NEOG had a fine quarter given the macro. Results exclude the 3M merger so limited insight there. Grew revs 3%, ex-currency changes would have been 6%. Profitability lagged and bottom line numbers were near flat y/y. I still feel confident in the long term investment thesis despite the obvious issues.

CEO and COO bought more stock after the release of the Q. Pretty significant purchases from both. Clearly putting their money where their mouth is.

Also from the earnings call:

3M Food Safety lagged forecasts due to supply issues. They announced that they likely wouldn't hit the NTM $300mm EBITDA target and they will announce full year forecasts with Q2 results. Not great but didn't seem a long term impairment issue.

They are already finding synergies from the merger. They talked a few situations where they were benefiting both on the cost side and revenue side.

I think management made it clear the 3M integration is huge task and its taking most of the focus of management.

CFO is retiring next year. He will stay on to manage the transition to the next guy. It is an amicable situation that doesn't signal any major issues.

Analyst questions focused on the inherent uncertainty of the business due to the merger. I think this highlights a key aspect of the investment thesis: other investors are scared of the uncertainty surrounding the merger and are applying an uncertainty discount, as investors get results of the combined business that discount will go away.

Lets say they don't hit the $300mm AdjEBITDA target and miss by $30mm, so $270mm. By my calculation that is still ~14.5x EV/EBITDA at current prices. Seems fair to me.

If the earnings call did give good concreate examples of growth opportunities and synergies and the CEO and COO didn't buy a big chunk of stock I would be much more critical of the Q.

The margin compression is not encouraging especially considering they just took on a sizeable amount of debt in the 3M deal. Rising Dollar will continue to hurt results, right now is not the time that global exposure will shine.

However, I like the food safety business long term and like the organic and inorganic reinvestment opportunities. I think the consistency of the business should shine in macro weakness, and, despite all the challenges of the integration, sill believe that 3M Food Safety + NEOG will work out and become a dominant player in food safety.

I'm open to messages.

Neogen is a predictable quality business that is oversold and undervalued due to the transformational merger transaction with 3M Food Safety.

Thesis Overview:

I first read about NEOG earlier in August in connection to the 3M Food Safety merger. The merger was completed on Sept. 1. If you haven’t read about the deal this press release does a good job explaining it. Brief overview of the transaction: 3M spun out their food safety business and sold it to NEOG as a “Reverse Morris Trust” to avoid taxes. Neogen gave 3M ~$1B of cash and 50.1% of Neogen’s total stock post merger, so they roughly doubled the shares outstanding. As part of the transaction 3M offered 3M shareholders the choice to exchange their 3M shares for the NEOG shares at a discount.

Embedded in the exchange offer was an arbitrage opportunity: go long MMM, short NEOG then exchange MMM for NEOG at a discount, washing out the short and capturing the discount spread in the process.

The most recent short interest data is from August 15th. I think it is fair to assume that the upward trend in short interest shown in the chart continued as the date of the exchange approached. I think this put non-fundamental downward pressure on the stock. I also think it is possible that we could see more nonfundamental pressure on the stock from selling by unhedged 3M holders who decided to exchange and decide to sell.

Insiders have bought stock over the summer in the low $20s with the most recent purchase on August 16. The CEO’s purchase was near the size of his annual cash salary.

Neogen is a company with multiple product offerings in the food safety and animal safety businesses. Their products span the whole food supply chain, and customers often buy products for more than one use case. A good example of a food safety customer is a consumer packaged goods company’s food test lab; they would buy allergen tests, pathogen tests, and sanitation products. Many of these tests are required by regulators to bring a product to market. Here is a slide from the 3M merger announcement with a complete revenue breakdown by product type:

Historically, NEOG was about a 45-65 split in revenue between food and animal safety, however the 3M Food Safety merger changes the revenue mix to be about 75% food safety. The company sales pitch for a shift towards food safety is that food safety will be the faster growing end market going forward.

Management forecasts that revenue will grow by 10% going forward, roughly in line with their historical growth rate. I think this is obviously high for a long term growth rate but entirely possible for the next few years. Also, a 10% revenue growth rate is only 2-4% above the market growth rate, so not totally unreasonable. Assuming they have similar incremental ROIC to historic levels of 10-14% and reinvest 100% of profits back into the business a 10% growth rate is reasonable.

The business is consistent with attractive margins. Much of the consistency of the business comes from the fact that their products are regulatorily required and aren’t discretionary. Customers can’t stop using them when budgets are tight. Also, most of the revenue is consumable products of which customers don’t carry large inventories, so they usually make regular orders. Additionally, customers face some switching costs if they were to switch suppliers which makes sales relationships sticky. The combination with 3M food safety will increase product portfolio which will add additional economies of scale, and increase value proposition to customers.