Introduction

Thermo Fisher is a global supplier of scientific instruments, consumables, and services to accelerate life sciences research and manufacture life-changing vaccines and therapies. Thermo Fisher is a market leader (about 20 per cent share) in the $225 billion life sciences market that is growing four per cent to six per cent each year. They are a trusted partner to pharma and biotech customers, big and small, in providing mission-critical products and services to advance new medicine. These products and services range throughout the full drug development cycle, from the early stages of discovery and research to running clinical trials and manufacturing medicine on behalf of biopharma firms. This broad value proposition has allowed them to stand out among competitors, realize strong growth in authorizations/bookings, and gain market share. Thermo Fisher is continuously investing in that value proposition and will do so either organically or through acquisitions.

We view Thermo Fisher Scientific as a core long-term holding in our fund.

Less Cyclical and More Defensive Portfolio

Over the last five to 10 years, life science tools and services businesses have shifted their portfolios to more defensive and less cyclical end markets such as pharma and biotech. In addition, revenue profiles have shifted to more recurring revenues. The average mix of recurring revenue for the sector is about 60 per cent of overall revenue (vs. about 40 per cent in 2010). In a research note, Jefferies analysts ran correlations against macroeconomic variables. The data suggests that life science tools and services businesses are less economically sensitive today than they were in previous periods. This is a result of the shift into defensive end markets and recurring revenue models.

According to Jefferies’ research:

“Looking back at ‘09/GFC, peak-to-trough organic growth for the overall sector went from +6-7 per cent to -4 per cent, while certain defensive and insulated company’s saw much shallower troughs (~flat). Today, many more companies fit into this more defensive basket with >50 per cent recurring revenues, and thus, would likely fare much better in a recessionary environment (approx. +low-single-digit troughs).

“We analyzed 0ver 20 years of quarterly organic growth data for our core Tools coverage and ran extensive correlations against ~50 macroeconomic variables across ~350 scenarios. Our data indicates industry organic growth has become less correlated to the macro, with only four variables significantly correlated (vs. 32 over 2001-2013/24 in 2001-2017).”

Studying Thermo Fisher, we have seen their revenue profile and end market exposure evolve since the 2008 financial crisis. Thermo Fisher has significantly reduced the cyclicality of group revenues by cutting industrial and applied market exposure (today about 13 per cent vs. about 30 per cent in 2008). These are cyclical and macroeconomic-sensitive markets that are more likely to be negatively impacted in a recessionary period. In turn, Thermo Fisher has more than doubled its exposure into the faster-growing and less cyclical pharma and biotech market, including sub-segments like biologics, specifically in cell and gene therapy and mRNA platforms (today about 58 per cent vs. about 24 per cent in 2008). This has been achieved by way of organic investments in R&D and multiple strategic acquisitions like Patheon, Bio Brammer, and mostly recently, PPD (e.g., prior to the acquisition of PPD, Thermo Fisher’s pharma and biotech represented almost 30 per cent of group revenues). Pharma and biotech is the company’s largest customer set, and over the last five years, has averaged almost 14 per cent in organic revenue growth.

Thermo Fisher has seen a sizable shift from selling capital equipment (i.e., instruments with slow replacement cycles) to a recurring revenue model of services and consumables that now represents 82 per cent of total revenue (vs. 65 per cent in 2008). This has been a strong focus for the company. Looking at the biosciences business, for example, it generates revenues of over $5 billion, of which 90 per cent is recurring in nature (made up of reagents and consumables). The company’s recurring revenue base consists of high-margin, single-use consumables for instruments (e.g., single-use bioprocess containers for lab centrifuges). These instruments typically form a closed system. In other words, they will only operate by using their own branded consumables. This results in a relatively sticky, durable revenue stream and “locks-in” the customer over the lifetime of an instrument, which ranges from five to twelve years.

The lack of exchangeability in consumables—and importantly, the regulated processes where consumables are used—allows for more pricing leverage in the lifetime cost of consumables. The life science industry is rewarding in terms of having stable and increasing prices over time. Thermo Fisher has never been in a period where they’ve seen deflationary pressures on pricing. Company-wide, Thermo Fisher raises prices on average 50-100 basis points each year. This year is different. The life sciences industry is offsetting the impact of rising inflation through strong pricing activity in the market. Thermo Fisher says pricing is expected to be at least double their normal rate. Thermo Fisher expects the pricing activity to be permanent in the revenue base. There is no expectation of pricing to come back down to previous levels. In other words, if an item that priced at $1.00 increased to $2.00, the item will not revert back to $1.00.

Final Remarks

We believe Thermo Fisher is a wide-moat business as defined by their high recurring revenues, pricing power, durable cash flow, economies of scale, and high barriers to entry in regulated markets. Thermo Fisher has a highly defensive mix of recurring revenue (>80 per cent) and favourable end market exposure that is less cyclical. We believe the company is well positioned to take advantage of secular demographic trends (e.g., aging population, people living longer, and more instances of chronic diseases) that are contributing to pharma and biotech’s strong growth. Rapid advances in vaccine and therapeutic technologies are fueling health care’s long-term growth prospects.

There is a record number of pre-clinical and clinical pipeline projects for biologics and advanced modalities (e.g., mRNAs, gene and cell therapy, monoclonal antibodies, etc.) that will drive higher usage of life science tools and services. Remember that all of these projects will come to clinical research over the next few years, and then commercialization if they are granted FDA approval. This will benefit the likes of Thermo Fisher’s contract research organization (CRO) via PPD that conducts and collects the data from the human trials required for drug certification. When pharma and biotech customers are ready to choose their drug manufacturing partner, Thermo Fisher has a complementary contract development and manufacturing organization (CDMO) via Patheon and Bio Brammer that can be mobilized to mass produce and bring new medicine or research formulations to market.

All in all, Thermo Fisher is in a very unique position as a trusted partner in the pharma and biotech industry.