Can New Management Drive New Growth At Techne?

| About: Bio-Techne Corp. (TECH)
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Techne (NASDAQ:TECH) has always been a little different in the realm of publicly-traded life science companies. While the company's headquarters are pretty pleasant once you're inside, the surroundings are a pretty nondescript commercial/light industrial zone. Likewise, it's a little strange to sit down as an analyst with a management team that tells you they will not do road shows or conference calls, and doesn't much care whether they get any attention from Wall Street at all.

None of this is meant as a criticism against the company - management was always unfailingly polite and helpful to me in my analyst days, and the company's stock has generated excellent returns over the past 20 and 10 years. Where there is an issue, though, is in the more recent performance, where Techne has notably lagged other life sciences companies like Thermo Fisher (NYSE:TMO), Sigma-Aldrich (SIAL) and more specialized/focused companies like Illumina (NASDAQ:ILMN).

I'm optimistic about the potential for new management to put Techne on a more growth-oriented footing, not only with an expanded international focus but also perhaps a wider view of the company's addressable market opportunities. While I could see bull-case upside into the low $80s for Techne, that requires a level of transformation that is pretty aggressive. A more probable trajectory suggests Techne is close to fair value today, but still offers good near-real time exposure to life sciences spending.

Starting From A Solid Base

Wherever new CEO Charles Kummeth takes Techne, he will be starting from a very solid base. Techne is a leader in the production of purified proteins (particularly cytokines), antibodies and biochemistry assay kits. As many of Techne's competitors are components of much larger companies, it can be challenging to generate market share numbers. Using journal citations as a substitute, Techne would appear to have the #1 position in proteins with roughly 30% share (more than double #2) and the #1 position in ELISA kits with over 40% share (against more than double #2).

So many things about Techne are a little different from the norm, and its core business plan is one of them. Where companies like Thermo Fisher and Illumina talk about focused product development guided by close client relationships, Techne takes an approach more akin to carpet bombing than surgical strikes.

Techne maintains as many as 1,000 genes in its development pipeline, first looking to commercialize a protein, then antibodies and finally immunoassays. All told, each gene typically results in three to 10 products produced over a nine- to 12-month window. Even more interesting, Techne doesn't really develop these products with an idea of which ones will be successful. Rather, Techne lets the market decide - it often takes eight to ten years for a product to reach maturity, but once it does the revenue contributions can go on for a very long time (about 10% of the company's sales are from products more than 20 years old).

If readers are wondering why Techne operates this way, it is because it is difficult to determine which genes will be clinically or commercially relevant. While "discovering" a gene isn't all that complicated (relatively speaking), figuring out what it does can take quite a long time. Only as researchers investigate the function of genes, their proteins, and their antibodies does it become clear which are most interesting from a research or commercial perspective.

Competing On Quality And Quantity

Techne owes its strong market position to at least two important factors. First, when a customer needs a cytokine, antibody or assay kit, there's a pretty good chance Techne produces it. That sort of scale is important, but it doesn't necessarily separate Techne from rivals like Life Technologies (NASDAQ:LIFE), Sigma-Aldrich, Becton Dickinson's (NYSE:BDX) BD Biosciences, Merck KgA, General Electric's (NYSE:GE) Amersham or Bio-Rad (NYSE:BIO).

The second component of Techne's edge is the quality of its products, which in this case means consistency. Researchers absolutely hate variability in their research materials, as it can dramatically impact results and complicate the experiments. There aren't too many published "bake-offs" comparing Techne's products to its competitors, but those I've managed to find suggest a much tighter range of batch-to-batch consistency for the reagents sold by Techne, and that would certainly help explain why the company's products are frequently chosen by researchers.

Is It Time To Spend Money To Make Money?

There are a lot of good things about Techne's model from a financial perspective. The use of FIFO inventory accounting and long inventory lives boost cash flow, and the company's in-house manufacturing and minimal backlog are good for margins.

I do wonder, though, if the company has been too focused on margins for its own good. The 10-year revenue and operating income growth rates of 9% and 12% look good, but that growth has been fading and the three-year growth rates are 6% and 3%, respectively. The company has a very small quota-carrying sales force, and that's not such a big deal in the U.S. where the company's reputation is firmly established. The company's reputation is not so strong in China, though, and that's where a lot of the real growth potential in life sciences is likely to be over the next decade (or more).

The question now, then, is what Techne and its new CEO Charles Kummeth can do to stimulate growth. The company's hematology calibration controls business (where it is #3 behind Danaher's (NYSE:DHR) Beckman and Streck) isn't a real growth opportunity, and the company's investment in ChemoCentryx (NASDAQ:CCXI) isn't likely to lead to a buyout (it's hard to imagine Techne wanting to go into drug development).

Given that Techne's board highlighted Kummeth's experience in international operations and M&A when he was hired, I think that's where the growth emphasis is going to be. The company's sales to China were up 25% in the fiscal third quarter (the most recent quarter) while sales in the U.S. were down by single digits. So investing in the manufacturing, distribution and sales infrastructure to grow the China business seems like low-hanging fruit.

The M&A side is harder to predict. While there are numerous potential targets in areas like clinical diagnostics and biological products, many of these companies are small, private and relatively unknown outside of the science/research community. That puts investors in the unenviable position of having to basically just trust that management will "figure something out" and deliver better revenue growth in the coming years.

The Bottom Line

Due to the nature of Techne's business, it has often been a good real-time indicator of business/operating conditions in the life science and academic research markets. To that end, the 4% decline in biotechnology revenue this quarter (including 25% growth in China and nearly 10% growth in non-China Asia sales) cannot be too encouraging for shareholders in Life Technologies, Thermo Fisher, Sigma-Aldrich or Bio-Rad. It likewise reflects the difficult operating environment that Techne faces - a large percentage of the company's customers depend upon government grants for funding, and that pipeline is not looking so strong right now.

Techne scores very high in terms of quality, and that generally keeps the shares from getting too cheap, even when growth fades for a time. To that end, my expectation of 5% long-term revenue and free-cash flow growth points to a fair value of $66.25, or almost identical to the current price. While going with the "they'll figure something out" hypothesis and assuming that revenue growth will re-accelerate to 7.5% on a long-term basis would lead to a fair value in the low $80s, I'd need to see more detail about management's plan to re-accelerate growth before investing on the basis of that scenario. Consequently, Techne looks like a high-quality "hold" and a candidate for the watch list, but not a compelling buy today.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.