This reviled pharmaceutical firm holds promise of a healthier future
Summary
A short seller’s report raised concerns about Barcelona-based Grifols this year, but a selloff seems overdone.This column is part of the eighth annual Heard on the Street stock picking series.
Pharmaceutical firm Grifols is wounded. The bleeding can be stopped.
Between the time it first listed on Spain’s stock market in 2006 and the onset of the Covid-19 crisis in 2020, the Barcelona-based company outperformed the S&P 500 almost fivefold thanks to its role as a supplier of blood-plasma-based medicines and its geographical diversification. Half of its revenue comes from the U.S.
Ever since, though, the stock has become reviled and lost more than 70% of its value. During the pandemic, Grifols invested in research on the use of antibodies derived from the plasma of patients newly recovered from the coronavirus as a treatment. The results were disappointing, but that wasn’t the pandemic’s worst impact on the company. Lockdowns prompted blood-collection centers to close, resulting in a plasma shortage that contributed to a 69% drop in the company’s net income in 2021.
At the start of this year, the company suffered an even deeper cut in the form of a report released by Gotham City Research, the short-seller fund responsible for sinking Gowex in 2014. The Spanish wireless-network provider ended up admitting that it had falsified its accounts.
In the post-Theranos era, leveling a similar accusation against a blood-related company tends to make investors a little jumpy, and Gotham did raise some reasonable concerns.
One is that Grifols’s acquisition spree of the past decade and a half now looks ill-advised. Debt went from amounting to about three times earnings before interest, taxes, depreciation and amortization, to eight times at the end of 2023. During that time, operating margins went from 25% to 11%.
Another is that Grifols has an opaque relationship with one of its shareholders, an investment firm called Scranton Enterprises. Shortly after buying Haema and Biotest in 2018, Grifols immediately sold them to Scranton. It also signed a long-term agreement to get plasma from these firms and retained the option to repurchase them.
Because of the contraction of its core business, two-thirds of Grifols’s 2023 earnings were generated by what it calls minority interests—including the two companies it sold to Scranton, together with Grifols Diagnostics Solutions, of which it owns 55%. Gotham argues that Grifols misled investors by reporting results as if these enterprises were fully under its control, overstating earnings and understating debt. Its shares are “uninvestable and likely are worth zero," the January report said.
Gotham has also warned that Scranton is “a Grifols family entity." The family members, which trace the origin of Grifols to 1909 and have held a tight leash on it since, claim that they are only minority investors. Grifols has sued Gotham, insisting that all transactions were done “at arms’ length" and were announced at the time.
Regardless of the legality of the whole affair, investors are right to be on guard. A disinterested third party would hardly have engaged in such transactions with Grifols. The pre-existing relationship with Scranton is indisputable, and Grifols seems to have used it to its advantage, acquiring costly firms while keeping the accounting as flattering as possible—or, in the words of the 2018 annual report, to “reinforce its financial structure."
But this seems to contradict the claim that Grifols shouldn’t count earnings from these companies as its own. Indeed, Spanish regulators concluded in March that it does retain control over them.
Concerns about the firm’s financial engineering linger, though. In their review, officials still scolded executives for not having provided debt ratios excluding minority interests in several reports. And, two months ago, Grifols had to restate its accounts from 2020 through 2023, admitting that it had treated its stake in Chinese firm Shanghai RAAS incorrectly.
Canadian asset manager Brookfield has been working on the possibility of helping to take Grifols private but, according to a Spanish online newspaper, it has hit snags because of accounting issues regarding RAAS. A more recent report from Bloomberg suggested a takeover is still possible.
The silver lining: Grifols has become extremely cheap. Its enterprise value is roughly nine times prospective Ebitda, while its closest competitor, CSL, trades at 21. For 2024 as a whole, a powerful postpandemic rebound in the plasma market has led analysts to expect Grifols’s core profit will be almost seven times higher than in 2023, once again dwarfing the contribution of the contentious minority holdings. Most of the RAAS stake has now been sold and has helped pay down debt.
Moreover, governance concerns have been addressed in recent months by naming new board members, replacing top executives and reducing the day-to-day involvement of the Grifols family.
A penchant for creative accounting is always a bad sign, but it doesn’t necessarily make a company worthless, especially if it is willing to repent. Whether the upside comes from a takeover or a revenue recovery, Grifols could be an interesting target for opportunistic investors—as long as they don’t faint at the sight of blood.
Write to Jon Sindreu at jon.sindreu@wsj.com