Analysis of CellaVision, 2017

CellaVision is a Swedish company founded in the student city of Lund. It provides software and hardware products for the hematology medicine market. The products are by far the most popular ones in their niche market, making CellaVision the industry leader in a market with strong support from megatrends like demographic change and digitalization. Furthermore, the company is innovative and moving into neighbor markets at a high pace. At a P/E of 55, it’s also one of the most expensive shares on the Stockholm Stock Exchange though. Also, the combined estimated size + growth of its current markets doesn’t give the company an extensive room for growth potential – which is crucial at such valuations.

Products

CellaVision develops hardware and software products for laboratories in the healthcare and veterinary markets. It operates in the hematology branch of medicine, which is the study of diagnosis, cause, treatment and prevention of blood disease. The products make a niche part of the hematology market – digital microscopy and cell counting – more efficient and qualitative. It reduces the time it takes for laboratories to analyze blood samples, while standardizing the process – allowing for greater quality in the assessments. It allows a laboratory analyst to become an editor, rather than having to author the whole book (metaphorically).

Hardware products:

  • DM9600: Can analyze up to 30 slides (with blood samples) per hour and has almost 100 slides in loading capacity. This product is marketed towards large laboratories.
  • DM1200: 20 slides per hour in capacity, 12 slides for loading. Aimed at large and medium-sized laboratories.
  • DI-60: A jointly-developed product together with Sysmex, CellaVision’s main distribution partner. This product prepares slides for analysis from blood samples received from hospitals.

(For the veterinary market, just add -vet to the product names)

CellaVision’s software products are products with -application or -system in their names. Basically, they visualize the analysis made by the hardware, categorizing and presenting blood cells of interest, and creates patient profiles.

A DM1200 or DM9600 costs around $150,000 (DM9600 is more expensive). Considering that the analysis can become up to 50% faster, and that it frees up time for the laboratory personnel (with high salaries), there is a compelling case for the products.

CellaVision is developing additional products, aiming towards the medium-sized and smaller laboratories. The release of these products is expected to be in 2018.

Geographies

USA is the company’s primary market, with about 50% of the revenue. Due to rapid growth, China has now claimed the runner-up spot here. CellaVision has offices all over the world, and establishes in new markets at a rapid pace – in 2016-2017 alone it doubled the number of countries where it has a market organization.

Business model

CellaVision develops and markets hardware and software products within digital microscopy and cell counting for hematology, but it has outsourced the production, and the distribution, to other parties. Regarding the distribution partners, CellaVision has agreements with all the top companies in hematology (the parent market) – Sysmex, Beckman Coulter and Siemens. Together these three own more than 90% of the current market.

From the graph, we can tell that the company has a scalability in the business model. As the revenue increases, so does the margin. CellaVision has mentioned that it will have to start paying (more) tax this year though, as it has absorbed all the tax shields from previous years of losses. At the same time, it has improved its supply chain. The margin is likely to stay high.

The products that CellaVision sells doesn’t bring reoccurring revenue streams, but the systems are replaced every 7-10 years. Therefore, an aftermarket has started to form itself.

Customers

CellaVision has three different customer segments within hematology:

  • Large laboratories
  • Medium-sized and smaller laboratories
  • Veterinary laboratories

For large laboratories, the primary buying criteria are efficiency and price. Secondary, CellaVision has identified a need for establishing local offices for market support. For medium-sized and smaller laboratories, the same quality must be achieved, but the need for capacity is reduced and the price is more important.

Employees

CellaVision seems to have a good relationship with its co-workers:

  • Sick absence is at 1,2%, compared to 3,5% for the overall Swedish statistics
  • Employee turnover at 8%, which is also very solid, compared to just above 20% for the benchmarking segment
  • Bonus incentives for all employees. Only 1/2 of the monthly salary on a yearly basis though

The salary is SEK 34,000 per month, after employment tax and excluding group executives, on average. This is not outstanding, but not low either.

Executives

Among executives, there are incentives to develop the company well in the long-term. A 12% insider ownership is spread out among the CEO and a few board members. At today’s share price, there’s been a reduction of the insider ownership by 3%, which makes it less appealing.

CellaVision seems to be recruiting executives primarily from outside of the company. The (quite new) CEO, Zlatko Rihter, is such an example. He did give a strong impression in an article I read about him though, and he has a background in medicine from the companies Gambro and Getinge.  But Zlatko is not the only new person in the executive team, 6/7 has left since 2012. This could mean trouble, I don’t like to see such high turnover among top executives. At the same time, the company is a different beast today than five years ago, and that might require different executives.

The salary level of the CEO is at SEK 2,6 million, and for the other executives its SEK 1 million. This is in line with similar companies.

Valuation + Key financials

CellaVision has experienced exceptional growth, especially in profits, since 2012. A ROA of 34% is among the highest on the Stockholm Stock Exchange. The valuation is also among the highest though, with a P/E ratio of 55, even when including the first quarter of 2017, which was brilliant.

Financially, the company is doing great too. It holds no long term nor interest carrying liabilities, and has a debt/equity of 20%, which must be one of the most defensive financing strategies I’ve seen in a company. This creates possibilities for more offensive expansion, maybe through acquisition of technology in other parts of the blood analysis value chain.

60% of the profit becomes dividend. At today’s valuation, this is certainly too high. With a P/E of 55 it gives a dividend yield of just above 1%, and that’s not great. CellaVision should reinvest more in the company to capture the remaining market share, or to expand into areas with strong synergy. In my shareholder-biased opinion.

During 2016, CellaVision improved its supply chain by moving its production in Lund to a subcontractor. The change will show in the income statement in mid-2017, with improved profit margin as a result.

It’s not safe to say that the margins will improve bottom-line though. This is the first year that the company will have to pay full tax. Earlier, it was able to use investments/losses in the business to accumulate tax-shields, but now these are gone.

Market

The market is taking advantage of two strong trends – digitalization and demographic change. The average lifetime of a human being is increasing, and old people require more healthcare. Furthermore, biomedical analysis is a part of the labor force that finds it hard to attract young people. So, we have an increase in demand and a decrease in supply. This is where CellaVision’s products comes in. Even though these megatrends support the market, the company only estimates it to grow by 2% per annum.

What’s in CellaVision’s favor here, is that most of the market is still consisting of manual microscopy and cell counting solutions. CellaVision estimates that it has a 16% market penetration for large laboratories, and that competitors have a negligible part at 1% (see the part about competitors later).

The markets that CellaVision is interested in are:

  • Large laboratories (SEK 1 billion per year), where CellaVision has a 16% penetration
  • Medium/small laboratories (SEK 500 million per year), negligible penetration
  • Veterinary laboratories (SEK 100 million per year), low penetration – but recently orders have increased a lot

These numbers are based on a fully penetrated market. CellaVision themselves states that instruments will be replaced every 7-10 years, let’s say on average every 8 years. In that case, the value of the remaining penetration in the market is:

  • Large laboratories: SEK 6,6 billion
  • Medium/small laboratories: SEK 4 billion
  • Veterinary laboratories: A little bit less than SEK 800 million

CellaVision has a good chance of being the company to do the remaining establishment in the market, considering that the competitive landscape is weak.

In adoption theory, it always takes time before an innovation gets acceptance among customers. The products of digital microscopy and cell counting for hematology seem to have moved out of the “Early adopters” period, and entered the “Early majority” part. This would mean that stronger growth is on the horizon, which the results in 2016, and especially in the first quarter of 2017, agrees with. In 2016, 25% of the laboratories that upgraded their instruments (digital or manual) bought a solution from CellaVision.

Also, the number of tests will probably increase in the future as other parts of the healthcare system becomes more digitalized and efficient. Examining blood before a disease breaks out could be very useful, but it’s too costly with today’s healthcare system. Other parts of the value chain, i.e. the manual labor required to take blood samples from humans, are bottlenecks.

Competitive landscape

The company states that it’s the only company in the world with a global, commercial acceptance in the field, and that they have gained governmental approval more than anyone else. Sales of any other company is limited.

Agreed that the competition is limited. It is concentrated and it was quite time consuming to find them (meaning that they don’t promote themselves that well, or that my research skills are inadequate). Anyways, four competitors were identified:

  • Medica Corporation, with the solution EasyCell
  • Roche Diagnostics, with the solution Cobas m511
  • TissueGnostics, with the solution HemoFAXS
  • Horn Imaging, with the solution HemaCAM (bankrupt)

Medica Corporation

Medica Corporation is a company based in the US with 160 employees. It markets and sells clinical chemistry analyzers, electrolyte analyzers, hematology analyzers (CellaVision’s market), blood gas analyzers and OEM ISE modules (whatever that is). In 2010, the company released the product EasyCell, which also got approved by the Food and Drug Administration (FDA), the American version of Läkemedelsverket. It can analyze 12 slides per hour and has 30 slides loading capacity, which makes it a competitor for the DM1200 product, but probably not for the DM9600. EasyCell doesn’t have a complementary product for staining/smearing (preparing) the slides. Medica has a good network of distributors, just like CellaVision. For instance, it has a partnership with Sysmex as well, so the deals are non-exclusive. The company market its products as “the affordable solution”.

Roche Diagnostics

Roche Diagnostics is a global competitor with offices all over the world. It offers products in pharmaceuticals, solutions for diagnosis (CellaVision’s segment) and products for researchers, with 94,000 employees in 150 countries on a group level. The product is called Cobas m511, and was released in the beginning of 2017. It doesn’t have FDA approval yet, which I see as a sign of weakness, as many of the company’s other products have it. The features of the product isn’t great either. It has a capacity of only 10 slides per hour. It does have a large loading capacity of 500 slides though, and the preparation of slides is done automatically.

The Cobas m511 is CE-marked, so it’s allowed for selling in countries accepting that. This excludes CellaVision’s core market, the Americas, and the Pacific area, but includes most countries in Europe.

There’s somewhat of an “innovator’s dilemma” for Roche in this niched segment – it’s too small to be a part of their core business, so it might be hard to rationalize allocating a lot of resources to it. This is in favor for CellaVision.

On a side note, Roche makes quite entertaining videos, describing the workflow of its products, considering that it doesn’t operate in the most amusing business. The company has chosen to showcase its products to the sound of epic music, see link https://www.youtube.com/watch?v=6P-jaC3_d3o (note that this isn’t the Cobas m511).

Horn Imaging

Horn Imaging was a competitor for CellaVision up until 2014, when it filed for bankruptcy. Its product, HemaCAM, was developed together with scientists at the Fraunhofer Institute for Integrated Circuits IIS. The product never achieved any commercial success before the bankruptcy.

TissueGnostics

A competitor active in tissue analysis, antibodies and blood screening. Its product, HemoFAXS, was released back in 2008, and the company filed for FDA approval back then. From what I can see, it has no approval yet, and it doesn’t communicate anything regarding commercial success for the product. I interpret this as a sign of weakness. Furthermore, TissueGnostics’ product is more of less a copy of that from Fraunhofer Institute/Horn Imaging, which has filed for bankruptcy. Also, the company doesn’t have the same network of distributors as CellaVision does.

The software of the companies seems similar, at least the front-end. The analyzing time of the slides is what really differentiates, and CellaVision has the most rapid analysis on the market with one slide every 2 minutes for the premium product. Another thing that differentiates when it comes to product features, is the preparation of slides. CellaVision and Roche have products that do this automatically, while Medica and TissueGnostics don’t.

Regarding innovation, Roche is not comparable, as it just released its product, but CellaVision is outstanding compared to Medica and TissueGnostics when it comes to updating their product/service offering.

For geographies, it’s tough to make a comparison. Roche should be considered the top candidate here, as it has offices in 150 countries. But CellaVision has a strong network of distributors which it uses for international sales. Furthermore, the company establishes offices at a fast pace – doubling the number of countries that it has market organizations in during 2016-2017 alone. Medica is somewhat lagging here, but does have strong partnerships as well. TissueGnostics is falling behind, neither its presence nor distributors impress.

Overall, I think it’s fair to agree with what CellaVision communicates regarding competition – it is outstanding in its niche market. The commercial success of its competitors is limited to a market share of around 1%. The remaining market share of 83% (for large labs), that manual microscopy makes up, is pretty much CellaVision’s for the taking as the current situation is. One eye should be kept on Roche and its solution though. If it gains FDA approval and start to communicate more interest in the market, I would be less optimistic.

Moat

CellaVision has a better product than its competitors, both among manual and digital competitors. Higher quality through standardized processes and greater efficiency through faster analysis are just two of many compelling arguments for the products compared to manual alternatives.

Apparently, the technology is hard for competitors to copy. Not only must they get around the patents that CellaVision possess – 24 families and 58 registered ones – they also need to get FDA approval for their solutions. This is easier said than done, considering that Roche, an international giant in the business, can’t get one. Furthermore, CellaVision is the industry leader and has a high-quality brand reputation, and a first-mover’s advantage.

Risks

Subcontractors and distributors are an important part of CellaVision’s business model, which increases the operating risk compared to having it in-house. On the other hand, it creates an efficiency and lever that the company wouldn’t be able to achieve on its own. On the third hand (whatever), CellaVision has strong long-term partnerships. The deal with Sysmex, for instance, was established almost 15 years ago.

Single customers make up a substantial proportion of the revenue still. In 2016, the larges one amounted to 30%, the second largest 20%, and the third largest 12% of the total. That’s more than half of the revenues gone if three customer relations go south.

The company is also somewhat affected by the business cycle, as the cost of the systems are rather high. Even though the case for the company’s products is compelling in the long-run, laboratories might push the investment into the future a few years if a recession hits.

Almost 50% of the revenue comes from the United States, while almost 100% of costs are accounted for in Sweden. The currency relation between US dollars and Swedish crowns is therefore of importance. In the long run, this shouldn’t matter too much, but it could have a significant effect on the revenue in the next, say 2-3 years. Especially with Trump steering the ship.

Although it doesn’t seem likely today, there’s a risk for disruptions in the market as well. I would consider the risk to be low though, as it’s CellaVision who’s the disruptor of the manual microscopy and cell counting market, which still has more than 80% share.

Other

Roche is a large competitor, who also has proven its willingness to consolidate the market and acquire smaller ones. In 2013, it bought the Bloodhound technology (now integrated in its Cobas m511 solution) when it acquired the competitor Constitution Medical. Therefore, a buyout of CellaVision can’t be excluded.

DCF

The company has a goal of achieving 15% organic growth and an EBIT-margin of 20%. I think this is a conservative goal to set due to their current market position.

What worries me is the estimates that CellaVision makes regarding its own markets. With a total yearly size of SEK 1600 million (large labs + medium/small labs + veterinary), a market growth of 2% per annum, and a conversion rate (share of labs upgrading equipment that picks CellaVision) at 25%, it is very difficult to justify the current valuation. At least if you want to achieve a 15%+ yield yearly.

For CellaVision to be able to yield that, according to my model, we must assume that either:

  1. CellaVision’s estimates about the market is wrong – the market is substantially larger and is growing at a higher pace
  2. Roche, or some other medical company, sees extensive synergies with current operations, and decides to buy the company
  3. CellaVision moves into other markets with larger size and faster growth

I don’t want to bet on any of these cases. CellaVision is innovative, so number 3 could be a possibility, but it has a lot to do in its current markets already as it is. The company just got a few orders from veterinary laboratories, and will be moving into medium/small human ones during 2018.

Because of this, the CellaVision share gets one out of five elks.

What do you think of CellaVision? Is the company low-balling the market estimations on purpose to keep competitors away? Let us know in a comment!

For more investment tips (hopefully scoring more elks), stay tuned!

NOTE: I owned CellaVision shares up until 8/6-2017

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