ATRIUM INNOVATIONS INC ATB CN
April 17, 2011 - 2:16am EST by
cxix
2011 2012
Price: 16.25 EPS $1.60 $1.90
Shares Out. (in M): 33 P/E 10.0x 8.0x
Market Cap (in $M): 532 P/FCF 10.0x 8.0x
Net Debt (in $M): 264 EBIT 0 0
TEV ($): 796 TEV/EBIT 0.0x 0.0x

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Description

Atrium Innovations (Ticker: ATB CN) is an under-the-radar Canadian vitamin and supplement company that was spun out of parent Aeterna Zentaris (Ticker: AEZ CN) in 2005. Since then, ATB has spent more than 600mm rolling up various smaller-scale brands. While I'm generally not a fan of roll-ups, there are a couple of reasons why I think that ATB is an exceptional case:

1. The company provides excellent disclosure around its past purchases - both in terms of the incremental financial impact and prices paid. As such, it is possible to track the progress of historical acquisitions and confirm that the combined business today is stable and growing organically.

2. Certain industries seem to be more conducive to roll-ups than others. In the business of vitamins and supplements, niche brands often do not have the manufacturing scale or distribution reach to justify standalone operation beyond a certain (small) size, particularly with FDA and FTC-mandated industry quality standards tightening over the last few years. As such, these brands are often prime candidates to be consolidated onto a larger platform, thereby utilizing shared, GMP-approved manufacturing bases and common distribution channels.

Last year, I posted NBTY, a leading mass-market vitamin and supplement supplier that had spent nearly a billion dollars over the past decade successfully rolling up various competitors. From 2000 to 2009, NBTY's sales and operating income quadrupled, and its stock price rose from $6.00 to $55.00, where it was taken private by Carlyle. I feel that ATB is a similar story, albeit on a smaller scale and with a somewhat different market focus. Whereas NBTY targeted the largest retailers - Wal-Mart, Costco, Target, etc. - for the distribution of lower potency, mass-produced products, ATB sells high-end and specialty formulations primarily via the healthcare practitioner channel ('HPC').

The healthcare practitioner channel is as it sounds - vitamin and supplement sales by way of doctor, chiropractor, and homeopath/nutritionist recommendations. It happens to be one of the fastest growing channels within the industry, compounding sales at nearly 8% a year over the past five years to 2.1bn. ATB is the largest provider of products to this channel, with an estimated 15% market share. According to a recent study by the Nutrition Business Journal, two of the company's primary brands, Pure Encapsulations and Douglas Laboratories, are "among the top three brands in the HPC channel in the United States." The company also sells product in Europe, primarily in Germany and the Netherlands (68/32 North America/Europe revenue split in 2010).

At scale and with a properly diversified product line, I think that the vitamin and supplement business model is a good one. It's asset-light and produces repeat-purchase products demanded by a customer base that is loyal to certain brands. Moreover, unlike the weight-loss or sports nutrition sub-categories, ATB's business is less susceptible to faddish sentiments. The majority of the company's core brands have been around for over 20 years, with several product lines at or nearing the 50-year mark.  

ATB's EBITDA has grown from roughly 25mm at the time of the spinoff in 2005 to over 80mm in 2010. Management recently confirmed 2011 EBITDA guidance of between 105 and 110mm. This translates into diluted EPS of between $1.87 and $1.96 per share. At the current stock price of $16 and change, you're paying a multiple of 8.5x fully-taxed 2011 cash earnings and 10x fully-taxed 2010 cash earnings. Industry comparables, including HLF, NATR, NUTR, PRGO, RELV, STKL, VSI, and WNI are trading at an average forward P/E of 17x, median of 16.3x, and a range of between 9.5x and 25.5x. I feel that ATB's discount is unjustified given the company's competitive position, financial stability, and long-lived brands.

Perhaps the most vivid illustration of the market's capriciousness is the fact that ATB currently trades at the same stock price that it did in mid-2006, when gross and net profits were one quarter of what they are today. This is not a company that has historically been neglected by the market - until the crash of 2008, the stock regularly traded at P/E multiples in the mid-to-high teens. Since then, however, the price has yet to recover, even though the underlying business has grown quite substantially.  

Business Description

ATB offers over 2,000 SKUs, comprising many disparate product lines spanning vitamins, minerals, enzymes, probiotics, and omega-3. I will highlight a few of the major brands here. First, in North America:

- Pure Encapsulations: 20+ year history, offered to 36,000+ healthcare practitioners, primarily via a catalogue mailed 3-4x a year, with 375+ hypoallergenic products presented in vegetable-based capsules. Key products include natural multi-vitamins for adults and children, condition-specific and high-end antioxidants. 30%+ EBITDA margins.
- Douglas Laboratories: 50+ year history, 650+ branded, custom-label, and private-label products, "professional-grade multiple vitamin and mineral formulas." Again marketed to healthcare practitioners, via a dedicated sales force. 20%+ EBITDA margins.
- Seroyal: the company's latest acquisition, closed at the end of 2010. 26-year history of selling to HCPs in Canada and the US, 455 SKUs under the Genestra, UNDA, and Pharmax brand names. Includes probiotics, vitamins, minerals, herbal extracts, enzymes, and essential fatty acids. 30%+ EBITDA margins.
- Garden of Life: ATB's offering in the health food store channel. Sells "supplements promoting digestive health", including Perfect Cleanser and Primal Defense probiotic supplements. A much lower margin business given its retail focus.

In Europe:

- Mucos: primary brand is Wobenzym, a near 50-year-old product line with strong consumer recognition in Germany and parts of Eastern Europe. Treats joint pain and inflammation, as well as overall immune system health. This is ATB's largest single brand, representing ~25% of sales, although only 10% of such sales originate directly from Germany (more on Mucos/Wobenzym below).
- MCO Health: includes Orthica and AOV product lines, leading vitamins, food supplements, etc., in the Netherlands.

Acquisition History

Since 2004, ATB has made the following acquisitions:
 
Date Name     Size (mm)   EV/LTM Sales EV/LTM EBITDA
Sep-00
Biotherapies

               1.5
               1.0
                    -
Mar-04
Pure Encapsulations
             38.0
               1.9
               5.6
Dec-05
Douglas Laboratories
             92.6
               1.3
               6.4
Sep-06
Douglas Laboratories Canada                4.1
               1.0
               6.0
Jan-07
Aquacap

             19.3
               1.3
               6.0
Jul-07
Mucos Pharma
           178.8
               2.1
               6.6
Feb-08
Multicare BV

             31.4
               1.4
               7.0
Sep-08
Orthos Europe B.V.
             11.0
               2.0
               6.0
Dec-08
EAB-Enzym
             27.6
                    -
               5.5
Jan-09
Nutri-Health Supplements              23.9
               0.9
               5.6
Sep-09
Garden of Life
             52.4
               0.7
               6.5
Mar-10
Trophic Canada
             11.0
               1.5
               6.0
Dec-10
Minami Nutrition
               7.4
               1.1
               5.5
Dec-10
Seroyal International
           110.0                  2.8                  7.5  




TOTALS/AVERAGES            609.0
               1.4
               5.7
 
As is evident from the table above, management has been quite disciplined with its purchase prices. The average deal was done at 1.4x EV/Sales and 5.7x EV/EBITDA, both of which are substantially below the company's own trading multiples. It's worth noting as well that the deals were financed with debt and cash on hand rather than equity, as diluted shares outstanding have remained relatively constant over the last five years.

ATB has also managed to integrate the acquired companies without losing any incremental revenue or profit. This suggests to me that the acquired brands are self-sustaining rather than one-hit wonders:
 
Date Name     Implied Sales Implied EBITDA Implied Margin
Sep-00
Biotherapies

               1.5
 NA 
 NA
Mar-04
Pure Encapsulations
             20.0
               6.8
33.9%
Dec-05
Douglas Laboratories
             71.2
             14.5
20.3%
Sep-06
Douglas Laboratories Canada                4.1
               0.7
16.7%
Jan-07
Aquacap

             14.8
               3.2
21.7%
Jul-07
Mucos Pharma
             85.1
             27.1
31.8%
Feb-08
Multicare BV

             22.4
               4.5
20.0%
Sep-08
Orthos Europe B.V.
               5.5
               1.8
33.3%
Dec-08
EAB-Enzym
 NA 
               5.0
NA

Jan-09
Nutri-Health Supplements              26.6
               4.3
16.1%
Sep-09
Garden of Life
             74.9
               8.1
10.8%
Mar-10
Trophic Canada
               7.3
               1.8
25.0%
Dec-10
Minami Nutrition
               6.7
               1.3
20.0%
Dec-10
Seroyal International
             39.3                14.7   37.3%




TOTALS/AVERAGES            379.5
             93.8
24.7%
 
2004 Revenue: less than 30mm
2011E Revenue: ~430mm
Difference: at least 400mm
Acquired Revenue: 379.5mm
Organic: 20.5mm

2004 EBITDA: Less than 10mm
2011E EBITDA: ~110mm
Difference: at least 100mm
Acquired EBITDA: 93.8mm
Organic: 6.2mm

Why It's Cheap & Conclusion

ATB's real organic growth rate is arguably understated in the figures directly above because of an issue that has recently been affecting the company in Germany.

When management acquired Mucos in 2007, they picked up the key Wobenzym product line. All pharmaceuticals that are sold behind the counter in Germany - including Wobenzym - must first be licensed by the German regulatory authorities. Wobenzym's license was set to expire in August of 2009. The re-licensing process would require a series clinical trials to demonstrate efficacy - prohibitively expensive for a company of ATB's size. As such, management's plan at the time of acquisition was to pull the original, animal-based formulation from the market in late '09 and replace it with an altered, plant-based version. This new version didn't take up as quickly as anticipated and the company lost some original Wobenzym customers as a result.

There are a couple of reasons why this issue is less relevant going forward. For one, with the most recent acquisition of Seroyal, the entirety of Wobenzym sales in Germany accounts for only 10% of total revenue (~60% of Wobenzym sales are outside of Germany). Secondly, and perhaps more importantly, German sales hit a clear trough in 2Q10, and have been growing at "low double digit sequential rates" in the two quarters since then.

Ex-Wobenzym Germany, ATB grew overall revenue by 9% organically in 2010, on top of 6.6% organic growth in 2009. Management expects at least 4-5% company-wide organic growth going forward.

Another ostensible reason that the stock is cheap is because the company is somewhat levered. However, debt-to-EBITDA is less than 3x and interest coverage is greater than 10x.

The final reason is because the company is a roll-up. As I said above, I'm generally not a fan of roll-ups, but I feel that given ATB's relative transparency and business quality, it deserves a better multiple than 8x earnings.

In November of 2010, ATB management announced a buyback of 5% of its shares outstanding, of which the first purchases took place recently. The largest shareholder of the company, with a 15.8% stake, is Fonds de solidarite FTQ, a Canadian private equity fund. Fonds first invested in 2000 and has not sold a share since then; ATB is their largest publicly-listed position but they are generally passive buy-and-holders. The second largest holder is Fidelity Investments, with a 10.1% stake. Fidelity just recently got to this size. As I understand it after speaking with ATB's CFO, Fidelity was previously invested in NBTY before it was taken out and decided afterward to replace that investment with ATB.

Catalyst

- Management delivering on 2011 results, integrating Seroyal successfully and lapping the Wobenzym difficulties from last year.

- Continued share buybacks.

Catalyst


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    Description

    Atrium Innovations (Ticker: ATB CN) is an under-the-radar Canadian vitamin and supplement company that was spun out of parent Aeterna Zentaris (Ticker: AEZ CN) in 2005. Since then, ATB has spent more than 600mm rolling up various smaller-scale brands. While I'm generally not a fan of roll-ups, there are a couple of reasons why I think that ATB is an exceptional case:

    1. The company provides excellent disclosure around its past purchases - both in terms of the incremental financial impact and prices paid. As such, it is possible to track the progress of historical acquisitions and confirm that the combined business today is stable and growing organically.

    2. Certain industries seem to be more conducive to roll-ups than others. In the business of vitamins and supplements, niche brands often do not have the manufacturing scale or distribution reach to justify standalone operation beyond a certain (small) size, particularly with FDA and FTC-mandated industry quality standards tightening over the last few years. As such, these brands are often prime candidates to be consolidated onto a larger platform, thereby utilizing shared, GMP-approved manufacturing bases and common distribution channels.

    Last year, I posted NBTY, a leading mass-market vitamin and supplement supplier that had spent nearly a billion dollars over the past decade successfully rolling up various competitors. From 2000 to 2009, NBTY's sales and operating income quadrupled, and its stock price rose from $6.00 to $55.00, where it was taken private by Carlyle. I feel that ATB is a similar story, albeit on a smaller scale and with a somewhat different market focus. Whereas NBTY targeted the largest retailers - Wal-Mart, Costco, Target, etc. - for the distribution of lower potency, mass-produced products, ATB sells high-end and specialty formulations primarily via the healthcare practitioner channel ('HPC').

    The healthcare practitioner channel is as it sounds - vitamin and supplement sales by way of doctor, chiropractor, and homeopath/nutritionist recommendations. It happens to be one of the fastest growing channels within the industry, compounding sales at nearly 8% a year over the past five years to 2.1bn. ATB is the largest provider of products to this channel, with an estimated 15% market share. According to a recent study by the Nutrition Business Journal, two of the company's primary brands, Pure Encapsulations and Douglas Laboratories, are "among the top three brands in the HPC channel in the United States." The company also sells product in Europe, primarily in Germany and the Netherlands (68/32 North America/Europe revenue split in 2010).

    At scale and with a properly diversified product line, I think that the vitamin and supplement business model is a good one. It's asset-light and produces repeat-purchase products demanded by a customer base that is loyal to certain brands. Moreover, unlike the weight-loss or sports nutrition sub-categories, ATB's business is less susceptible to faddish sentiments. The majority of the company's core brands have been around for over 20 years, with several product lines at or nearing the 50-year mark.  

    ATB's EBITDA has grown from roughly 25mm at the time of the spinoff in 2005 to over 80mm in 2010. Management recently confirmed 2011 EBITDA guidance of between 105 and 110mm. This translates into diluted EPS of between $1.87 and $1.96 per share. At the current stock price of $16 and change, you're paying a multiple of 8.5x fully-taxed 2011 cash earnings and 10x fully-taxed 2010 cash earnings. Industry comparables, including HLF, NATR, NUTR, PRGO, RELV, STKL, VSI, and WNI are trading at an average forward P/E of 17x, median of 16.3x, and a range of between 9.5x and 25.5x. I feel that ATB's discount is unjustified given the company's competitive position, financial stability, and long-lived brands.

    Perhaps the most vivid illustration of the market's capriciousness is the fact that ATB currently trades at the same stock price that it did in mid-2006, when gross and net profits were one quarter of what they are today. This is not a company that has historically been neglected by the market - until the crash of 2008, the stock regularly traded at P/E multiples in the mid-to-high teens. Since then, however, the price has yet to recover, even though the underlying business has grown quite substantially.  

    Business Description

    ATB offers over 2,000 SKUs, comprising many disparate product lines spanning vitamins, minerals, enzymes, probiotics, and omega-3. I will highlight a few of the major brands here. First, in North America:

    - Pure Encapsulations: 20+ year history, offered to 36,000+ healthcare practitioners, primarily via a catalogue mailed 3-4x a year, with 375+ hypoallergenic products presented in vegetable-based capsules. Key products include natural multi-vitamins for adults and children, condition-specific and high-end antioxidants. 30%+ EBITDA margins.
    - Douglas Laboratories: 50+ year history, 650+ branded, custom-label, and private-label products, "professional-grade multiple vitamin and mineral formulas." Again marketed to healthcare practitioners, via a dedicated sales force. 20%+ EBITDA margins.
    - Seroyal: the company's latest acquisition, closed at the end of 2010. 26-year history of selling to HCPs in Canada and the US, 455 SKUs under the Genestra, UNDA, and Pharmax brand names. Includes probiotics, vitamins, minerals, herbal extracts, enzymes, and essential fatty acids. 30%+ EBITDA margins.
    - Garden of Life: ATB's offering in the health food store channel. Sells "supplements promoting digestive health", including Perfect Cleanser and Primal Defense probiotic supplements. A much lower margin business given its retail focus.

    In Europe:

    - Mucos: primary brand is Wobenzym, a near 50-year-old product line with strong consumer recognition in Germany and parts of Eastern Europe. Treats joint pain and inflammation, as well as overall immune system health. This is ATB's largest single brand, representing ~25% of sales, although only 10% of such sales originate directly from Germany (more on Mucos/Wobenzym below).
    - MCO Health: includes Orthica and AOV product lines, leading vitamins, food supplements, etc., in the Netherlands.

    Acquisition History

    Since 2004, ATB has made the following acquisitions:
     
    Date Name     Size (mm)   EV/LTM Sales EV/LTM EBITDA
    Sep-00
    Biotherapies

                   1.5
                   1.0
                        -
    Mar-04
    Pure Encapsulations
                 38.0
                   1.9
                   5.6
    Dec-05
    Douglas Laboratories
                 92.6
                   1.3
                   6.4
    Sep-06
    Douglas Laboratories Canada                4.1
                   1.0
                   6.0
    Jan-07
    Aquacap

                 19.3
                   1.3
                   6.0
    Jul-07
    Mucos Pharma
               178.8
                   2.1
                   6.6
    Feb-08
    Multicare BV

                 31.4
                   1.4
                   7.0
    Sep-08
    Orthos Europe B.V.
                 11.0
                   2.0
                   6.0
    Dec-08
    EAB-Enzym
                 27.6
                        -
                   5.5
    Jan-09
    Nutri-Health Supplements              23.9
                   0.9
                   5.6
    Sep-09
    Garden of Life
                 52.4
                   0.7
                   6.5
    Mar-10
    Trophic Canada
                 11.0
                   1.5
                   6.0
    Dec-10
    Minami Nutrition
                   7.4
                   1.1
                   5.5
    Dec-10
    Seroyal International
               110.0                  2.8                  7.5  




    TOTALS/AVERAGES            609.0
                   1.4
                   5.7
     
    As is evident from the table above, management has been quite disciplined with its purchase prices. The average deal was done at 1.4x EV/Sales and 5.7x EV/EBITDA, both of which are substantially below the company's own trading multiples. It's worth noting as well that the deals were financed with debt and cash on hand rather than equity, as diluted shares outstanding have remained relatively constant over the last five years.

    ATB has also managed to integrate the acquired companies without losing any incremental revenue or profit. This suggests to me that the acquired brands are self-sustaining rather than one-hit wonders:
     
    Date Name     Implied Sales Implied EBITDA Implied Margin
    Sep-00
    Biotherapies

                   1.5
     NA 
     NA
    Mar-04
    Pure Encapsulations
                 20.0
                   6.8
    33.9%
    Dec-05
    Douglas Laboratories
                 71.2
                 14.5
    20.3%
    Sep-06
    Douglas Laboratories Canada                4.1
                   0.7
    16.7%
    Jan-07
    Aquacap

                 14.8
                   3.2
    21.7%
    Jul-07
    Mucos Pharma
                 85.1
                 27.1
    31.8%
    Feb-08
    Multicare BV

                 22.4
                   4.5
    20.0%
    Sep-08
    Orthos Europe B.V.
                   5.5
                   1.8
    33.3%
    Dec-08
    EAB-Enzym
     NA 
                   5.0
    NA

    Jan-09
    Nutri-Health Supplements              26.6
                   4.3
    16.1%
    Sep-09
    Garden of Life
                 74.9
                   8.1
    10.8%
    Mar-10
    Trophic Canada
                   7.3
                   1.8
    25.0%
    Dec-10
    Minami Nutrition
                   6.7
                   1.3
    20.0%
    Dec-10
    Seroyal International
                 39.3                14.7   37.3%




    TOTALS/AVERAGES            379.5
                 93.8
    24.7%
     
    2004 Revenue: less than 30mm
    2011E Revenue: ~430mm
    Difference: at least 400mm
    Acquired Revenue: 379.5mm
    Organic: 20.5mm

    2004 EBITDA: Less than 10mm
    2011E EBITDA: ~110mm
    Difference: at least 100mm
    Acquired EBITDA: 93.8mm
    Organic: 6.2mm

    Why It's Cheap & Conclusion

    ATB's real organic growth rate is arguably understated in the figures directly above because of an issue that has recently been affecting the company in Germany.

    When management acquired Mucos in 2007, they picked up the key Wobenzym product line. All pharmaceuticals that are sold behind the counter in Germany - including Wobenzym - must first be licensed by the German regulatory authorities. Wobenzym's license was set to expire in August of 2009. The re-licensing process would require a series clinical trials to demonstrate efficacy - prohibitively expensive for a company of ATB's size. As such, management's plan at the time of acquisition was to pull the original, animal-based formulation from the market in late '09 and replace it with an altered, plant-based version. This new version didn't take up as quickly as anticipated and the company lost some original Wobenzym customers as a result.

    There are a couple of reasons why this issue is less relevant going forward. For one, with the most recent acquisition of Seroyal, the entirety of Wobenzym sales in Germany accounts for only 10% of total revenue (~60% of Wobenzym sales are outside of Germany). Secondly, and perhaps more importantly, German sales hit a clear trough in 2Q10, and have been growing at "low double digit sequential rates" in the two quarters since then.

    Ex-Wobenzym Germany, ATB grew overall revenue by 9% organically in 2010, on top of 6.6% organic growth in 2009. Management expects at least 4-5% company-wide organic growth going forward.

    Another ostensible reason that the stock is cheap is because the company is somewhat levered. However, debt-to-EBITDA is less than 3x and interest coverage is greater than 10x.

    The final reason is because the company is a roll-up. As I said above, I'm generally not a fan of roll-ups, but I feel that given ATB's relative transparency and business quality, it deserves a better multiple than 8x earnings.

    In November of 2010, ATB management announced a buyback of 5% of its shares outstanding, of which the first purchases took place recently. The largest shareholder of the company, with a 15.8% stake, is Fonds de solidarite FTQ, a Canadian private equity fund. Fonds first invested in 2000 and has not sold a share since then; ATB is their largest publicly-listed position but they are generally passive buy-and-holders. The second largest holder is Fidelity Investments, with a 10.1% stake. Fidelity just recently got to this size. As I understand it after speaking with ATB's CFO, Fidelity was previously invested in NBTY before it was taken out and decided afterward to replace that investment with ATB.

    Catalyst

    - Management delivering on 2011 results, integrating Seroyal successfully and lapping the Wobenzym difficulties from last year.

    - Continued share buybacks.

    Catalyst


    Messages


    SubjectQuestions
    Entry04/18/2011 07:59 PM
    Memberjgalt
    Thanks for the great write-up.
     
    A few questions:
     
    1. I'm put together a table similar to yours on previous acquisitions and started looking at the SEDAR filings. There's an acquisition document for the MUCOS acquisition (http://sedar.com/GetFile.do?lang=EN&docClass=13&issuerNo=00021793&fileName=/csfsprod/data84/filings/01161659/00000001/n%3A\Atrium\BusReprt\eng_sept2007.pdf) which shows on page 6 that the 2006 TTM EBITDA for MUCOS was around 17.4m and not the 27.1m implied in the table above.
     
    (One may think that the 7 months to the July 2007 acquisition provided more EBITDA but on page 5 the company has no EBITDA to speak of in the 6 month period ending 6/30/07.)
     
    Have you spoken to the CFO or anybody else to figure out why the discrepancy?
     
    2. I see a sales multiple for Pure Encapsulations in the investor presentation, but not an EBITDA multiple. How did you arrive at an implied EBITDA of 6.8?
     
    3. This is just a nitpick, but if you add up all the acquisitions, sales and EBITDAs (assuming 0 EBITDA for Pure Encapsulations as in the investor presentation), you get 1.6x sales and 7.0x EBITDA, not 1.4 and 5.7 as above (makes sense; a 110m acquisition at 7.5x has more weight than a 7.4m acquisition at 5.5x).

    SubjectUpdate from anyone?
    Entry11/11/2011 12:44 PM
    Memberstraw1023
    This idea received a solid rating, but has performed quite badly.
     
    It does not look like EBITDA or EPS numbers forecast in the write-up will come to fruition, but at these levels, stock does seem to trade at 10x unlevered FCF (after all taxes and capex, but not acquisitions) and growing organically at 3% or so. Not too shabby.
     
    Thoughts from anyone?
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