Sartorius: When will it finally recover?
One of Germany's most glorious stock performances ever has come to an abrupt halt. However, the company's future remains bright. At some point, its share price should reflect that again.
As a heads-up, this one ended up being a bit longer than usual. I have a history with this stock because it was one of the first ideas I pitched to the portfolio managers in my first analyst job 15 years ago. Felt great diving into it again after such a long time. As usual, the TLDR summary upfront will hopefully help you to digest it.
If you have always found Biotech intriguing, but struggled with how to approach it, this article is for you.
TLDR Summary
Biotech has had a rough few years with disappointing R&D results and a necessary deflation of the 2020/21 sector bubble. Yet its long-term future remains bright. Biotech allows for coding biology. As nature’s programming language, it will continue to push the boundaries of innovation in medicine.
There are however two main problems with Biotech investing. Firstly, investors will often have to accept binary risk where outcomes hinge entirely on the success or failure of a single clinical trial. Secondly, the complexity of the business tends to attract charlatans who are great at story telling, but weak in actually delivering on their promises. Biotech is the ground zero of meme stocks. Markets eventually uncover these frauds. But that can take years and cost investors a lot of money.
As a supplier of Biotech production and R&D equipment, Sartorius offers exposure to this industry as a whole without the binary risk. They will simply serve whoever succeeds in cooking up new blockbuster drugs. A role similar to what NVIDIA is to the information technology industry (although part of me hates making this analogy for its cheapness).
The company has done tremendously well for the last twenty years. They were the first mover on single-use bioreactors which allow for cost-efficient and flexible drug development and production. This created a marvelous success story that abruptly ended in 2022 when demand for vaccines went over the cliff and Biotech companies started dialing back their R&D programs.
The stock is currently down 70% from its high. There are signs for an industry turnaround. There is growth in the company’s consumables business which points to a rising capacity utilization that should eventually launch the equipment business as well. But investors are not yet eager to buy into it. Guidance is still cautious and it’s uncertain what sustainable growth rate the company will ultimately settle for. That uncertainty might create opportunity.
To understand the investment case for Sartorius requires knowledge about the Biotech industry as a whole and how the company fits into it.
History of Biotech
The Pharma industry was established in the early 20th century following significant scientific progress in the understanding of chemistry in the 19th century. The invention of aspirin in 1897 could reasonably be used as the beginning of the era of rational drug design.
For the coming decades, drugs were mainly manufactured through chemical synthesis, i.e. cooking up various compounds together and let them react into the desired final molecule. Most of these drugs were classified as so called small molecule drugs given their simple structure.
Biotechnology entered the stage in the 1970s and 1980s following scientific progress with recombinant DNA which is about using enzymes as tools to manipulate the DNA of microbes to make them produce the desired final molecule in a process that you probably know well: fermentation.
This process itself is obviously not a novelty. Using microbes as factories to convert naturally occurring substrate molecules into desirable product molecules via fermentation is a superpower that mankind has utilized for thousands of years. Think about the invention of beer 6,000 years ago in Mesopotamia for example. What made the 1980s biotech revolution possible was the convergence of pharmacology with information technology.
The ancient Mesopotamians had no clue why the magical juice formed when their grains rotted. They probably stumbled across it by chance and then appreciated the result. We are also still pretty clueless. But our rapidly increasing ability to process and store information has enabled us to brute force solve biotechnological challenges. We can perform tons of experiments and simulations to manipulate the DNAs of microbes to see what compounds they poop out and whether those are any good when applied to our bodies.
Using fermentation in drug production has greatly accelerated innovation in this space. It created powerful drugs and it allows the development of tailored treatments for patients.
Over time, this has created marvelous returns for the shareholders of those companies that made the right bets. To name two of those:
Amgen famously pioneered Epo which helps patients with kidney disease and athletes with a strong affection for gold medals. Their stock is up 140,000% since their IPO 40 years ago.
Genentech came up with synthetic insulin. Over time, this pumped the stock from a $260m valuation in 1980 to $100bn when it got bought out by Roche in 2009.
These were two of the earliest Biotech success stories and both companies managed to operationalize their R&D to churn out new drugs regularly. Biotech has been creating blockbuster products for decades. I don’t have any reason to believe this will stop anytime soon.
There is a problem with investing in Biotech though. Despite all of our technological and scientific progress, biotechnology is still about finding the needle in the haystack. We have an idea how certain compounds should behave in our bodies. But the only way to find out with certainty is by testing them in practice. And this works via clinical trials, the backbone of the industry.
Clinical Trials
Once the safety and potential for efficacy has been explored via pre-clinical research, the Biotech company files an Investigational New Drug (IND) application with the Food and Drug Administration (FDA). Clinical trials are then performed on humans which typically follows a three phase pattern:
Phase 1: Evaluation of safety in a small group of healthy individuals. Typically takes 1-2 years with a 60-70% success rate.
Phase 2: Evaluation of safety and preliminary evaluation of proof-of-concept in a small group of patients. Typically takes 2-3 years with a 30-40% success rate.
Phase 3: Evaluation of safety and efficacy in a large group of patients. Typically takes 2-3 years with a 60-70% success rate.
After the clinical research, the biotech company can submit a New Drug Application (NDA) or a Biologics License Application (BLA). This process is often referred to as Phase 4 and typically takes a year with an 80-90% success rate. The cumulative probability of success is somewhere around 10%.
A clinical trial can be an existential event for a small pre-revenue biotech company. The process takes years, can cost hundreds of millions of dollars and the outcome is highly uncertain. And even if it works, the stock can sell off and stay depressed for a long time creating opportunity costs for investors.
This causes two main issues for investors. Firstly, it exposes them to binary risk. Even the most promising mechanisms are just one bad data release away from their end and even the best analysts have a tough time anticipating that. This makes concentrated investing difficult. Investors wishing to bet on the proliferation of Biotech as a whole therefore must diversify to ensure they participate in the next big thing.
Which leads however to the second problem. The complexity of the industry attracts charlatans that are great story tellers, but lack the ability to actually deliver on their promises. Biotech is the ground zero of meme stocks. Mr. Market will eventually uncover the frauds. But that can take years which can cost investors a lot of money.
Wouldn’t it be nice to invest in Biotech without all of that? A concentrated bet on a winner without binary risk?