One of the best parts of writing for Real Money is all the great people I get to meet. I have made some great friends with fellow contributors and Real Money subscribers over the years, and I enjoy hearing from everyone who writes and comments on my articles. Not everyone agrees with me, and I have enjoyed some of the debates and discussions about the merits of my ideas and approach and have learned quite a bit from them.
One group of readers that I have become good friends with over the years are the folks out at Glacier Peak Capital in Seattle. Glacier Peak is a value-oriented investment firm that uses an approach similar to mine, and we have swapped ideas for several years. We also engaged in some pretty spirited debates over baseball, and I may turn the text messages exchanged when the Orioles play the Mariners into a lovely coffee table book. They recently shared an idea with me that I find intriguing and with their permission and am sharing with the rest of Real Money today.
Harvard Biosciences (HBIO) is what I call a pick, shovel and blue jeans story. When the California Gold Rush started would be when miners flocked to the state. A few got rich but most didn't. However, the entrepreneurs who sold the miners picks, shovels and other equipment did very well for themselves. On such individual, Levi Strauss, developed a new way of making denim pants with rivets, and a legend as well a fortune was born.
If you follow the market at all, you have seen some of the spectacular booms and busts in small biotech companies. I do not think that there is any way for most of us to have a clue which of these small research and development firms will make a break-through and which ones will just burn through all the cash before finding something they can sell. What we can predict is the folks doing the research will all need a lot of specialized equipment, and that's where Harvard Biosciences comes into play.
It makes and sells laboratory equipment in the United States and internationally. Most of their international business is in Europe, but they have recently begun expanding into China and other parts of Asia. That is a huge step as China currently is the second-largest spender on medical and biotech research and development and is projected to pass the United States by 2020. Fully 80% of sales are to governments and research institution with the remaining 20% coming directly from pharmaceutical and biotechnology firms.
One of the biggest moves by CEO Jeffrey Duchemin since he took over in 2013 is to restructure the company. Previously, Harvard Bioscience had 13 independently operating brands with no shared infrastructure or cross-selling efforts. He has formed the companies into three separate product groups with coordinated sales operations. It also allows them to focus on acquisitions that complement the existing product groups rather than acquiring businesses that do not fit into the new model.
They have also gotten rid of some companies that do not fit into the new structure. Harvard Bioscience recently sold its liquid-handling products (AHN) division based in Germany for $1.7 million. Duchemin said on a recent conference call that they sold the division because, "Although the business was an interesting one for our portfolio, AHN required substantial capital to continue to grow without meaningful future leverage or synergies with our existing business."
Now that the reorganization is close to complete they have three primary product groupings: Cell and Animal Physiology sells instruments and accessories for tissue, organ and animal-based lab research; Laboratory Products and Services sells biology products focused on liquid handling; and Molecular Separation and Analysis sells lab equipment like spectrophotometers, microplate readers, amino acid analyzers, gel electrophoresis equipment and electroporation instruments.
One of the concerns with this company is that much of their U.S.-based business consists of selling to research labs that depend on National Institutes of Health funding. Duchemin addressed those concerns during his call, telling investors, "The NIH budget ran through Sept. 30 and included a 6% increase in funding over the fiscal year 2015. Despite the budget increase, when the U.S. government released the funding data for fiscal 2016, actual outlays of funds declined 0.1% compared to 2015. If we isolate Q3, spending over last year was down just over 4% in the quarter. Our results have a correlation with the decline because of our concentration in academia, and this had a tangible impact on our business. We are confident in our position in the market and our strategy and should the NIH funding environment improve, our commercial teams are positioned to reap the benefits."
I like the story and the management. The CEO and CFO are also believers as they were buying shares of the stock in November. The opportunity in Asia, especially China in the near term, is huge and just getting started. Consolidating locations is an ongoing process and should continue to help the bottom line.
Harvard Biosciences is not a classic Melvin value play, but it fits into the asymmetrical long-shot classification. If everything works out well over the next few years, even a relatively small investment in the stock could lead to huge rewards for patient but aggressive investors.