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Evotec AG (EVT-DE): A risk-diversified approach
Recommendation: OUTPERFORM
Target Price: EUR19.40 (increased from EUR13.00)
Current Price: EUR15.50 (cob on 14^th March 2018)

KEY TAKEAWAY

The CRO market continues to be highly attractive and only a few players are positioned as main consolidators. Evotec is well underway to become a main player in this field. The company recently completed multiple successful transactions and formed attractive agreements with drug manufacturers. In addition to our detailed bottom-up analysis for EVT's iPSC platform, we have modelled a top-down view of the CRO market and EVT's potential market share in the mid- to long-term. The underlying drivers of the CRO industry and Evotec's robust business model suggest strong, steady share price momentum for many years to come. We believe that EVT is set to follow a strong, relatively de-risked long-term upward trend. In this report, we describe parallels between EVT's approach and other successful healthcare business models. We reiterate our OUTPERFORM recommendation and raise our TP to EUR19.40 (from EUR13), representing c.25% upside potential. Most of this upside potential is related to the still underappreciated iPSC platform, which we value at EUR994m (EUR8.7/share).

Pharma productivity dilemma benefits Evotec - Pharma companies used to be fully vertically integrated from preclinical research to clinical research, marketing, production, packaging, distribution and tail-end product management. The consolidation of the drug industry and the poor output on innovation in the last decade have resulted in a significant slowdown in earnings growth. Evotec is in a sweet spot to benefit from this productivity dilemma. Our Pharma outsourcing composite has outperformed both Biotech and large cap pharma significantly.

Strong outsourcing trend from Big Pharma / Biotech benefits the CRO business model - Poor historic returns from R&D investment and an increasing complexity of ever emerging new tools and platforms become more difficult to manage for drug manufacturers. The increasing pressure to launch more blockbuster products stems from the dilemma of ever-growing large cap marketing platforms due to distressed consolidation. This situation makes it harder to deliver sustainable and long-term earnings expectations from in house products.

Consolidation in a still fragmented CRO market will drive strong earnings acceleration for Evotec - The increasing complexity of emerging technologies requires larger players who can bring them onto one platform and optimise for best possible results. Smaller players can no longer compete on a stand-alone basis and acquisition multiples in this field are therefore likely to contract.

Recent agreements and transactions create significant value - EVT combines latest drug discovery technologies for an optimised and state of the art approach for modern R&D. It has announced attractive agreements with Sanofi, Bayer and Celgene, validating the technology from the strongest drug manufactures, and completed the highly accretive acquisition of Aptuit. We believe there is ample upside from future agreements. Both a strong outsourcing trend from Pharma and a highly fragmented CRO market represent healthy and sustainable earnings drivers.

Pricing power and more product rights will drive value of best-positioned CROs - The best CROs will become inevitable partners for large and mid Cap Pharma/Biotech looking to overcome their in-house drought of pipeline assets. Venture Capital-driven early-stage Biotech will remain an option to overcome this problem. However, we believe CROs will increasingly benefit from the early-stage biotech price frenzy with growing contract volumes. Assuming CROs will come up with successful products, then the established players will enjoy pricing power with higher royalty rates and larger milestones.

We reiterate our OUTPERFORM recommendation and raise our TP to EUR19.40 (from EUR13), representing c.25% upside potential.

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Kind regards,

goetzpartners Corporate Research | Research Team
Martin Brunninger | Analyst

goetzpartners Corporate Research
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