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‘Rational’ Exuberance

Why do Australians pay crazy multiples for CSL?

Sam Byrnes
Sam Byrnes

Last month, I was sitting in a hotel lobby (actually the bar) in Amsterdam after attending the International Plasma Protein Conference. I started talking with a fellow attendee who is a Patient Advocate for the rare diseases, Guillain-Barre Syndrome (GBS) and Chronic Inflammatory Demyelinating Polyneuropathy (CIDP) (don’t lose me, I promise no more big words).

To explain, GBS and CIDP are rare disorders of the peripheral nerves that lead to numbness, weakness, loss of reflexes and paralysis of limbs and (potentially) even breathing. Basically, CIDP is the chronic, life-long version of GBS. As this amazing patient advocate reeled off story after story of people that she knew to suffer from these horrible diseases, it struck me how varied these conditions present.

Through her story, it made sense why it is so hard to diagnose and treat such an elusive and volatile condition. One man who contracted and was treated for GBS, found out years later that it was actually CIDP after his symptoms returned. He (and the advocate) had to push his physician for another round of Immunoglobulin (IgG) therapy which alleviated his symptoms, and finally led him to receive regular prophylactic treatment for CIDP.

Why am I telling you this? GBS and CIDP are two of many rare autoimmune diseases that CSL treat with its main IgG therapies, Privigen and Hizentra.

CSL has been a core holding for ECP for many years. So we thought it would be worth sharing some feedback from the conference, what we think you need to be wary of in the future and why we think this is a pivotal point in the company’s history.

There just might be some rationality behind why Australian’s pay those crazy multiples for CSL!

Supply is Short

A key theme from this year’s conference is that the supply of raw plasma is very short; one participant even suggested there is no longer a spot market for plasma (can you imagine this happening in iron ore?). There are a number of factors why that is, but the key reason is that the Big 3 plasma fractionators are struggling to keep up with demand.

With demand outstripping supply, Grifol’s and Takeda are acquiring independent collection centres and centre networks such as Biotest and Haema to gain control of the supply (this does not grow industry supply). This has pushed up collection centre sale prices to between $9–12m for immature centres that are yet to turn a profit and have had as little as $2m of capital invested (yes, we are in the wrong business, although CSL isn’t).

When combined with significant donor fee inflation, independent operators generate far better returns selling their centres to Grifols and Takeda as they open them, rather than collecting and selling the plasma.

On the other hand, CSL is organically rolling out 30+ centres per year and extracts more plasma per centre than its competitors, meaning it has better supply at a lower cost. In addition, it doesn’t have to deal with integration issues with multiple conflicting “Standard Operating Procedures” and sub-optimal geographic locations.

As the lowest cost producer in the plasma commodity market, we would consider CSL to be a good investment over the long term. However what makes it a great investment and a Quality Franchise, is that it also extracts more revenue per litre from that plasma. This is due to CSL’s ability to extract more products per litre than its competitors. It is the only player with all 5 major protein products, and a well established Subcutaneous IgG franchise in Hizentra, giving it a material competitive edge.

A Pivotal Point in CSL’s history — Platform Shifts in Healthcare

All of that said, we believe we are at a particularly interesting point in the history of CSL.

Looking at the progression of disease treatment through history, we have observed a couple of significant platforms evolve.

Pharmaceutical companies have traditionally used chemicals and compounds to find innovative medicines that alter the chemicals in the body to treat diseases. For a long time this was the only main way to treat many diseases.

Then came advancements in Biologics. Biologics use living cells, such as recombinant proteins, tissues, genes, allergens, cells, blood components and vaccines to treat diseases better. Plasma therapies have thrived since the middle of last century, particularly in the treatment of rare autoimmune diseases as well as immunodeficiency indications.

In our view we are at the start of a third major platform evolution. Cell and Gene therapies have seen huge advancements and are now showing promise in the treatment of cancer and rare genetic disorders.

This is exciting for patients that are living with rare debilitating diseases and actually introduces the possibility of a cure in many cases (not far away in the case of Hemophilia A for example). It also poses an interesting question for shareholders of many Pharma and Biologic companies. Can my company make the jump to Cell and Gene Therapy?

In most cases, including CSL’s, this is impossible to answer just yet. However, what is clear as a shareholder of CSL, is that the management team is seriously looking at this. It is laying the early groundwork with its Calimmune acquisition and collaboration with Momenta.

This illustrates to us that CSL is willing to disrupt itself to find better therapies for diseases it already treats, as well as discover a treatment for new ones.

The big question remains — “Does CSL’s expertise and sustainable competitive advantage lie in the therapy, or in the indications that it treats?”. We still must not forget that, in all likelihood, there will still be a strong Biologics industry just as there is still a thriving Pharma industry.

While these are important long term trends that need to be thoroughly understood, we caution placing too much weight on emerging therapy risk.

The recent launch of Hemlibra in Hemophilia and Lanadelumab in Hereditary Angioedema (HAE) demonstrate that emerging therapies take a long time to impact incumbent treatments.

There are many factors at play including management and distribution of the emerging therapy, the cost of the treatment to payers as well as physician’s opinion on the risk of switching versus the incremental benefit to the patient.

Interestingly, the patient advocate I spoke with highlighted these issues and indicated that not all patients are yet aware of the benefits of CSL’s Hizentra; a product that has been on the market for over 5 years but has only just received approval for CIDP in March 2018.

CSL is not Without Risk

If you have been in the Australian market for some time you have heard the adage “never sell CSL”; and a quick perusal of CSL’s historic returns certainly justifies the mantra. However, no company should ever be blindly owned or left without scrutiny. CSL has quite a few risks that need to be constantly monitored. Below highlights some of our concerns:

Margin Risk

  • Donor fees: A nearer-term risk highlighted at the conference was strong upward pressure on donor fees. The extended shortage of plasma has increased donor fees to attract more supply resulting in fees as high as $50 per donation, up from $35 only a few years ago. We believe that IgG pricing inflation should be enough to offset this cost inflation as they have the same driver, and it is not a 1 to 1 relationship. However that is not to say that competitive behaviour cannot be irrational.

  • Last litre balance: The strong pace of IgG growth may threaten the balance of last litre economics. Plasma litre economics is important to the profitability of the industry. A litre of plasma is fractionated into as many as 2000 proteins, only 15–20 (5 main proteins) of which have been found to be useful to treat disease. These proteins have different size markets, so only the products with the largest markets, being IgG and Albumin, are used from the last litre processed. The demand for these products dictates how much plasma is collected. Currently, Albumin demand is showing signs of falling behind. If this continues, the economics of the last litre may be a growth inhibitor for the industry.

Both of these risks relate to the whole industry and not just CSL. In fact, CSL’s industry-leading margins and broad product portfolio provide some protection.

However market expectations matter, and if Consensus expect high single-digit demand to continue into the long term at the current margins due to a “two product last litre”, then there are some valuation risks to consider.

FcRn Inhibitors

FcRn Inhibitors is one of the nearer term threats to CSL’s IgG franchise, with some estimating it could affect up to 40% of the IgG market. We understand that FcRn Inhibitors block the FcRn receptors and limit the ability to recycle IgG, which kills bad IgG (unfortunately also the good IgG) that is aiding the disease. We believe this leads to a degradation in IgG to treat disease.

Conference feedback on FcRn was benign, arguing that immuno-suppressant therapies are not ideal as they elevate the patient’s risk to other infections. This feedback is unsurprising though, given the vested interests from the plasma industry.

We view FcRn’s as a credible but unproven threat to some IgG indications. The Netherlands-based company, Argenx, is showing promising signs in Phase II data, however, has so far only progressed to Phase III for one indication representing~5% of IgG demand. CSL is also investing in this area with its collaboration with Momenta. However, as discussed above, we are careful not to overplay the materiality and probability of this threat eventuating.

Management are also squarely focused on these long term threats, just take a look at their incentive structure for assurance of that.

Upside to Balance Risks

We have focused on a couple of risks that CSL face in the future. But there are some positive risks for CSL that we have not factored in that are likely to get more attention over time.

CSL112 — Recurrent Heart Attack Prevention

CSL112 is CSL’s research and development project in recurrent heart attack prevention — it is their largest and highest risk bet to date. The new product is aimed at reducing recurrent heart attacks in high-risk patients by rapidly reducing cholesterol from the arteries. CSL112 has progressed to Phase 3 trials with an estimated cost of ~$700m recruiting 17,500 patients. Market expectations place a low probability of success, as do we, however as the catalyst approaches the market can tend to get excited at the possibility of success.

We caution a “Sirtex” style event where expectations of success rise as commentators start to apply CSL’s strong track record of R&D returns to CSL112.

The company has an enviable track record of success in R&D. However, to date, this success has been underpinned by a very well managed portfolio of lower risk label extensions and new indications for existing products.

We wonder if the size of the potential prize has influenced CSL’s decision to move to Phase 3. The success of CSL112 has the potential to change the entire business model. Instead of collecting to IgG demand it may be able to collect to 112 demand, changing last litre economics as we know it and increasing its competitive advantage.

Time for Transplants

On the other end of CSL’s R&D risk curve is its newly formed ‘Transplant Franchise’. We believe Transplant is a near-term, lower risk opportunity for CSL. Neither the Market, nor ECP for that matter, has been placing much value in it. In Transplant, CSL is focusing on an area of unmet medical need with existing plasma-derived products that already have existing safety and efficacy in other diseases.

A Quality Franchise

While we do not pretend to be healthcare specialists, we are experts in identifying Quality Franchises. In CSL, we see a company that is organically growing the supply of plasma ahead of the industry, while in a supply constrained market.

The company’s sustainable competitive advantage is driven by its extensive suite of products that allows it to generate higher revenue per litre than its competitors, and is also the lowest cost producer, a powerful combination.

It is competing against a company that has just been acquired by a far bigger Pharmaceutical company, and another that has over-leveraged itself to acquire supply and will need to focus on paying down debt.

CSL is a Quality Franchise and, importantly, it has a management team that has continually demonstrated a long-term commitment to its patients. They understand the key success factors in the industry and their strategy is set to take advantage.

Oh, and the answer to why we pay those perceived crazy multiples for CSL? It’s long-term consistent organic earnings growth, industry leading margins, high returns on capital, strong R&D investment (expensed), extremely high barriers to entry and long term visibility on industry disruption. Simply — it’s a Quality Franchise.

Disclaimer: The article has been prepared by ECP Asset Management Pty Ltd. ECP is a funds management firm based in Sydney, Australia. ABN 26 158 827 582, CAR 44198 AFSL 421704. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for financial advice. ECP owns shares in CSL Limited. For further information visit

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