SourceBio reinvesting for post-Covid business
SourceBio International PLC (AIM:SBI) (Source), a UK-based company, provides clinical and drug development laboratory services to blue-chip pharmaceutical companies, the NHS and private clinics. Source operates three core business units: healthcare diagnostics, genomics, and stability storage, and has a non-core infectious disease diagnostic testing unit.
Source is now emerging from two years of a global pandemic in which its infectious disease unit running COVID-19 PCR tests dominated sales. In 2020, infectious disease testing generated £34.5mln in sales at a gross margin of 39.6% with 758,000 tests administered. In 2021, Source went on to generate £73.6mln in testing sales at a margin of 38.8% with 2,100,000 tests run. This gave Source £33.3mln in year-end cash. It is using this to boost its core businesses.
The infectious disease business unit is due to be wound down over the next 12 months as the demand for COVID testing diminishes. Both funds and staff are being redirected from the infectious disease unit towards healthcare diagnostics, specifically cellular pathology. Pre-empting the projected decline in COVID sales, Source boosted its cellular pathology business by acquiring LDPath Ltd, a private digital pathology company. The transaction was completed in March 2022 for a cash payment of £18.5mln. In the 12 months to 31 January 2022, LDPath generated revenues of £4.6mln, with an EBITDA (underlying earnings) of £0.4mln and £0.3mln gross profit.
In 2021 (FY21), Source’s core business units made modest profits despite reduced demand for its COVID-related services. With surgical procedures and pharmaceutical research returning to or exceeding pre-pandemic levels, Source is seeing increased demand. Management notes that the shortage of pathologists and backlog of elective surgeries provides ample market opportunities, so Source aims to gain more of the NHS outsourced services. The LDPath acquisition improves Source's pathology offering, and gives additional expertise in digital pathology and case management, a nucleus of private healthcare clients, and artificial intelligence (AI) capabilities; however, future growth needs long-term NHS contracts and this can be a slow process.
Source's market capitalisation stands at just under £100mln (early April) with £33.3mln net cash as of 31 December 2021. It is debt-free following the 2020 initial public offering (IPO). The two years of high COVID-19 testing generated strong cash inflows. FY21 total revenue increased by 82% to £92.4mln, up from £50.7mln in FY20. The gross profit rose to £36.2mln (FY20 £19.8mln) with an adjusted FY21 EBITDA of £24.1mln (FY20: 14.2mln).
Looking forward, Source is investing in its core operations and has the cash (about £15mln post the LDPath acquisition) to invest to achieve strong organic growth. In FY22, the rapid decrease in COVID-19 testing will inevitably cause a reduction in overall sales and EBITDA.
Year end Dec 31 · 2020 · 2021
Revenue £-mln · 50.74 · 92.40
EBITDA (£M) · 14.2 · 24.1
Revenues by half year and business unit are shown in Graph 1. This clearly shows the explosive growth in infectious disease revenues from the second half of 2020 (H2FY20). We note that this growth will have required huge efforts from management and staff. After a H2FY20 pandemic dip, total core business unit revenues have shown underlying growth to nearly £10mln in H2FY22, and we expect this to continue in FY22.
Source’s cash (as of 31 December 2021) was £33.3mln. The acquisition of LDPath Ltd cost £18.5mln in March giving about £15mln before changes in working capital. This is a very healthy amount to support investment into the core business and to absorb the decline in revenues during the transition to a post-COVID business. SourceBio raised £35mln at its IPO and became debt-free. High cash, in-demand pathology services and no debt put Source in an advantageous position to gain new business with the NHS.
Key Financials
Graph 1 - Half-year revenue growth
Graph 2 shows reported business unit profits in financial years 2020 and 2021. Core units made £7.7mln gross profit on £18mln of sales — a 41% gross margin.
The FY21 financial statement shows extra costs attached to COVID-19 testing, notably that distribution costs in H2FY21 increased to £2.7mln vs £0.7mln in H1FY21 making £3.7mln for the full year vs £1.6mln. We assume these costs will scale back. The admin costs in FY21 rose due to Source's listing and to increased business to £11.6mln (FY20 £8.2mln). In FY22, LDPath will bring extra admin costs before any rationalisation. Hence, we expect to see careful cost control as the COVID-19 cash flow diminishes. There is a possibility, in our view, that Source might show a negative FY22 EBITDA as it adjusts costs and as it invests in its core activities and marketing. This will become clearer with the interim FY22 results.
Graph 2 - Business Unit Gross Profits
Cellular pathology pivot
As part of its transformation into a post-COVID-19 healthcare company, Source is directing funds and resources into developing its healthcare diagnostics business unit, primarily cellular pathology — the examination of patient tissue pre- and post-operation, typically, but not only, in cancer removal. This generated promising growth pre-pandemic, reaching around 40% year-on-year through 2018 and 2019. Source has developed a network of Royal College of Pathologists-registered consultants to provide a full service for the sectioning, processing, staining and analysis of tissue samples on self-prepared and pre-prepared slides. 2021 saw healthcare diagnostics generate £6.4mln in revenue, grossing £2.1mln at a margin of 33.3% — close to a 10% year-on-year increase in profit margin.
Management predicts that the shortage of pathologists in the UK and the backlog of elective surgeries caused by the pandemic will result in high volumes of outsourced cellular pathology work. Hence, we expect healthcare pathology to be a high-growth business. H1 and H2 2021 saw 40.6% and 68.9% growth in healthcare diagnostics revenue respectively, making it the fastest-growing core business unit, albeit from a depressed pandemic H2FY20. Future growth prospects are predicated on the extent to which Source can capture a share of outsourced pathology services as the NHS tackles the surgical backlog over the last two years. A long term issue is whether Source can gain stable, contracts. Here the LDPath acquisition could unlock significant future growth potential.
Figure 1 - Pathology work flow
Source: FY21 results presentation
Strategic digital pathology acquisition
Source acquired LDPath Ltd in March 2022 for £18.5mln. In the 12-months to 31 January 2021, LDPath generated £4.6mln in revenue with an EBITDA of £0.4mln, and £0.3mln in profit before tax. This acquisition gives Source innovative digital pathology infrastructure and expertise (75% of LDPath's business is digital).
This digital capability could be crucial for increasing sales to NHS since digital infrastructure dramatically reduces turnaround times for tissue examinations from almost a week to as little as one day (Figure 1). By supplying LDPath's well-designed pathology lab management software to hospitals, Source should be able to create long-term relationships since this technology does not appear to be available to many NHS trusts.
In the long-term, Source’s integrated digital infrastructure could allow it to hire Royal College-trained pathologists across the world to allow for even more rapid turnaround times for image examination across time zones. Source believe that digital pathology is best placed to tackle the challenges of cellular pathology demand in the post-COVID-19 healthcare environment in terms of efficiency, capacity, and cost.
Genomics
Source’s genomics business unit consists of DNA sequencing for research and clinical discovery. Source provides both Sanger sequencing and Next Generation Sequencing (NGS):
- Sanger is the industry gold standard for single-strand DNA analysis. It is excellent for shorter sequences.
- NGS uses highly automated and expensive equipment to read in parallel multiple DNA strands enabling whole genomes to be rapidly sequenced.
Other methods, such as nanopore sequencing can be used. Source is agnostic as to the technology.
Genomics saw a revenue increase of 17.6% in 2021, Chart 1, after low sales in H1FY20 presumably affected by lockdowns closing customer labs; however, in FY21, the revenue stream from Sanger sequencing decreased from £1.6mln to £1.3mln between H1 and H2 while NGS increased from £0.9mln to £1.1mln. This disparate growth in revenue streams reflects management’s investment in a new NGS system from Ilumina in 2019. We expected that NGS will make up an increasing proportion of the genomics business.
Chart 1 - Genomics sales by method
Source: ProActive Graphic, Source reports
Chart 2 - Stability sales by category
Source: ProActive Graphic, Source reports
Stability Storage
The stability storage operation is split between:
- storage services for stability trials of pharmaceuticals and medical devices;
- servicing and validation of said manufactured equipment for customers; and
- manufacturing of temperature and humidity control equipment.
Source operates stability facilities and services in the UK, Ireland, and US.
The largest of these three revenue streams is stability storage which generated £3.8mln in sales in 2021. These are typically three-year projects where the product is stored under controlled conditions and tested at intervals. These are legally required tests.
Service and validation generated £2.3mln. These services are crucial for validation to make the stability data acceptable to regulators.
Manufacturing and supply of the specialist equipment for companies to do their own storage tests generated £0.9mln. This is a more marginal business for Source.
H2 2021 saw a slight decrease in overall revenues for the Stability business unit from £3.9mln to £3.56mln. This is attributed to the 43.5% decrease in the manufacturing revenue stream in H2 2021. The storage revenue stream saw modest H2 2022 growth of 8.1%, Chart 2, and servicing remained roughly the same. Despite this, the stability storage business unit continues to far outperform the other core businesses in terms of gross margins, with a 2021 gross margin of 50.6% compared to genomics at 38.7%.
Winding down testing operations
Source’s non-core infectious disease business unit took advantage of the dramatic increase in testing during the initial outbreak of COVID 19 in 2020, and through the omicron variant wave at the end of 2021. Source’s Nottingham facility had a testing capacity of roughly 10,500 tests per day at the end of 2020, growing to 20,000 tests per day by October 2021. Infectious disease revenue increased from £28.4mln in H1 2021 to £45.2mln in H2 2021, generating a gross profit for FY2021 of £28.5mln from £73.6mln of sales generated by over 2mln PCR tests. This represents the overwhelming majority of Source’s cash inflow in FY21.
The demand for PCR testing in FY22 has already diminished rapidly with about 1,000 tests a day in Q1FY22 following the removal of isolation and testing mandates across the UK. Nonetheless, part of the infectious disease revenue stream is expected to remain, with management estimating a roughly 50% half-on-half decrease in demand from the beginning of 2022. Source can redirect infrastructure utilisation towards the infectious disease business unit should the market demand increase again.
Geography
Source's operations centres are spread across the UK, Ireland and the US (Figure 2). US operations based in San Diego are chiefly related to the stability storage core business unit, with additional stability storage facilities in Rochdale and Tramore. Genomics operations are based in Dublin and Cambridge with the primary focus of Source's resources going forward, healthcare diagnostics, based at their headquarters in Nottingham. In Q4 2020, the Nottingham facility was sold for £5mln and leased back. This has contributed to cash but leaves higher ongoing leasing costs.
Figure 2 - SourceBio locations
Source: Annual report 2020
Summary
Source is entering a new phase of its development. Its flexible response to the COVID-19 pandemic showed its capabilities and enabled it to generate significant cash by December 2021. It is now investing that cash into the core business units. In FY22, the infectious disease business is still ongoing although reducing but by 2023, we expect it to be a minor part of the overall mix with digital pathology being the predominant business.
Table 1 gives a summary of business units sales by half-year with a summary of costs, EBITDA and cash.
