Lonza Group AG

Executive Summary

Investment Thesis (3 Sentences)

Lonza is "The Factory for Biotech" - a pure-play CDMO (Contract Development and Manufacturing Organization) with narrow moat characteristics including regulatory barriers, switching costs, and capacity scarcity in large-scale biologics manufacturing. The stock has corrected 29% from its COVID-era peak, creating a potential entry point as the core business (excluding lost Moderna revenue) grows 7%+ organically with 29%+ EBITDA margins. However, the current valuation offers insufficient margin of safety for a capital-intensive business exposed to biotech funding cycles.

Key Metrics Dashboard

Verdict: WAIT

Intrinsic Value Estimate: CHF 480-520 Strong Buy Price: CHF 336 (30% MOS) Accumulate Price: CHF 400 (20% MOS) Current Margin of Safety: Negative (-2% to +10% overvalued)

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PHASE 1: RISK ANALYSIS (Inversion Thinking)

"How Could This Investment Lose 50%+ Permanently?"

Risk 1: Customer Concentration / Contract Loss (High Impact)

The Moderna Lesson: Lonza manufactured the Moderna COVID-19 vaccine, which was a significant revenue contributor. When Moderna terminated its contract, Lonza lost substantial revenue (~CHF 500-700M annually). The stock dropped from CHF 743 (2021 peak) to CHF 339 (2023 trough) - a 54% decline.

Risk Quantification:

• P(Major customer loss in next 5 years) = 30%
• Impact if occurs = -25% to -40% share price decline
• Expected Loss Contribution = 30% x 32.5% = 9.75%

Mitigants: Lonza has diversified its customer base post-Moderna. Large pharma (like Genentech, from whom they acquired Vacaville) represents the majority of commercial revenue, which is more stable than biotech.

Risk 2: Biotech Funding Winter / Early-Stage Demand Collapse

Mechanism: When biotech funding dries up, early-stage drug development slows, reducing demand for Lonza's development services. This happened in 2022-2023.

Risk Quantification:

• P(Prolonged funding winter) = 25%
• Impact if occurs = -20% to -30% share price decline
• Expected Loss Contribution = 25% x 25% = 6.25%

Mitigants: Lonza's revenue mix is shifting toward commercial manufacturing (more stable) vs. development services. 2024 saw 20%+ rebound in biotech VC funding.

Risk 3: Asian Competition / Price Erosion

Mechanism: Asian CDMOs (Samsung Biologics, WuXi AppTec) have lower labor costs and growing capacity. The U.S. BIOSECURE Act may help Lonza in the short term but doesn't eliminate long-term Asian competition.

Risk Quantification:

• P(Significant market share loss to Asia) = 20%
• Impact if occurs = -30% to -40% margin compression
• Expected Loss Contribution = 20% x 35% = 7%

Mitigants: Lonza benefits from European/U.S. regulatory relationships, "friend-shoring" trends, and customer preference for Western manufacturing. BIOSECURE Act could significantly benefit Lonza.

Risk 4: CapEx Intensity / Return on Investment Failure

Mechanism: Lonza is investing 22% of sales (CHF 1.4B annually) in growth CapEx. If new facilities don't ramp up successfully or demand doesn't materialize, ROIC will suffer.

Risk Quantification:

• P(Major capex project failure) = 15%
• Impact if occurs = -15% to -25% share price decline
• Expected Loss Contribution = 15% x 20% = 3%

Mitigants: Lonza has a strong track record of facility execution. The Vacaville acquisition adds proven, large-scale capacity. Management targets >30% ROIC on new assets at full ramp.

Risk 5: Regulatory / Quality Failure

Mechanism: A major FDA warning letter or manufacturing quality issue could devastate customer trust and revenue.

Risk Quantification:

• P(Major regulatory failure) = 5%
• Impact if occurs = -40% to -60% share price decline
• Expected Loss Contribution = 5% x 50% = 2.5%

Mitigants: Lonza has decades of regulatory track record. Quality culture is deeply embedded.

Bear Case Summary (3 Sentences)

Lonza is a capital-intensive manufacturer exposed to the boom-bust cycles of biotech funding. The loss of a single major customer (like Moderna) can wipe out years of growth. Asian competitors with lower costs continue to gain share, and Lonza's premium valuation leaves no room for execution stumbles.

Pre-Defined Sell Triggers

1. Customer Concentration: Any single customer exceeds 20% of revenue
2. Margin Erosion: CORE EBITDA margin falls below 25% for two consecutive years
3. Capital Allocation Failure: ROIC falls below 8% persistently
4. Regulatory Failure: Material FDA/EMA warning letter affecting major facilities
5. Management Departure: Loss of key technical/operational leadership without adequate succession

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PHASE 2: FINANCIAL ANALYSIS

5-Year Financial Performance

Observations:

• Revenue grew from CHF 4.5B to CHF 6.6B (+47%) over 5 years
• Peak EBITDA margin of 32% in 2021-2022 during COVID boom
• Margin compression to 29% post-Moderna reflects mix shift
• CapEx running at ~22-27% of sales - heavy investment phase

Profitability Metrics

Note: ROIC is suppressed due to heavy growth CapEx. Management expects >30% ROIC on new assets at full ramp.

Divisional Performance (2024)

Balance Sheet Strength

Note: Leverage increased due to CHF 2.1B Eurobond issuance for Vacaville acquisition and growth investments. Remains comfortably investment grade.

Owner Earnings Calculation

Owner Earnings (2024 Estimate):
  Net Income:                    CHF 670M
  + Depreciation/Amortization:   CHF 600M (estimated)
  - Maintenance CapEx:           CHF 560M (40% of total CapEx)
  - Working Capital Increase:    CHF 100M (estimated)
  ─────────────────────────────────────────
  Owner Earnings:                CHF 610M

  Per Share (70.2M shares):      CHF 8.69

Valuation Metrics

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PHASE 3: MOAT ASSESSMENT

Moat Type: NARROW MOAT (Morningstar Rating)

Moat Sources

1. Regulatory Barriers & Switching Costs (Strong)

Mechanism: Pharmaceutical manufacturing requires extensive regulatory approval (FDA, EMA). Once a drug is approved using a specific manufacturing process at a specific facility, switching manufacturers requires re-validation and potential regulatory re-submission.

Evidence:

• Average customer relationship: 5-10 years
• Cost to switch manufacturers: $10-50M+ and 18-36 months
• Multi-year contracts with annual volume commitments

Durability: HIGH - Regulatory barriers are structural

2. Technical Expertise & Capacity Scarcity (Moderate)

Mechanism: Biologics manufacturing is technically complex. Large-scale mammalian cell culture capacity is scarce globally. Lonza is one of few CDMOs with proven ability to execute complex biologics at commercial scale.

Evidence:

• Vacaville facility: One of world's largest biologics plants
• Demand for large-scale capacity exceeds supply
• 60%+ of CapEx deployed for growth projects

Durability: MODERATE - Asian competitors gaining capabilities

3. Intangible Assets (Moderate)

Mechanism: Lonza's 125+ year history and track record with regulators provides credibility advantage. The "Lonza Engine" operating model creates process excellence.

Evidence:

• Founded 1897; CDMO focus since 2000s
• Relationships with all major pharma companies
• BBB+ investment grade rating

Durability: MODERATE - Reputation is sticky but can be damaged

Moat Erosion Forces

10-Year Moat Trajectory: STABLE TO NARROWING

The biologics CDMO market is growing 8-10% annually, but competition is intensifying. Lonza's moat is likely to remain intact but narrow modestly as Asian players improve quality and gain regulatory approvals.

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PHASE 4: VALUATION SYNTHESIS

Valuation Trinity

1. Liquidation Value (Floor)

Not applicable - Lonza is a going concern with specialized facilities. Liquidation value would be a fraction of book value due to specialized nature of manufacturing assets.

Estimated Liquidation Value: CHF 150-200/share (deeply distressed scenario)

2. DCF Valuation (Conservative)

Assumptions:

• Owner Earnings (2024): CHF 610M
• Growth Years 1-5: 8% (CDMO market growth)
• Growth Years 6-10: 5% (normalization)
• Terminal Growth: 2.5%
• Discount Rate: 8.5% (WACC estimate)

Calculation:

Year 1-5 PV:   CHF 2.9B
Year 6-10 PV:  CHF 2.4B
Terminal PV:   CHF 12.8B
─────────────────────────
Enterprise Value: CHF 18.1B
- Net Debt:       CHF 2.7B
= Equity Value:   CHF 15.4B

Per Share:        CHF 219 (Conservative DCF)

Note: This DCF may be too conservative as it doesn't fully credit growth CapEx optionality.

3. Owner Earnings Multiple

4. Relative Valuation (Reality Check)

Average Peer EV/EBITDA: 18-20x Lonza Fair Value at 18x EBITDA: CHF 1.9B x 18 = CHF 34.2B EV = ~CHF 450/share

5. Analyst Consensus (Reference)

Synthesis: Intrinsic Value Range

Conservative Intrinsic Value: CHF 400-450 Base Case Intrinsic Value: CHF 480-520 Optimistic Intrinsic Value: CHF 600-700

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FINAL INVESTMENT RECOMMENDATION

┌─────────────────────────────────────────────────────────────────┐
│                     INVESTMENT RECOMMENDATION                    │
├─────────────────────────────────────────────────────────────────┤
│ Company: Lonza Group AG          Ticker: LONN.SW                │
│ Current Price: CHF 529           Date: December 25, 2024        │
├─────────────────────────────────────────────────────────────────┤
│ VALUATION SUMMARY                                                │
│ ┌─────────────────────────┬─────────────┬─────────────────────┐ │
│ │ Method                  │ Value/Share │ vs Current Price    │ │
│ ├─────────────────────────┼─────────────┼─────────────────────┤ │
│ │ Conservative DCF        │ CHF 219     │ -59% (Overvalued)   │ │
│ │ Owner Earnings (20x)    │ CHF 174     │ -67% (Overvalued)   │ │
│ │ Relative (18x EBITDA)   │ CHF 450     │ -15% (Overvalued)   │ │
│ │ Analyst Consensus       │ CHF 665     │ +26% (Undervalued)  │ │
│ │ Base Case IV            │ CHF 500     │ -5% (Fair Value)    │ │
│ └─────────────────────────┴─────────────┴─────────────────────┘ │
│                                                                  │
│ INTRINSIC VALUE ESTIMATE: CHF 480-520 (weighted)                │
│ MARGIN OF SAFETY: -5% to +10% (Insufficient)                    │
├─────────────────────────────────────────────────────────────────┤
│ RECOMMENDATION:  [ ] BUY  [ ] HOLD  [ ] SELL  [X] WAIT          │
├─────────────────────────────────────────────────────────────────┤
│ STRONG BUY PRICE:          CHF 336 (30% below Base IV of 480)   │
│ ACCUMULATE PRICE:          CHF 400 (20% below Base IV)          │
│ FAIR VALUE:                CHF 500 (Intrinsic Value midpoint)   │
│ TAKE PROFITS PRICE:        CHF 600 (20% above IV)               │
│ SELL PRICE:                CHF 750 (50% above IV)               │
├─────────────────────────────────────────────────────────────────┤
│ POSITION SIZE: 0% (Wait for better entry)                       │
│ CATALYST: BIOSECURE Act; Biotech funding recovery (12-18 mo)    │
│ PRIMARY RISK: Customer concentration, Asian competition         │
│ SELL TRIGGER: EBITDA margin <25%; major regulatory failure      │
└─────────────────────────────────────────────────────────────────┘

Recommendation Rationale

Why WAIT (Not BUY):

1. Insufficient Margin of Safety: Current price of CHF 529 offers no meaningful discount to our base case intrinsic value of CHF 480-520. Value investing requires 20-30% margin of safety.

2. Post-Recovery Valuation: The stock has already rallied 52% in 2024, recovering from the 2023 lows. Much of the "easy money" has been made.

3. Execution Risk Premium: At 20x EBITDA, the market is pricing in successful execution of growth projects. Any stumble would cause meaningful downside.

4. Cyclical Exposure: The biotech funding winter may not be fully over. Early-stage CDMO demand remains soft.

Why WAIT (Not PASS):

1. Quality Business: Lonza is a narrow-moat business with genuine competitive advantages in a growing industry.

2. Structural Tailwinds: Biologics outsourcing is a secular growth trend. BIOSECURE Act could benefit Western CDMOs.

3. Management Quality: Conservative balance sheet (BBB+), disciplined capital allocation, clear strategy.

4. Known Cyclicality: Biotech funding cycles are known; a future downturn will create buying opportunities.

What Would Change My View

To BUY at Current Price:

• Evidence of sustainable 30%+ EBITDA margins
• Successful ramp of Vacaville with major customer wins
• Clear customer diversification (no single customer >15%)

Target Entry Price:

• Strong Buy: CHF 336 (would require ~37% decline)
• Accumulate: CHF 400 (would require ~24% decline)

Probability of Entry Opportunity: Moderate (40%)

• Biotech funding cycles typically create buying opportunities every 3-5 years
• The 2023 trough (CHF 339) was a textbook entry point

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Monitoring Metrics

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Sources Used

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Analysis completed: December 25, 2024 Methodology: Buffett/Munger/Klarman Value Investing Framework