GRFS - Grifols: Wait And See For Now
2024-01-10 13:15:00 ET
Summary
- Gotham City's recent allegations against Grifols have caused GFRS stock to significantly decline. Our team at Mare will remain waiting for clarifications.
- We expect the company's stock to be under pressure in the short term and probably not investable. For this reason, we are now neutral.
- On positive news, Grifols reached an alliance with Haier Group and raised SRAAS' proceeds to $1.8 billion.
These have been a difficult couple of days for Grifols, S.A.'s shareholders ( GRFS ). The company lost 30% of its market value yesterday, wiping off nearly $3 billion. This was due after hedge fund Gotham City Research questioned the company's accounting. The company was initially suspended on the Madrid stock exchange; shares opened with a 42% decline and slightly recovered during the day. At the time of writing, the company stock price is slightly down. Historically, Spanish short sellers have been rare, and these allegations are a bombshell for the corporation.
Looking at the Gotham City allegation , the short seller questioned the following:
- The sale of two businesses to Scranton Enterprises. In 2018, the company invested in Haema and BPC Plasma and then sold the two companies to Scranton. Scranton is the company's family investment vehicle and Gotham noticed that both Scranton and Grifols fully consolidated the two companies in their financials. Gotham called the accounting treatment " materially deceptive and incorrect; "
- These transactions have allegedly backed Grifols to understate its debt ratio. Gotham claimed that the correct leverage ratio should be between 10x and 13x and not 6.7x;
- 99% of the company's 2023 nine months income was backed by NCI results (non-controlling interest), with 40.1% of Grifols 2022 profit related to NCI in Haema and BPC Plasma;
- Gotham also reported how Grifols provided Scranton with a $95 million loan in 2018, which Gotham believes is related to the Haema and BPC deals.
In a nutshell, Gotham City argued that the Spain-based pharmaceutical firm reported EBITDA and debt that was manipulated, causing its reported leverage to be artificially reduced… Should Gotham City's Grifols debt estimate be correct, the company " will face notably higher financing costs. " The research outfit furthermore advises: " Consequently, Gotham believes shares are uninvestable, likely zero ."
KPMG audits Grifols, and Gotham City explained how the auditor " has consistently released unqualified audit reports. " KPMG did not comment. Grifols' SA has issued a response to the allegations, denying all the allegations levied by Gotham. At the time of writing, according to Reuters , Grifols confirmed it would sue Gotham City fund over the damaging report.
On its corporate website , Gotham City is a company that "focuses on due diligence-based investing ," adding that it may have short or long equity positions in the companies it invests/covers. Dan Yu founded Gotham City and has a mixed track record in short positions. On a negative record, Gotham failed with the SES-imagotag allegation but proved right in exposing accounting problems to the Spanish Wi-Fi provider Gowex, which filed for bankruptcy a few months later. Another successful case was NMC Health.
What's next?
This earthquake has shaken Grifols' foundations; however, looking at the company's reply, Grifols questioned the Gotham City Research report with enough arguments.
Looking at the 2022 annual report (page 104), Grifols disclosed that:
On 28 December 2018, the Group sold BPC Plasma, Inc. and Haema, AG to Scranton Enterprises B.V (shareholder of Grifols) for US Dollars 538,014 thousand. To pay the mentioned amount of the sale, Scranton signed a loan contract dated 28 December 2018 for US Dollars 95,000 thousand (Euros 82,969 thousand) with Grifols Worldwide Operations Limited. The compensation is 2%+EURIBOR and is due on 28 December 2025.
In the same report (page 8), Grifols explained that
On 1 February 2021, the Group signed a call option on the shares of Haema Plasma, exercisable by the Group only 12 months after signing and with an expiry of 48 months from the date the option becomes exercisable. The option price was set at thirteen times EBITDA minus net debt.
These transactions include a call option for Grifols, which grants the exclusive right to acquire the shares sold to Scranton (both simultaneously) at any time from the effective date of sale.
Going to the NCI composition, we see non-controlling interest at 23% of the company's results. Of course, if the numbers weren't correct, it would undermine everything else.
Source: Grifols 2022 annual report
Sell-side analysts have updated their views on Grifols and have generally trusted the company. All four investment banking covering the Spanish player (Citi, Alantra, CaixaBank, and Bestinver) have maintained their buy recommendation. Among the four IBs, looking at the target price, the lowest is Bestinver, with a buy rating of €15.5 per share, while the highest is that of Citi, with a buy rating of €23 per share.
Conclusion
Here at the Lab, for safety reasons, we decided to move Grifols under review without any recommendation or target price for the time being. We decided to wait for further clarifications and anticipate that Grifols stock might be under pressure in the short term.
Mare Evidence Lab has historically been bullish on shares of Grifols and moved from a Buy to a Strong Buy rating in the past year. In our December report, we cited two drivers for upsides . Our Promising Buy Opportunity , as presented in July 2023, finally materialized on Grifols' news in late December. The company was in advance negotiations with China Merchants to sell Shanghai RAAS with a valuation of a 26% equity stake of approximately $1.5 billion. As a reminder, in the Q3 call, Grifols had strong confidence about closing the transaction and maintained multiple interested parties, which were never disclosed then. Finally, the company reached a strategic alliance with Haier Group. With a share purchase agreement, the company will sell approximately a 20% equity stake in SRAAS to Haier for $1.8 billion, maintaining a significant 6.50% equity stake in the company and a board seat. As already emphasized, this will reduce the company's debt. We were waiting for this news.
However, with Gotham City's released report, we believe it is better to wait for this negative short-term momentum. In our previous estimates, including SRAAS' disposal, we used to value Grifols with a 17.5 EV/EBITDA multiple with a target price of €20 per share. Net debt to EBITDA 2024 was at 4x with a 2024 EBITDA forecast of at least €1.75 billion.
For further details see:
Grifols: Wait And See For Now