New Comments in Yellow
Overview
From an operational standpoint, Qiagen remains a solid company. Over the past few quarters, management has undertaken various cost cutting initiatives to increase operating margins. The programs have worked, as Qiagen will see an estimated 400bp boost to operating margin from 2002 to 2004. Unfortunately, analysts believe that the majority of the costs have been cut, and now it is time to deliver top-line growth to sustain the lofty 20%+ EPS goal.
The lack of visibility on pharmaceutical and biotechnology research spending causes a number of sell-side analysts to have concern for Qiagen’s future. Qiagen sells its R&D tools and kits to both academic and industrial customers. Sales to the latter, mainly large-cap pharmaceuticals, continue to struggle due to uncertain economic and corporate profit growth. However, some improvement was seen in 3Q-04.
Strengths/Opportunities / Weaknesses/ThreatsDominant market share in protein purification and nucleic acid preparation businesses. / Lack of visibility on industrial (pharmaceutical and biotechnology) research spending.
Increased growth in core academic areas such as functional genomics and clinical research. Strong growth in interference RNA. / Multiple contractions in the R&D life science and tool segment due to slowing outsourcing and contract spending demand from large-cap pharma.
Considerable improvement in operating margins over the past few quarters due to sizable cost cutting. / Weakness in European and Japanese markets.
Reasonably strong cash flow and solid 19% long-term growth rate. / Potential risk to NIH budget growth in 2004/2005 causes concern for academic research spending.
Valuation premium to peer group.
QIAGEN is a world-leading provider of innovative enabling technologies and products for separating and purifying nucleic acids (DNA and RNA). Since 1986, the Company has developed and marketed a broad range of proprietary products for academic and industrial markets, including life science research, genomics, gene-based drug discovery, nucleic acid-based molecular diagnostics, genetic vaccination, and gene therapy markets. The company is headquartered in Germany.
Qiagen has a solid business, with expertise in a number of core biotechnology and clinical research areas. The company possesses strong research kit and sample preparation technology, as well as product advantages in functional genomics and protein purification. Yet, the sell-side is noticeably neutral-to-negative on Qiagen due to a lack of visibility on growth to key pharmaceutical and biotechnology customers. Sales to academics remain strong, but with over 50% of the business still seeing questionable growth, most recommend waiting on the sidelines.
Sales
Qiagen is a leading provider of research and development instruments, products, and services. The company conducts business all over the world, with headquarters in Germany, Switzerland, and Maryland. Approximately 50-55% of the global sales are derived from the US, with rest spread throughout Europe, Asia, and the rest of North America. The company offers products in a wide variety of biotechnology and pharmaceutical categories:
Plasmid DNA isolation / AutomationGenomic DNA / Viral DNA isolation / Amplification
DNA gel extraction / Transfection
RNA isolation / Recombinant protein purification
Phage DNA isolation / Contract cGMP DNA purification
The company has strong DNA/RNA isolation market share at roughly 20-25%, and outstanding (pioneering) kit purification products (R.W. Baird).
The chief product category consists of product Consumerables used for research and development. Consumerables account for about84% of the total revenues at Qiagen, with roughly 80% sold directly to academic and industrial customers. The remaining 20% is to molecular diagnostic laboratories that use Qiagen’s products for collaborations or internal R&D. Gene expression and clinical molecular diagnostic sales are among the company’s core growth areas. In 3Q-04, the core business grew 15%. Though this represents a sequential reduction from 125 seen in Q2-04, growth remains well above the industryaverage. and QGENF saw strong demand for its core products. There was improving demand in Japan and selected European countries.Consumerables posted a solid growth of 16%, with demand from all customer segments. Diagnostics and Pharma were the major drivers to this growth. Analysts (UBS, R.W.Baird) believe there might be a rebound in Pharma sales. Qiagen has also entered into a global supply agreement with Novratis to provide consumable products for nucleic acid stabilization, separation, purification and handling as well as for automated instrumentation.
Sales to EU academic laboratories were unusually strong relative to US labs earlier in the year, with a few analysts (Deutsche Bank, Merrill) believing that the EU academic research facilities were attempting to “play catch-up” with their US counterparts. Now, that the conversion to “home-brew” methods is essentially complete, one analyst correctly predicted the EU would slow during the second-half of the year. The 2Q-04 was weak, and it looks like the slowdown has already started. US academic research spending had been robust due to strong NIH budgets in the previous few years. Unfortunately, we noticed one analyst (R.W. Baird) specifically mentions potential cuts in the NIH budget for 2004 as a major risk factor for Qiagen going forward. The top priority of these academic institutions seems to be functional genomics and protein purification, two of Qiagen’s strongest product offerings (R.W. Baird, SG Cowen, UBS).
Most of the analysts feel that molecular diagnostics is a potentially exciting market with increased penetration of existing tests and launch of new tests for infectious diseases and cancer.Most of the analysts expect it to grow at about three times faster than the products used for preclinical research,basic research and clinical research.During 2004-2005 the company is plans to introduce two diagnostic sample preparation kits for in vitro diagnostic purposes.The first one is for blood banks to purify nucleic acids and the second one for extracting virus DNA from blood.
Instrumentation product account for approximately 10% of the total top-line sales. Qiagen uses its instrumentation platform to leverage sales of reagents and other higher growth products (Deutsche Bank, SG Cowen). The main driver of growth in Instrumentation is from automation of clinical diagnostics products. Qiagen’s line extension from GenoVision’s BioRobot M offers a significant opportunity. The company has partnered with Roche to strengthen its molecular diagnostic sales. Qiagen offers sample preparation and automation for Roche’s blood screening research and development. In 3Q-04, QGENF saw strong demand for instrumentation. Instrumentation grew about 21% for the quarter, up from 4%growth seen last quarter.
The third division consists of DNA (oligonucleotide) synthesis, which accounts for roughly 3% of total sales. Sales grew by 1% in 2Q-04. Since Qiagen has divested its Operon synthetic business,Q2-04 was the last quarter its sales were incorporated in Qiagen’s P/L. Qiagen includes siRNA sales in consumerables from Q3-04. Strong siRNA growth and weak oligos were observed in the quarter.However one analyst (Lehman) feels that siRNA is not growing at the desired pace.
2002A / 2003A / 2004E / 2005E / Est. GrowthEst. Consumables / $215M / $258.1M / $290-310M / $340-$360M / 100%+
Est. Instrumentation / $34M / $35.5M / $40-$50M / $40-$60M / 100%+
Est. DNA Synthesis / $37M / $43.6M / $15-$25M / $0 / -
Qiagen has a number of collaborations and alliances that contribute to other income. The other income section increased 65% year-over-year, and consists of: 1) contract services, 2) milestone payments, and 3) licensing technology. Notable alliances are:
Novartis: Qiagen supplies a siRNA library encompassing roughly 3000 potential candidates targeting 30 genes. It has recently entered into an agreement with Qiagen to supply consumable products for nucleic acid stabilization, separation, purification and handling as well as automated instrumentation.
Thermo Electron: Recently announced they will incorporate Qiagen magnetic beads in its Kingfisher nucleic acid purification system.
Merial: Formed a research alliance involving synthetic acid based veterinary products
Roche: Collaboration with Roche Diagnostics on clinical blood screening and nucleic acid testing systems.
Affymetrix: Collaboration using Affymetrix’s microarray technology to optimize Qiagen’s siRNA mediated gene silencing products. The companies will publish their findings on optimized protocols post initial research, in technical notes to researchers.
Memorial Sloan –KeeteringCancerCenter:Qiagen has entered into a supply agreement for patented TOM-protected phosphoramidites for siRNA chemical synthesis. With this MSKCC is permitted to synthesize siRNA molecules to target the human genome using superior nucleic acid chemistry.
The company also partners in research efforts with EPOCH Biosciences. Many analysts (Merrill, Morgan Stanley, R.W. Baird) comment on the strength, but unfortunate lack visibility on how to model these sales. One analyst (UBS) notes that some of the alliances could involve ‘single gene therapy purification columns or service deals’ that may total $1M per contract.
2002A / 2003A / 2004E / 2005E / Est. GrowthEst. Total Revs. / $298.6M / $351.4M / $380-$405M / $400-$470M / 10%-15%
Quick Take: Our digest average for 2004revenue has decreased after Q3-04 release. ().
Margin
Given the struggling sales to large-cap pharmaceutical and biotechnology customers, Qiagen has undertaken significant cost cutting programs to drive EPS. Management cited improvement in manufacturing facilities as a significant driver of gross margins over the past few quarters. Qiagen has a new state-of-the-art facility in Maryland designed to service the US market. The company has operations in Germany and Switzerland, and will expand to Japan next year. The improved scale should create improved gross margin in the years to come (Deutsche Bank).
2004E Margins: / Gross Margin / Operating Margin / Net MarginDigest Average / 67.5% / 23.6% / 14.7%
Qiagen is also working to reduce staff in operations and overhead, and expand staff in marketing and sales. The company hopes the improved employee mix will contribute to higher margins down the line. The cost cutting over the past several quarters will contribute to sizable operating leverage. From FY02-FY04 Qiagen should see an estimated 400bp improvement in operating margin. That is rather impressive, especially since it will occur in the face of weak sales to industrial customers.
The company posted SG&MA expense at around 33% of the total revenues in 3Q-04.That number is expected to be around 33.3% this year. R&D should continue to track at levels seen over the past few quarters – roughly 8% of total revenues. One analyst (Merrill Lynch) is concerned that the low R&D spend in 3Q04 may be detrimental to Qiagen’s long term revenue growth. It is important for companies in the life sciences research tools market to continuously innovate and improve existing products to maintainpricing power and growth in customer demand. The company guided to a slightly lower tax rate (favorable sales mix) the rest of the year. The gross margins improved in Q3-04 to 67.5%. The operating margin in Q3 was 26.2% versus our 24.2%, partly due to cut in R&D expenditure and partly due to the disposal ofthe synthetic DNA business.Please see our QGENF.xls file for more detail.
Quick Take: Our digest average for Operating Margin has decreased slightly after Q3-04().
Earnings Per Share
Earnings visibility is the chief concern for some of the sell-side. Qiagen reported EPS of $0.10 for Q3-04 excluding relocation and restructuring expenses. Operating margins are expected to reach 24% and the EPS is expected to be in $0.36-$0.38(excluding charges) range.
FY-2004 / FY-2005Street Consensus / $0.38 / $0.46
Company Guidance / $0.36-$0.38 / -
Low Estimate / $0.37 / $0.43
High Estimate / $0.39 / $0.49
Weak demand in the Q3-04 in Europe (especially Germany and Italy) was observed due to government funding constraints and weak economic conditions, while rapid sales acceleration was observed in North American pharmaceutical and diagnostics market. This was a disappointment because after strong EU sales in late 2003 and early 2004, analysts were hoping this was going to be a new growth driver for the company. One analyst (Merrill) correctly predicted the slowdown.
There are a number of other swing factors for 2004 EPS. Total sales to academic institutions are roughly half of the top-line, and we note one analyst (R.W. Baird) specifically concerned with the NIH budget for next year. Additionally, others are concerned with the sustainability of the EU academic sales growth. However, the main concern of most sell-side analysts (Lehman, Merrill, UBS) remains large-cap pharmaceutical spending.
Quick Take: Our digest average for 2004 EPS has remain unchanged after the Q3-04()
Long-Term Growth
With the divestment of lower margin businesses (Operon and Rapigene), analysts (Morgan Stanley, R.W.Baird) believe Qiagen is demonstrating its focus on high-growth and high margin opportunities. One analyst (R.W.Baird) believes that Qiagen has reached a stable operating structure that can support future revenue growth and future operating leverage. Analysts (Morgan Stanley, Merrill, R.W.Baird) believe that Molecular diagnostics should provide an exciting market to Qiagen. They feel the company is well positioned to reap the benefits of the strong growth posted in this area. Analysts (Lehman, Morgan Stanley) believe that Qiagen should benefit from the several new product introductions in the 2H-04. However, at the same time, one of them (Lehman) believes that Qiagen has to book an aggressive growth of 70% in each of the remaining quarters in order to meet the management’s guidance. They are concerned by the continued weakness in instruments and at the same they also think that siRNA’s growth might not be as robust growth as expected.
Sales of functional genomics and protein purification remain the hot areas for academic laboratories. Clinical diagnostic products remain strong in Instrumentation and Consumerables. One analyst (SG Cowen) believes that the company entered a turning point for Instrumentation sales in the Q203. Unfortunately, the potential for reduced academic growth in 2004 warrants caution.
Our digest average for long-term growth rate is roughly 18.5%. Our CAGR from 2004-2006 EPS is roughly 22%.
We believe as visibility into industrial sales growth (50% of sales) improves, the sell-side may begin to model more aggressive long-term growth rates.
Quick Take: Our digest average for LTG Rate has decreasedslightly after the Q3-04 ().
Target Price/Valuation
Analysts are divided over valuation. While analysts (R.W.Baird, UBS, Deutsche Bank) believe the valuation is reasonable and justified due to its leading position, improving margins, higher growth rates and increased focus on profitable opportunities, others (Lehman, Merrill) have concerns regarding valuation and believe the such a lofty premium to the stock is unjustified. One analyst (Merrill) has given a price target of $7.6 which is lower than the current price of $11.03 as they believes the present valuation does not take into account the slow-down in demand from customers in Europe and Japan which might not reverse in the near future.
Based on a current price of roughly $11.03, and using management’s guidance of $0.38 for 2004, the stock sell for approximately 29X earnings. That is a slight premium to what we have found for Qiagen’s peer group (ABI, IVGN, WAT, TECH, AFFX, BCOR, MIL) at roughly 22X. If we incorporate the long-term growth rate of19%, we calculate a PEG of 1.7X. Again, that is a slight premium to the 1.25X PEG we calculate on the peer group. Some analysts (Lehman, Merrill) are concerned with this premium, believing that the lack of visibility on earnings growth warrants more of an in-line valuation.
Our digest average price target of $12.27 yields a 32X multiple using our digest average EPS forecast of $0.38 for 2004.
Additional Conversation
The company announced that effective January 1, 2004 the current CEO, Metin Colpan, will step down to take a Senior Technology Advisor role. Current CFO, Peer Schatz, will assume the CEO position. Many analysts believe Mr. Schatz is ready to take control, and that this has been in the works for months. The sell-side views this as a non-event (CSFB, Lehman, Morgan Stanley, R.W. Baird, SG Cowen, Smith Barney). Qiagen announced its intention to issue $150 million of senior unsubordinated convertible notes, due in 2024 to institutional investors outside U.S. The company intends to use these funds for general corporate purposes such as potential repayment of higher interest debt, further acquisitions etc.
Upcoming Events
Date / Event / CommentsIndividual Analyst Opinions
POSITIVE RATINGS
Morgan Stanley – Overweight ($16.5):The analyst states,“Fundamentals for the business appear to be intact with management reiterating 4Q04 guidance and mid-teen revenue growth for FY05. Qiagen’s business appears to be on track while the company’s life science peers have announced mixed 3Q04 results. We retain our Overweight rating on the stock and €11.90 price target. We expect Qiagen’s differentiated growth profile versus its peers to become clearer over the next 12-18 months. The company is positioning itself for the opportunity
presented by molecular diagnostics - an area forecast to grow at a 20-30% CAGR.”
R. W. Baird – Outperform($15): The analyst states,“QGENF reported Q3-04 revenues and earnings in line with expectations and reported improving conditions in recently sluggish markets including Japan and Europe. Strong instrument sales were reported along with the launch of a new CE-marked diagnostics sample prep system. We think QGENF continues to deliver industry-leading organic growth with improving profitability. We are modestly increasing our EPS estimates and anticipate upside to 2005 estimates. We recommend purchase with a $15 price target.”
NEUTRAL RATINGS
Deutsche Bank – Hold ($12.5): The analyst states, “QIAGEN represents a high quality pure play investment in
consumable products used to increase the productivity of life science researchers and in molecular diagnostics.
While greater detail will be had at the Q2 conference call on the individual businesses, it was the core consumables