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Ergomed - 80%+ of this year’s forecast covered

September 2022

Investing in shares may lose you all or some of your money. Past performance is no indication of future performance. Some of the shares recommended here may be small company shares, which can be relatively illiquid and hard to trade and this makes such shares more risky than other investments.

Although off their highs, Ergomed’s shares have more than tripled since I made them a main buy in October 2019 at 295p as investors have realised that profits are entering a phase of promising growth. Even now, however, the full scale of the improvement is not fully reflected in the price and having caught up with finance director Richard Barfield, all the signs point to full year forecasts being upgraded when interims are reported on 26 September.
Ergomed comprises two divisions: the first is involved in clinical trial services (CRO), speeding up the recruitment of patients into trials, conducting the trials and improving overall data quality (e.g. lower dropouts) and it has a strong reputation among its blue-chip pharma (six of the top 10 pharmas) and biotech customers. Its other division is PrimeVigilance, which provides outsourced drug safety monitoring (pharmacovigilance) services  once a medicine or vaccine has been authorized for use and is almost an annuity type business with 95% of contracts rolling over from one year to the next. 

Ergomed was founded in 1997 by Dr Miro Reljanovic (now chairman), who practiced as a physician in Zagreb and who was often called upon as a clinical investigator in numerous Phase II and III studies in the field of neurology. In 1997 he moved to the UK and founded Ergomed in Guildford as a CRO. 
As a CRO, Ergomed provides a range of contracted services over Phases I to III of the drug development process, ranging from expert consultancy services (assisting companies in designing clinical trials) through to delivery of trials (study / site management and physician support), data management and medical report writing.  
The shares listed on AIM in July 2014 at 160p and I think it has been the only CRO to list in the last decade. Contemporaneous with the float, Ergomed  also acquired PrimeVigilance, which was separately owned by Reljanovic, for £9m in shares. PrimeVigilance was one of the first focused service providers in the pharmacovigilance space, a market that has grown rapidly driven by an increasing regulatory focus on drug safety, as well as a continued outsourcing trend.  
But very soon after, Reljanovic had a rush of blood to the head and began to invest in product development, with a co-development offering seen as an extension of its CRO business and it selectively began to share some of the risks and rewards of the development of its partners’ drugs, in effect sacrificing some of its profitability (hence the low c.9-10% EBITDA margin at the time) in return for a carried interest in the future revenues of the product. Five active drugs were developed in this way and by 2016, Ergomed had also acquired one Phase II product outright (Haemostatix) in its entirety for £8m.  
When Barfield joined as finance director he quickly put an end to this strategy of investing in its own products, which he deemed as excess risk-taking and it had also been diluting its skillbase as quite a few members of staff were tied up on that stuff. Curtailing that immediately improved margins and cash generation.
Barfield was fresh from selling Chiltern, a VC-backed CRO, to Labcorp/Covance for US$1.2bn, having grown Chiltern’s profits spectacularly from US$27m to US$97m with sales rising from US$160m to US$550m between 2013-2018. He strengthened the board with new appointments (including several hands joining from Chiltern) and put in place an M&A strategy that has already electrified margins and profitability.
Grows to mid tier CRO status
Full year sales back in 2018 were £70m but Ergomed has just achieved that level in the latest first half - evidence enough of the remarkable progress the group is making. Compared to £2.5m EBITDA in 2018, this year’s EBITDA forecast is £28.5m but even this is erring on the low side.
As I said in last month’s issue of SCSW, consensus forecasts look lazy. Forecast sales of £141m for the full year implies just 12% growth for H2 even though Ergomed achieved 25% in H1. In addition, H2 is also going to include the latest acquisition of ADAMAS for 6 months versus 3.5 in H1. Barfield also notes that of the 1,500 employees, 250 are in the US highlighting that 20% of the cost base is in the US whereas 63% of revenue is coming in US$, with the strong US$ providing a helpful currency tailwind.  

High growth therapeutic areas
In the last two decades, the drug development space has been transformed by specialisation. Most of the small and mid sized biotechs and pharmas have their scientists, of course, who worry about the scientific challenges of discovering drugs but their sole focus is on getting a drug into a clinical trial and once they do that, many firms then outsource the running of the clinical trial to a Contract Research Organisation (CRO) rather than do it in-house.
According to the US database, there are over 60,000 clinical trials running at present with around 26,000 being started each year; the amount spent on clinical trials is US$105m and around 50% is run by CROs with the rest still being in-house.  
CROs are highly specialised operators and efficient at conducting trials. A big chunk of the outsourced market is in the hands of five very large CROs - IQVIA, Covance, ICON, PPD, Syneos - who garner 56% of the market but Ergomed punches above its weight by focusing on conducting oncology and rare disease studies where patient recruitment is often challenging and this allows it to achieve a higher margin.
Typically Ergomed gets appointed a few months before a trial is due to start. Its operatives organise the process of recruiting patients to a trial (a trial typically needs 100-1,000 patients), sets up patient centres, recruits the specialists to become the investigators for the trial (heads of research, professors and so on) and creates study documents (eg. protocols, patient information leaflets and final clinical reports).
Clinical Research Assistants are the staple employee within the CRO industry. These are normally medics or nurses who, once a trial start, provide on-site support for the investigator and study team and they are the ones who will oversee the trials and visit the investigators/heads of research, looking over their shoulders and ensuring that things are as they should be (e.g. making sure the right doses are being administered and reported correctly). After the trial completes, other staff members analyse the biodata and write up reports on the results and help with regulatory filings.
Pricing of contracts is typically on a “time and materials” basis and this is not based on study outcome. A contract with a customer will specify the study budget and provide very detailed pricing for various elements - payments are set at certain milestones based on the number of patients recruited, and individual items such as each scheduled patient visit, telephone calls and the shipment of blood / samples and so on are set out. What makes this a beautiful business is that gross margins are high - in FY21, gross margin for the CRO business was 41.4% - and as a typical clinical trial can run for 2.5 to 3 years, visibility is good. As some trials are run down others are starting up, which means Ergomed starts each financial year with a backlog of work (75% or more of the expected sales).

Strong reputation in CEE
The reason Ergomed hit the ground running early on was that from the start its focus was on running trials in Eastern Europe - Croatia, Czech Republic, Poland and Serbia. These countries have centres of excellence in several of the high growth therapy areas of oncology, neurology, immunology and the development of orphan drugs for rare diseases. In such “hot” therapy areas such as oncology, there are many drug candidates so in developed markets like the UK or US there is greater competition for patients (especially as some of them can be taking other drugs, which rules them out of certain trials) but it’s less of an issue in these countries, which speeds up recruitment rates and shortens trial timelines. When Ergomed was set up, the economies and regulatory frameworks in Eastern Europe were only starting to come into line with those of developed nations but Eastern Europe has become a quite established venue for clinical trials, and the globalisation trend continues into territories such as India, China and Latin America - which could all become target regions for Ergomed. Meanwhile, these days Ergomed has site coordinators across Europe, the US and Asia.
Ergomed’s CRO side has grown sales from £15.9m in 2016 to £40.5m in 2021, representing a compound increase of 22%, mostly organic but in late 2020, Ergomed acquired MedSource, a US-based specialist oncology and rare disease CRO for US$18m (1.1x sales and 10x EBITDA). And not in these numbers is the acquisition just seven short months ago of ADAMAS for £25.6m only. ADAMAS is a provider of regulatory compliance and consulting services and is therefore additive rather than overlapping with what Ergomed already does. Its services include all the behind the scenes stuff (such as Good Clinical Practice/GCP  for clinical trials) and also services for once a product has launched (eg. Good Pharmacovigilance Practice/GVP and auditing pharmaceutical manufacturing processes).
Now integrated, both deals have strengthened Ergomed’s physical presence in North America and this has been helping win new contracts and also to cross sell the drug safety monitoring (also known as pharmacovigilance) service. 

Post marketing activities
This business, PrimeVigilance, monitors and evaluates adverse drug reactions once a drug has been licenced for use and there is a legal obligation on its owner to aggregate safety data and submit safety reports in a timely manner. A patient may, for instance, go to their doctor and say their blood pressure tablet is giving them an allergic reaction. The PV division collates this type of data from all GPs and detects patterns of reaction and prepares statistical analysis, which is formally reported to the regulatory bodies. Margins in PV work are high - 50.9% in FY21 - and most contracts tend to become almost a permanent addition to revenues. This bit has been growing very fast, with net sales over the last five years growing at an annual 35% clip to £60.1m last year. Most of this was organic growth with just one acquisition of Ashfield for US$10m two years ago adding to its exposure to the US, which has historically represented the largest market for the PV division. It has also recently established a presence in Japan and will shortly expand into India.   

80-85% of current year forecasts covered 
But as Barfield has previously described, most PV contracts get repeated and as such are “hidden” as they are not formally reported in its order book, which in any case has already seen “a significant number of new contracts” and grown 18.7% to £284.5m since January. That means it has covered 80-85% of current year forecasts of £23.6m pretax profit/eps 38.5p. For year starting 1 Jan this rises to £26.6m and 43.4p. But with £12m cash and an unused £80m facility, further M&A is likely, possibly in Asia or to scale up in North America.  Keep holding / Buy on a two year view.

* The writer has a holding

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