Medios - $ILM1

A recession-resilient healthcare microcap with a secularly-growing end-market and single-digit earnings multiple.

Investment Summary

Medios is a European healthcare company which operates predominantly in Germany and the Netherlands (with smaller presences in Belgium and Spain). They have two main business lines: a wholesale business and a compounding business. Both segments have an emphasis on “specialty pharma”, a rapidly growing segment of the pharmaceutical market. The wholesale segment operates in Germany where it is the largest player in the market with a ~14% share. The compounding business offers outsourced compounding services for pharmacies and hospitals. Within Germany, the focus is chiefly on the compounding of specialty pharmaceuticals, but with a recent acquisition (Ceban) they now also compound a broader range of pharmaceuticals in the Netherlands and Belgium. They are the leader in the compounding of specialty pharmaceuticals in Germany, yet only have 4% market share. The market is still dominated by in-house compounding at pharmacies and hospitals (in ballpark of ~85% of market), but there is a strong trend towards outsourced compounding driven by rising regulatory burden and favorable economics. This is a tailwind for Medios’ compounding segment and there is an enormous opportunity to take share from in-house compounding.

Specialty pharmaceuticals are “a recent designation of pharmaceuticals classified as high-cost, high complexity and/or high touch.” Such medicines usually cost >$800 per dose, often involve special compounding tailored to the individual, and are a rapidly growing portion of the pharmaceutical market thanks to their success treating a range of indications (often for rare/chronic diseases). The growth of specialty pharma is also underpinned by an aging global population, with extending lifespans leading to higher frequency of rare diseases. Despite Medios’ position as a niche market leader in several segments of this growing, recession-resilient end-market, it trades at a lowly ~7x multiple of 2025 earnings. I therefore believe it represents a compelling investment opportunity, and believe fair value is at least double (maybe triple) the current price.

A Closer Look at The Company

Medios was formed via successive mergers of smaller companies with the goal of being the “leading European specialty pharma company”. In June of 2024 they completed their acquisition of Ceban, which has operations in the Netherlands, Belgium and Spain. Prior to this acquisition, Medios’ operations were solely in Germany.

The company reports in three segments. First is the wholesale segment which is referred to as the “Pharmaceutical Supply” segment or “PS” segment. This is a classic wholesale business operating in Germany where Medios sits in between the large number of specialty pharma manufacturers and the large number of pharmacies and hospitals. Essentially they handle the logistical challenge of taking large deliveries from the many pharma companies, holding inventory, and breaking inventory into the smaller deliveries needed by pharmacies/hospitals on a just-in-time basis. Pharmaceutical wholesaling is tightly regulated in Germany with the purchase price and selling price usually dictated by regulators. Because of all the acquisitions, it is difficult to determine exactly how rapidly this segment has organically grown in the past, but the company has reported that organic growth for the combined PS and compounding (PST) segments has been 21% on the topline from 2017-2023. Growth has slowed down over time as the business matures with organic growth of the PS segment at 17% in 2021, 3% in 2022, 9% in 2023 and 12% in the first half of 2024. While it is difficult to see margins expanding much from current levels due to tight regulatory oversight, the rapidly growing end market means this segment should grow at a steady clip moving forward.

The second segment is the “Patient Specific Therapies” segment or “PST” segment. This is the offsite compounding segment in Germany. As with the PS segment, there is significant regulatory oversight in this industry with compounders earning a fixed €100 fee per preparation on top of a margin tied to price. In many cases, as with the PS segment, this margin is fixed, but in some cases only the sale price is fixed and Medios has the opportunity to source ingredients more cheaply. The purchasing scale Medios has thanks to its large wholesale operation is a boon for the PST segment in this regard. There is a certain regulatory cadence here to margins and the ability to earn higher margins relative to the PS segment is a bit of a double-edged sword, as the market has discovered recently. Drugs go off-patent and there is a window where Medios can source generic ingredients more cheaply and earn super-normal margins. Regulators allow this for a period, presumably to encourage companies to find the cheapest possible ingredient sources. Regulators then drop the mandated selling price to fix margin back at a typical level.

Recently, the PST segment has had margins hammered by regulators dropping selling prices, which I think goes a long way to explaining the local cheapness of the stock. I think the market is being excessively short-term here. In addition to the expanding end-market, growth in this segment is supported by a trend towards out-sourced compounding. This is both because regulators prefer the higher standards maintained by dedicated compounding facilities (GMP), and have hence been encouraging this transition via increasing regulatory burden, but also because it just makes sense economically. A sell-side research firm offered the following example (paraphrasing): Consider a hypothetical drug that comes in 100ml vials and costs >€1000. Imagine the average actual dosage for the drug is 80ml. An individual pharmacy who only has one patient using the drug will waste 20ml, whereas a dedicated compounding facility with 10 patients can simply only order 8 vials. The PST segment was growing strongly organically until the end of 2022 when the regulatory environment worsened leading to negative organic growth through the first half of 2024. While I don’t have much insight into the exact details and timing of pharma regulations in Germany, I believe that the company is implying in their earnings guidance that the worst is over. Such margin compression also naturally can only go on for so long as regulator’s intent is not to begin driving compounders out of business. The tightening margins naturally push smaller players underwater first and hence ultimately encourage more pharmacies/hospitals to outsource the work to Medios.

The third and final segment is the “International” segment, which is composed of the operations of the recently acquired Ceban. By EBITDA, I estimate this segment is ~60% offsite compounding (similar to the PST segment but not exclusively specialty pharma), 20% “Active Pharmaceutical Ingredient” (API) sourcing and 20% local pharmacy. The API segment is basically a sourcer/distributor of the raw ingredients used in compounding. The potential synergies with Medios’ existing German compounding operations are obvious. The local pharmacy chain, comprised of 23 pharmacies operating in the Netherlands, carries the “Medsen” brand name and has been pitched as an important source of information for the other, larger segments of the company.

Earnings & Valuation

Putting all the segments together and estimating Ceban EBITDA margins for the individual segments I get to roughly 46% of 2023 EBITDA coming from the wholesale operation (PS), 40% coming from the outsourced compounding operations (PST and Ceban compounding), 7% coming from Ceban’s API segment and 7% coming from the pharmacy chain. In 2023 the companies in aggregate did €89.5M of EBITDA adjusted for non-recurring expenses. Management has guided to €110M of adjusted EBITDA for 2025. This would imply a growth CAGR of close to 11%, which seems very achievable to me, despite the continued headwinds in PST, because of the underlying industry growth and the obvious synergies that can be realized when combining companies of this small size. The company should see expanded purchasing power, cross-selling opportunities (most obviously launching APIs through Medios’ existing network in Germany and the launch of cytostatic compounding in the Netherlands) and significant back-end cost synergies. Management has met their guidance in each of the last three years despite the tumult from major acquisitions in 2020 and 2021, and I think is incentivized to be a bit on the conservative side with guidance so as to give themselves a reasonable bar to clear. Taking their $110 of adjusted EBITDA guidance I can get to €2.16/sh in adjusted earnings:

Note that officially reported earnings are understated due to a significant ongoing amortization of acquired intangibles that needs to be adjusted for when assessing go-forward profitability.

So at €15/share the company is only trading ~7x my 2025 earnings estimate and will have a YE24 Net Debt / 2025 EBITDA of only ~1.2x. This low multiple is inappropriate in my view given the non-cyclical nature of the business and the high potential for steady growth as the specialty pharma market continues to expand and compounding mixes towards offsite. I am currently targeting an 18x multiple, which on my 2025 numbers would give a price target of ~€39.

Catalysts/Why Is This So Cheap?

Back in 2020/21 Medios traded at a peak of just above €40 despite the lower earnings / FCF generation at that time. I believe the reason was that Medios was perceived as a recession-resilient grower with a long runway for both organic growth and inorganic growth as it “rolled up” the fragmented compounding market. The price came crashing down in late 2022 when the regulatory actions that hammered the PST segment started to come into view. Investors may have realized they knew less about the company/industry than they thought. Another factor weighing on the stock might be the lack of public comps. Medios has many competitors, but none of them are public. I have been unable to find a comparable that reasonably approximates Medios’ business mix and hence have relied on my intuition to set a target multiple. The lack of a broad comparable pool may make Medios somewhat isolated and less well policed.

The catalyst here I think are the next 3 half-year earnings reports (so 2H2024 and then the 2025 reports). If Medios delivers on its 2025 targets that will greatly simplify the story and underscore the low multiple. In order to reach my target multiple I think we will also need to see evidence that the compounding segment is returning to growth which will prove my thesis that the recent weakness is just a local dip in an upward trend.