New Holdings - IDEXX Laboratories and Cryoport

Gareth Campbell - Fund Manager

10 June 2020

Over the last few months we have added two new healthcare businesses to the portfolio, IDEXX Laboratories and Cryoport. They are very different businesses but share the common characteristics of being global market leaders with high barriers to entry and excellent long term growth opportunities.

New Holding – IDEXX Laboratories

IDEXX Laboratories is the largest animal diagnostics business in the world. They serve the market through point-of-care tests at veterinary surgeries and a network of large outsourced laboratories.

Why did we invest?

Pet ownership and the amount owners are willing to spend on their pets has been increasing for decades. Increasingly people see a pet as one of the family and where possible want to give it the same standard of care that any other family member would receive. IDEXX Laboratories has played an important role here, as their broad suite of diagnostic tests help inform veterinarians leading to better treatment outcomes.

The animal diagnostics industry is growing faster internationally than in the US, as spending on diagnostics is increasing to levels already seen in the US. In emerging markets this faster growth is combined with rising rates of pet ownership. We see a very low probability of these factors reversing their trend and agree with IDEXX Laboratories’ management that it could support industry growth of 8%+ for the next 20+ years.

The majority of revenue is from selling the chemistry used in every diagnostic test. This business model creates a predictable recurring revenue stream. As they add new tests to existing equipment the proportion of recurring revenue has increased from 81% of sales in 2010 to 89% of sales today.

High Barriers to entry

IDEXX Laboratories is the market leader and invests 5% of their sales in R&D every year, raising the hurdle for competition. The absolute investment in R&D is more than all of its other competitors combined so we think it is unlikely that competition increases over time.

It offers an unrivalled breadth of products and services making it one of the most important suppliers to any veterinary surgery. An example of its value to customers is its IDEXX 360 program which helps finance diagnostic equipment for new veterinary practices. The cost of starting a veterinary surgery limits new practice formation so this a great way to help veterinarians start their business and for IDEXX Laboratories to lock in a growing revenue stream for 6 years with a very grateful customer.

IDEXX Laboratories is also one of the leading providers of the software veterinarians use to run their practice. As customer data is recorded on this software it is rarely replaced. Increasingly it’s adding new features which improve integration and workflow efficiency.

Private pay reduces price deflation risk

As an ageing human population puts increasing financial strain on global healthcare budgets we think price deflation will be inevitable for healthcare equipment and services which aren’t unique or offer compelling value.

This is why the majority of our investments in healthcare are focused on leading and unique technologies with very high barriers to entry, which we think are less at risk from price deflation.

All animal health treatments are paid for privately, either out-of-pocket or through pet insurance claims. This means IDEXX Laboratories avoids one of the main risks that is likely to impact the rest of healthcare over the long term.

Timing Opportunity

Concerns about the impact of veterinary surgery closure and transmission of the coronavirus through pets caused the share price to fall significantly in March. We don’t think either of these factors dramatically alter the long term growth opportunity of the business so we used it as an opportunity to build a new position.

New Holding – Cryoport

Cryoport is the global leader in managing logistics for cellular therapies.

Cellular therapy involves injecting living cells into patients. It is one of the biggest breakthroughs in therapeutic research for decades as it has very broad applications such as cancer treatments, cures for genetic disease and stem cell therapy.

Living cells are either multiplying or dying and these changes in cell composition can impact the effectiveness and safety of a treatment. For that reason they have to be shipped at -130C, which puts the cells in stasis (essentially asleep).

Cryoport use specialist shipment containers which are cooled to -190C using liquid nitrogen, they can stay below -150C for up to 10 days enabling global shipment of cellular therapies. Physical logistics are supported by advanced monitoring equipment and software which tracks key variables to ensure the therapy arrives in perfect condition.

Why did we invest?

There are currently over 1,000 clinical trials using cellular therapy technology, of which Cryoport has around 40% market share. As a clinical trial progresses through the different stages towards regulatory approval the number of treatments increases and so does the revenue to Cryoport.

With over $12 billion spent annually on cellular therapy R&D the early stage trials which fail will be replaced with new therapies, while every successful approval significantly increases the long term addressable market for Cryoport. We believe this has created a unique portfolio of over 400 recurring revenue streams with different probabilities of commercial approval.

Cryoport has invested in infrastructure to support these launches. These costs mean the business currently is loss making, but the capital required for growth is low and with over 50% gross margins we expect that as the number of commercially approved therapies increases we should see a significant improvement in margins, returns on capital and strong free cash flow; key attributes of an HL Select business.

High barriers to entry

Cryoport’s combination of services and software create a “chain-of-compliance” which monitors location, temperature and shock along with multiple other variables for every delivery.

This level of oversight isn’t important for your typical Amazon delivery, but if the package is worth over $1 million and a patient’s life may be at risk if it doesn’t arrive in perfect condition, the need to ensure service quality becomes obvious.

The quality of its service can be seen in its partners which include UPS, Fedex and DHL. They are the global leaders in logistics and collectively have a market cap of $150 billion, but they’ve decided to outsource managing cryogenic shipments to Cryoport rather than compete directly with Cryoport.

Customers are highly risk averse

Reinforcing every aspect of Cryport’s barriers to entry is its customer base which is notoriously risk averse. Therapeutic companies spend on average over $900 million developing a new treatment so customers are unwilling to take chances with unproven competitors.

Raising the bar

Cryoport’s technology and digital-focused strategy differentiates it from peers and constantly raises the bar of customer expectations. For these reasons we are confident that longer term Cryoport will continue to play a key role in the logistics of cellular therapies.