes we expect to ship in 2018 . There is no minimum volume stipulated in the agreement for 2020 .” – Q4 2017 Earnings Call Source: Cambrex Q4 2017 Earnings Call Page 15
Oh, and Then There’s That Whole Take -Or-Pay Thing Take-Or-Pay Payments Cambrex’s Take-Or-Pay It is what it sounds like Cambrex booked a $6.2 million take-or-pay payment in Q4 of In contracts with these 2017 , which is the first time provisions, a company must since 2003 that “take -or- pay” either take the product from its has been mentioned in their supplier or pay a penalty to the filings supplier Why it’s likely Gilead: Since the In general, take-or-pay payments majority of APIs Cambrex pale in comparison to the produces are for drugs with revenue that would have been annual market sales less than $5 generated by actually selling the million, Gilead’s HCV franchise product is the only one with large enough sales to justify a payment this size Page 16
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