Cerba - Agreement at what cost - Positioning

All,

Please find our updated model on Cerba here.

As we stated in our November note post Q3 results, Cerba remains significantly overleveraged on a reported EBITDA basis, with the sponsor likely out of the money. What has changed since then to warrant a fresh look at Cerba? The secured bonds have rallied 3-4pts, with the subordinated bonds rising 8pts, primarily on the back of the agreement reached between the French state and the unions on pricing going forward. However, we are not convinced the deal is as positive as the market reaction would imply.

Investment Rationale:

- We are taking a 2% short position in the Secured bonds at 88%, yielding 7.5%, and a 1% short position in the Unsecured bonds at 68%, yielding 15.5%.

- Our negative view stems from an overly confident market in the view that volumes will stay elevated as seen in FY23 and the early part of FY24. There will be pressure from the ultimate payer, the French state, to lower testing volumes, and our interpretation of the release from Health Insurance (l’Assurance Maladie) and the unions hints at lower volumes in Q4.

- But even without lower volumes, most of the rate reductions imposed in September 2024 will remain. Our model sees limited prospect for deleveraging over the coming quarters and without further acquisitions, funded by external capital.

Potential for positive news:

- The agreement does allow for some tariffs to be increased, but we can’t ascertain if Cerba is overweight in this segment. However, we are confident that the majority of tariffs remain at the reduced September pricing given Cerba’s size. Its portfolio of testing will be reflective of the broader market.

- The Company have acknowledged that its acquisition strategy remains on pause. Linked to this is a desire to do further divestment of non-core assets. Management did state nothing was imminent, but an asset sale may be deleveraging depending on the multiple. However, more broadly, the pause/cessation of the roll-up strategy is reflective of the sponsor's acknowledgement that tougher times are ahead and the business is over-leveraged.

- However, we struggle to see a path to deleveraging organically and further acquisitions may be required. If the sponsor reaches a similar conclusion and injects further equity to achieve this, the bonds will rally.

- The remaining upside for Cerba will come from a return of the Research/Advanced Biology segment. Cerba opened its new speciality platform in Frepillon in FY24 and it is now fully operational. With book to bill ratio having returned to above 1.0x in September, there is scope for growth in this segment. However, it is less than 25% of total revenue and with the business still undergoing a transformational program, we don’t expect to see progress immediately.

Price Agreement:

- In late December, the Unions agreed to call off strikes following the lowering of prices in September. The background to the dispute is higher than expected volumes in Q1-Q3 2024, which would have resulted in the government overspending its budget for FY24. Therefore, the government unilaterally lowered the price per test in mid-September. The agreement in December ensured that pricing would predominately stay at the lower level until December 2026. Some rates were increased from the revised (lower) September rates, but the majority are left at the lower rates.

- Although this is positive news, we highlight one line that is in the official communication, stating there has been a recent slowdown in the volume of testing. This is not expected and would run counter to the market projections. Any downward pressure on volumes will be exasperated by the lower rates. Note: although there is an agreement, it is to maintain the rates at the new lower September levels (with some carve-outs).

Model changes:

- We have made some modest changes to our model, namely on top-line growth and the level of synergies achieved over the coming years.

- The main impact of the change of top-line growth is with respect of the French business, which reflects the points made above concerning the dynamics of volume and pricing for Q4 24 and FY25.

- Separately, we have made small adjustments to our CAPEX and tax rates going forward, but these are minor in the overall context. The ultimate change in the model is in revenue growth, as we see volumes only marginally outpacing the decline in pricing.

Next Steps:

- Cerba are unlikely to report FY24 numbers until mid-April, leaving a vacuum of news until then. Although we are taking a short position, we don’t expect materially worse numbers in the Q4 results than market expectations. However, we expect some comments on volumes, which won’t compensate for the lower tariffs.

Happy to discuss

Tomás

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk

Tomás Mannion7 February 2025CERBA