Aenova – European CDMO Market Update

1.

Before we dig into Aenova, I think it’ll be useful to set some context of the wider CDMO [contract development and manufacturing organisation] market dynamics. How should we be thinking about the magnitude of input cost and raw material inflation for oral solids, soft gel and semi-solid manufacturing CDMOs today?

2.

To confirm I understood, there is a significant difference in CDMOs’ ability to pass on cost increases depending on their core focus? Oral solids, soft gels, and semi-solid CDMOs, which by nature focus on more commoditised services, are more exposed to the aforementioned pressures given the level of competition, the pricing environment and the customer type, ie, generics, than a sterile manufacturing operation?

3.

I appreciate it’s difficult to average out across the generic and/or innovative customer segments, but if we take a run-of-the-mill, oral solid, soft gel and semi-solid manufacturing CDMO – to what extent can they pass through costs via price increases? Are we talking 1-2pp of the roughly 10% inflation we’re seeing today at maximum? Do you see that 1-2pp being the best- or worst-case scenario?

4.

Going back to oral solids, this is an intensely competitive market. If in your example where a CDMO wants to pass on EUR 0.05 of the EUR 0.10 cost increase to this hypothetical EUR 1 product, realistically speaking, how often can they do that? Aenova notes in its 2021 annual report that it believes this to be feasible because of the high switching costs for customers, but in context of today’s macroeconomic environment and the level of competition especially for the more commoditised oral solids, how sticky are these customers in practice? How should we be thinking about the price elasticity of demand?

5.

We’re using Aenova as a case study here, but I suppose this applies to other CDMOs as well. Any increase in pricing in the short term will potentially have longer-term ramifications, ie, after the 3-5-year period, we could see customers – especially of more commodity-esque CDMO services – look to switch to other suppliers that haven’t risen their prices as much or otherwise have a more competitive cost base. Is that a fair summary?

6.

Can you walk me through the robustness of Aenova’s contracts and the company’s ability to bake in pass-through clauses? If you look at certain CDMOs, such as PolyPeptide in the peptide CDMO market, management alluded in its recent earnings that it is having a hard time passing through costs and in addition to other variables, have issued a profit warning. Indeed, specialists in previous Forum Interviews have noted as such – Polypeptide contracts were not particularly watertight, didn’t allow for effective cost pass-through, and were designed to attract customers in the first instance. What’s Aenova’s approach to contracting with its customers? What does that mean for the company’s ability to offset the supply chain cost inflation going forwards?

7.

If you look at Aenova’s recent performance, how much of that do you think has been driven by its ability to pass through cost and increase pricing to the end customer? How much runway is there for continued price increases going forward?

8.

Do you think Aenova’s performance over the last nine months was sustained or driven by the company passing through costs to, and increasing pricing for, customers? If so, how long is that runway to continue doing so going forward? Or, do you think Aenova has not yet managed to pass through the majority of its cost increases? If the latter, does this represent an upside that could materialise over the next six months or so?

9.

On the CRO [contract research organisation] side, having spoken to a former executive from Iqvia a couple of times over the past few weeks, we have been hearing about a slowdown in biotech and pharma RFP [request for proposal] volumes. Does the same apply for CDMOs?

10.

It seems as if the slowdown and decline of CRO RFPs is a leading indicator for CDMO RFPs. What is that lag timeframe there? Are we talking a few months, weeks, or something more material like 1-2 quarters?

11.

We have heard of significant lay-offs at biotechs over the past few weeks, and Catalent recently lowered full-year guidance and alluded heavily to cash-sensitive decisions being made by customers, including pipeline re-prioritisation. It seems as if we are nevertheless seeing some impact on demand for CDMOs’ services. If RFPs are not being hit, are we seeing a cancellation of the contracted backlog and therefore a decrease in the magnitude of the backlog being converted into revenue?

12.

To confirm, we aren’t seeing a similar phenomenon at Aenova as we are with Catalent. However, there will likely be a lag effect and that will trickle down to Aenova, but likely over the course of 1-2-3 years vs anything under 12 months?

13.

To play devil’s advocate, Catalent isn’t only exposed to the biologics and C&GT [cell and gene therapy] markets because it does have the PCH [pharma and consumer healthcare] business. In the company’s recent earnings, Catalent lowered guidance in part due to lower consumer discretionary spending for CHC [consumer healthcare] and we therefore saw customer inventory destocking. Management cited significantly deteriorating trends over the past couple of months. Aenova also has a fairly large exposure to CHC business, at least by my understanding. How significant is this destocking phenomenon by CHC customers and how does that feed through to Aenova?

14.

How significant is the CHC category for Aenova as a percentage of revenue, broadly speaking?

15.

Only 10% of Aenova’s revenue is exposed to any significant headwinds from a demand perspective over the next 12 months, in your view. Is that correct?

16.

Let’s shift gears and dig into Aenova in a bit more detail. Just to ensure we’re all on the same page, can you outline Aenova’s CDMO services, its core competencies by end market and a rough revenue split across customer buckets including innovative and generic pharma?

17.

To tie into what we discussed around RFP volumes and book-to-bill dynamics, we’ve heard it’s really the pre-commercial emerging biotech companies that are suffering the most due to the current R&D funding crunch. Therefore, it seems Aenova is not exposed to that. Equally, the company isn’t exposed to the most resilient customer segment, the big pharma group, but the upside there is that perhaps Aenova has more leeway with pricing. Is that a fair summary?

18.

You mentioned that roughly 10% of Aenova’s business is coming from CHC companies. Could you split out the remaining 90% across innovative vs generic?

19.

Presumably Aenova will have difficulty raising prices for an oral solid manufactured for a generics company? Especially given your typical generics businesses – especially the commodity generics segment – operates at razor thin margins. Aenova is probably mainly increasing pricing with its innovative mid-size pharma which is roughly 30% of revenue. Is that a fair summary?

20.

Do you see a world where Aenova is essentially selling its oral solid manufacturing services for generic companies at cost over the next 12-24 months? We’re hearing that these commodity oral solid generics players – such as Sandoz and Teva – are already sometimes selling at, or very near, cost because of, for example, European reference pricing or due to the threat of the lower-cost Indian manufacturers that have a far more competitive cost, hence why western incumbents are increasingly pivoting or attempting to pivot into speciality generics. If Aenova’s generic customers are already nearly selling at cost, given this sharing principle you outlined, will Aenova have to do something similar?

21.

Going back to the revenue split across modalities, if you look at Aenova’s 2021 annual report, core oral solids is roughly 57% of revenue, semi-solids and liquids is 17% and soft gels is an additional 17%. However, the company has been talking about investing in sterile technologies and diversifying away from its core base over a number of years. How successfully do you see Aenova doing so and when do you see all of the previous CAPEX that had been invested in new technologies translating into revenue?

22.

Do you think Aenova has invested enough CAPEX to diversify? The company has spoken about investing in its Italian site for sterile injectables. I will admit that I’ve forgotten the exact amount, but from memory, it didn’t seem significant.

23.

If memory serves me correctly, Aenova CEO Jan Kengelbach previously noted the investments into the company’s sterile site in Italy could be used for mRNA vaccines and MRI tech more broadly, but given the level of investment so far, it’s unlikely Aenova will be working with players such as Moderna and BioNTech in the near term. Is that a fair assumption?

24.

I’d like to discuss Aenova’s recent performance, because based on previous Interviews and what I’ve heard of the market, the company has had operational issues historically. Essentially, it overextended with its plant acquisition strategy and ended up with multiple under-utilised plants, delivery delays and other supply chain issues. How has the turnaround been going over the past few years and what is Aenova’s quality and reputation among customers now?

25.

We’ll talk about capacity and integration dynamics in a few minutes. Going back to Aenova’s quality and reputation with customers, I suppose a good proxy for that would be how much attention the company’s booth was getting at the recent CPHI [Convention on Pharmaceutical Ingredients] conference, which we were discussing prior to the Interview. Relative to 2016, 2017 and 2018, how much attention has Aenova been getting at these conferences? How much buzz is there around the company’s presence?

26.

What’s been Aenova’s approach to winning new business? If you look at its annual report from 2021, it has 450 customers today and the company highlights securing an additional EUR 125m peak sales worth of new deals, of which EUR 48m was in oral solids, EUR 48m in semi-solids and EUR 29m in soft gel, so on what basis is it securing that new business?

27.

Why hasn’t Aenova been able to attract new customers? Does it lack the business development team?

28.

Given you said Aenova typically generates new business with existing customers as opposed to finding new customers, to what extent do you think the additional capacity the company is building out for HP [highly potent] or sterile manufacturing has already been booked by its existing customers? If you look at Lonza, it has a rule of thumb where 60-70% of capacity has to be booked or contracted out before it even begins a CAPEX project. Does Aenova follow the same principle with its new technologies, in that it gets existing customers to contract its future sterile capacity, for example, ahead of time?

29.

Thinking about how Aenova has been winning new business or penetrating its existing accounts further, a key customer KPC [key purchasing criteria] is default to delivery and fill and on-time, and it seems as if 89% of deliveries are now on-time, according to the 2021 annual report. Is 89% good enough, and what is the expected standard for a best-in-class CDMO?

30.

Do you think the 89% level is sustainable or expandable? Can Aenova increase that, given everything we’ve discussed around supply chain challenges and the site integration issue that we’ll talk about next?

31.

Can you elaborate on what you mean by integration issues and indeed, the level of utilisation on average across the 15 plants Aenova has in Europe?

32.

From a utilisation standpoint, I think you mentioned oral solids businesses are always struggling with utilisation to an extent, how should we be thinking about the percentage utilisation of Aenova’s oral solid sites, for example, as a consequence of this lack of integration?

33.

Thinking about the potential consequences of this lack of integration, if you look at Aenova’s accounts published in the 2021 annual report, it seems as if the CAPEX requirements remain fairly high, and the company notes it plans to increase CAPEX to expand production capabilities and increase productivity. I think CAPEX as a percentage of revenue was 7.96% in 2021. How do you see the magnitude of Aenova’s CAPEX evolving going forwards, and how much of that will be used to integrate sites?

34.

The increasing productivity aspect piques my interest. Instead of investing CAPEX into new technologies and expanding into sterile, it seems as if Aenova is having to invest significantly in its existing sites in improving productivity, as perhaps exemplified by only EUR 10m going into the HP-API [highly potent active pharmaceutical ingredient] site. How long do you expect that level of CAPEX allocated towards increasing productivity at existing sites to go on for and how significant is that as a percentage of total spend?

35.

If you look at the totality of Aenova’s manufacturing base today, do you think the company will have a higher maintenance CAPEX requirement than peers?

36.

Do you think Aenova will have to change its capital allocation priorities going forwards because of its debt load coupled with rising interest rates due to the inflationary environment? Otherwise put, will the company have to de-prioritise some of its CAPEX projects and if so, what does that mean for future growth?

37.

You mentioned how Aenova hasn’t invested significantly in the new technologies and the company is already, to a certain extent, playing catch up. If it were to hypothetically de-prioritise a number of CAPEX projects going forwards in order to service its debt, would it ever be able to catch up again?

38.

I think it’s important to discuss the corporate culture at Aenova given the ability to attract and retain talent plays an important part in the ability to service demand. Former Chief Commercial Officer Friedrich Sernetz recently left the company, and there is mention of a reorganisation of the sales department as well. How are you thinking about the corporate structure and culture at Aenova?

39.

I may be reading into your comments a bit too much, but has Aenova’s corporate culture translated into significant staffing turnover? Looking at the 2021 annual report, which I appreciate is fairly dated by now, the number of employees seems to have decreased YoY. There may be a coronavirus phenomenon at play there, but how successfully do you think the company has retained and attracted talent?

40.

How competitive are the wages Aenova can offer?

41.

You mentioned 2% of the workforce at Aenova is missing, based on its open positions, but if we think about staff turnover per year, do you think the company is seeing a greater turnover than industry average?

42.

Is the company somewhat hamstrung in its ability to grow in steriles, HP-APIs and some new end markets where talent is even shorter in supply due to its corporate culture?

43.

Let’s talk about the growth outlook for Aenova. Going back to what we discussed around new business, the company notes that its win rate – and I assume by win rate, it means RFP conversion – is around 23%. Euroapi says in its recent investor presentation that the typical RFP conversion rate in the industry is 20-30% so it seems as if Aenova sits squarely in the industry benchmark range. Would you agree with that or would you say the company’s RFP rate leaves something to be desired?

44.

If you were to benchmark Aenova’s RFP conversion rate, appreciating it’s hard to understand what goes into this number, and measure that metric according to industry standard – not how Aenova measures it in the 23%, but as other competitors would measure it – do you think the company is in line with peers or is it behind?

45.

Aenova has noted it has signed new business worth EUR 125m at peak. Oftentimes, there are multiple assumptions that go into a peak sales estimate and sometimes include blue sky scenarios. If everything goes well, Aenova will generate EUR 125m but usually the world isn’t perfect and peak sales forecasts need to be adjusted. Is there an industry rule of thumb for how we should be adjusting CDMO peak sales estimates into what is recognised in practice? Ie, typically, should we assume 80% of peak sales is what is typically recognised by these CDMOs? Or is it close to 100%?

46.

What do you think are the key growth drivers for Aenova in the near-to-mid-term?