TMO serves over 400,000 diverse customers across its four major segments as a leader in the global laboratory solutions space.
TMO's products and solutions are deeply entrenched in customer workflows, rendering many of them lifelong customers. These customers face substantial switching costs if they wanted to move to a competitor.
The company's workforce is huge, and research and development spending is astronomical. Not many companies can keep up with TMO's level of innovation and in-house expertise. A key differentiator is TMO's tight customer relationships that allow TMO to always be one step ahead of the pack when it comes to new product innovation.
About $9 billion of COVID-related revenues are expected to drop off soon, but this will not stop the freight train that is TMO. The company has ample organic growth opportunities, targeting 7 - 9% over the long run with a highly disciplined M&A process.
Overall, TMO is the perfect "picks and shovels" company to play the continued advancements expected in global science, and TMO is end-market agnostic. Whatever the newest, hottest, and most attractive end market in science is, TMO will be right there to serve the most advanced science research and processes.
Key Company Metrics
A set of metrics we constantly keep updated to monitor the investment thesis.
Scale and Innovation
TMO is massive - the company employs a workforce of around 130,000 and spent almost $1.5 billion on research & development ("R&D") in 2021. These large human and financial investments dedicated towards creating the world’s best products to serve science are the foundation of the scale TMO enjoys today, and vice versa. With its large scale, TMO can continue investing into its people and R&D at this scale.
This broad range of products and services enables the full end-to-end research and manufacturing process for its customers. The major workflows TMO supports include biological and medical research, discovery and production of new drugs and vaccines, diagnoses, logistics of clinical trials, and mass drug production for commercial purposes. The real list is much longer because TMO is deeply entrenched into the global science community and the developments that come from it.
For a science-oriented company, human and financial capital are the cornerstones of success. Without highly capable people and access to capital, TMO would not have the deep expertise, know-how, testing capabilities, and level of innovation it has today.
The results have been extraordinary. TMO splits up its R&D teams by favouring smaller teams with deep expertise rather than larger teams filled with generalists. These highly capable teams have been able to produce complex and powerful machines and solutions for TMO's network of over 400,000 customers.
TMO's innovative products aim to:
enable life sciences: discover novel drug targets, scale up bioprocessing, and accelerate advanced therapies;
enable diagnostics: improve accuracy and advance precision medicine;
enable material science: automate semiconductor process control.
On top of its people and large in-house R&D, TMO has the scale to leverage its relationships with customers to deliver cutting-edge products and technology. Specifically in the biotech / biopharma space, TMO has relationships with small and large companies and academic and healthcare institutions. These relationships help accelerate innovation by being in touch with TMO's customers, and delivering them what they want and need. The result is a vast portfolio with differentiated products that allow customers to innovate in their own way.
TMO benefits from operating as a "picks and shovels", end-market-agnostic laboratory solutions provider the global science community cannot function without.
Expertise and Accumulated Experience
TMO serves emerging, small, and large biopharma organizations. Through its trusted biopharma relationships, TMO has been able to develop deep expertise and accumulate experience that yield increasingly positive advancements in the form of best-in-class products, portfolio breadth, and pharma services capabilities.
By working with its customers, TMO creates an environment that is conducive to "knowledge share". Customers seek TMO's advanced products, but the only way TMO will know what customers need is through communication.
Therefore, these trusted relationships TMO has with its customers creates a double-whammy effect - customers get the products and services they need, and TMO reaps the financial rewards from advancing science forward.
Deep Workflow Embeddedness
TMO four segments are highly complementary to each other, meaning customers can mix-and-match and stack products and services from TMO to suit their unique workflows.
TMO's customers must also comply with strict regulatory requirements. TMO tailors its products to customers to not only comply under their respective regulatory requirements, but also provide high-quality products with high utility to serve science.
Pharmaceutical scientists and researchers must submit manufacturing information to demonstrate the company or organization can properly manufacture the drug when submitting a New Drug Application ("NDA") to the US Food & Drug Administration ("FDA"). In an NDA and other drug applications around the world, this includes having to specify the equipment and supplies used to manufacture the drug and where they are used in the drug manufacturing process.
Once the drug is approved, the process the company outlined is static - the company cannot deviate from it. If there are any changes to the process, the company must re-submit documentation that, once again, outlines the process and the equipment and supplies used.
Therefore, TMO customers face high switching costs. The highly complementary nature of TMO’s products and services, consistent regulatory compliance, and deep embeddedness into workflows and drug and other research applications ensure that customers stick around for long periods of time and face high financial and re-training costs if they try to move away from using TMO products or services in their workflows.
Not only are TMO's segments complementary to each other, but they are also all large on their own. TMO extracts major benefits from having four separate, important segments used in different industries or points throughout a particular scientific workflow.
Much of TMO's revenue is consumables - products used up quickly - accounting for almost 60% of revenues. These revenues are generally recurring given consumables are used time and again in research, medical, and scientific processes and sold at high margins. An additional ~20% of revenues come from services, another source of recurring revenues. In total, around 80% of TMO's revenues are recurring, primarily coming from its sales of consumables.
Recurring revenues mean consistent cash inflows, reducing financial volatility and allowing TMO to consistently reinvest in its high-return operations rather than worry about stashing cash away for a rainy day, like a commodity business might do.
Ample Firepower - Prolific M&A
TMO's strong recurring cash flow base and deep embeddedness in the global science community allows the company to generate tons of cash, raise lots of cheap capital, and conduct many mergers & acquisitions ("M&A").
M&A helps TMO unlock lots of shareholder value given the fragmented nature of the industry in which it operates. TMO maintains tight discipline in its search for M&A targets, only acquiring those companies that will enhance customer offerings, strengthen TMO's strategic position, and create shareholder value.
The M&A criteria and discipline TMO adheres to when evaluating a target against these criteria should help TMO widen its moat. Specifically targeted acquisitions typically help bring new, advanced products to market and / or strengthen the overall company strategy.
Over time, 60 – 75% of TMO's capital is expected to be deployed into M&A with the balance returned to shareholders. TMO is confident it will continue to acquire strong M&A targets throughout the future that help it advance science.
Pharma & biotech, TMO's largest industry group served, is poised to grow organically and via robust M&A activity. Following COVID, funding for new therapies, modalities, and other innovations in the sector is expected to push biotech and pharma advancements forward. For TMO, this presents an enormous opportunity. Companies in this sector use TMO's life sciences solutions, analytical instruments, and lab products and services (3/4 of TMO's segments) to innovate. We expect TMO to grow alongside this major trend as a comprehensive provider of solutions in the science realm.
The science industry remains highly fragmented. TMO estimates that between themselves and the top other players, more than half of the market is owned by smaller players. This creates a long runway for TMO to continue to perform acquisitions. Once a target is acquired, TMO uses its proven integration process to bolster financial and operating performance and top-line and cost synergies. The moat is further strengthened with each acquisition TMO makes.
Capital returns to shareholders will undoubtedly be robust as TMO continues to execute primarily on the pharma & biotech and M&A fronts. TMO repurchases billions of dollars worth of stock each year and pays a dividend too. As TMO grows stronger and free cash flow rises, we think capital returns will continue to be robust.
TMO spent tens of billions on acquisitions over the past decade. As with any acquisition, there are risks of underwhelming synergies, growth opportunities, and strategic qualities being gained after the closure of the acquisition.
Additionally, TMO sometimes conducts extremely large acquisitions that may take long periods of time to integrate with lots of potential pushback from the target's employees when being integrated into TMO. For example, TMO closed its acquisition of PDD, a clinical research services to the biopharma and biotech industry, for over $17 billion in 2021. These are huge acquisitions that could, at times, be difficult to integrate quickly.
TMO has a global presence with about 50% of revenues generated outside the US. In recent years, global trade was placed under threat with protectionist policies, like tariffs, from and against the US from European and Asian countries.
TMO would face a substantial financial burden if it were to face tariffs from any of these regions, which would hurt sales and reduce cash flow.
For one, TMO requires a solid pipeline of acquisition targets to grow at high rates. On average, organic revenue growth at TMO hovers around the mid-single-digit mark, excluding the growth from COVID the last two years. If regulators view TMO as a malicious competitive threat to the industry in any given region, TMO may see its M&A pipeline shrink substantially, or face costly regulatory hurdles even when acquisitions are approved.
Besides M&A, TMO's products are also subject to a plethora of regulatory, legal, and compliance requirements. These mainly include environmental, health, safety, food, and drug regulations. Should they become stricter than today or change quickly, TMO may not be able to react quickly enough or develop a product that is compliant under new regulations given the complex nature of its products and services.
COVID Will Not Last Forever
COVID may be an endemic, but the high revenues TMO generated as a result of will not be. In 2021, total COVID-related response revenue of over $9 billion was generated, of which $2 billion were from vaccines and therapies.
Going forward, TMO expects much of this revenue to simply fall off. Only about $100 million of revenue will be generated each quarter, or $400 million a year related to molecular diagnostics.
However, we think this drop-off in revenues has already been priced in by investors as it is no secret to anybody.