Gene therapies hold the potential to stop or cure debilitating diseases by correcting errors in DNA. While that creates an intriguing investment opportunity, investors will certainly have their hands full wading through all of the hype. But there is one under-the-radar area that should prove more lucrative and relatively less risky: manufacturing. 

The headlines might make it clear that AveXis and Spark Therapeutics were the first two companies to earn marketing approval for gene therapies in the U.S., but investors might not recognize that both companies invested heavily to develop leadership in gene therapy manufacturing. In fact, that likely had more to do with their respective acquisitions by Novartis for $8.7 billion and Roche for $4.8 billion than their drug products.

The globe-spanning operations of Novartis or Roche certainly dilute the opportunity in gene therapy manufacturing. That's why investors interested in the space should give Catalent (NYSE:CTLT) a closer look.

A finger pushing a chunk of DNA out of a longer strand of DNA.

Image source: Getty Images.

A big push into gene therapy manufacturing

Catalent is best known for formulating, developing, and manufacturing softgel drug delivery capsules -- something its predecessor first commercialized in the 1930s. In addition to steadily improving softgel capsules in the last 90 years or so, the business has diversified by developing other drug delivery technologies and the manufacturing know-how required for success.

Today, Catalent develops and manufactures softgel capsules, oral drug delivery technologies, and biologic and specialty drug delivery technologies for customers at volumes suitable for clinical trials or commercial operations. The niche hasn't blown investors away with double-digit growth, but the business exited fiscal 2019 with solid momentum. The only blemish was a 34% year-over-year drop in operating cash flow, although that was due to the adoption of a new accounting rule and delays in receiving payments from customers that implemented new digital payment processing systems during the most recent year. 

Metric

Fiscal 2019

Fiscal 2018

Change (Decline)

Total revenue

$2.52 billion

$2.46 billion

2%

Gross profit 

$805 million

$752 million

7%

Operating income

$274 million

$269 million

2%

Operating cash flow

$248 million

$374 million

(34%)

Data source: SEC filing.

Despite the relatively slow growth, Catalent's drug delivery niche has served shareholders well. The pharmaceutical stock has delivered a five-year return of 106%, compared with 68% for the S&P 500 (with dividends included) in that span. But management thinks it can do a better job leveraging the company's unique expertise by focusing on the profitable growth potential of biologic drugs

Biologic drugs include proteins, blood products, vaccines, and monoclonal antibodies. More recently, that list has expanded to include cellular medicines and gene therapies. They're more difficult to manufacture and require a special approval process from regulators in the form of a biologic license application (BLA). As a result, biologic drug manufacturing expertise is difficult to come by, which creates a sizable competitive advantage for companies that find success.

Catalent can be counted among the fortunate few. The business has manufactured monoclonal antibodies for 115 global clinical trials and 11 commercial products. That leadership is clearly evident when investors dissect fiscal full-year 2019 operating results by segment revenue and EBITDA

Metric

Fiscal 2019

Fiscal 2018

Change (Decline)

Softgel revenue

$872 million

$917 million

(5%)

Biologics and specialty drug delivery revenue

$742 million

$602 million

23%

Oral drug delivery revenue

$620 million

$574 million

8%

Clinical supply revenue

$321 million

$430 million

(25%)

Softgel EBITDA

$191 million

$196 million

(3%)

Biologics and specialty drug delivery EBITDA

$180 million

$147 million

23%

Oral drug delivery EBITDA

$187 million

$173 million

8%

Clinical supply EBITDA

$84 million

$76 million

11%

Data source: SEC filing.

The focus on biologic drugs is certainly paying off, and the best may be yet to come. In April 2019, Catalent acquired gene therapy manufacturing leader Paragon Bioservices for $1.2 billion. The business specializes in developing and manufacturing adeno-associated virus (AAV) vectors, lentivirus vectors, and plasmids -- all of which are used to develop gene therapies or deliver gene therapy payloads into target cells in the human body. 

Considering that the acquisition closed in late May, the new Paragon Gene Therapy business unit contributed for just half of the fiscal fourth quarter of 2019, or the three-month period ending June 30. But it won't take long for investors to notice the contributions: Paragon expects to deliver over $200 million in revenue in calendar 2019. 

The long-term potential looks to be significantly larger than $200 million in annual revenue. The acquisition immediately makes Catalent a go-to source for gene therapy vectors -- and it hasn't wasted time staking out market share. Consider the moves made since the acquisition was announced in April:    

  • Announced a partnership to manufacture AAV vectors to support early stage clinical trials of IVERIC bio set to begin in 2020.
  • Announced a partnership to manufacture AAV vectors for Amicus Therapeutics from clinical trials through commercial operations.
  • Announced a long-term partnership with Passage Bio to support clinical and commercial volumes of AAV-delivered gene therapies beginning in the second half of 2020.
  • Announced a long-term partnership with AveXis and Novartis to manufacture Zolgensma, the first gene therapy approved in the United States, near Baltimore (the drug is made in regional manufacturing facilities) and supply AAV vectors needed for pipeline candidates of AveXis.
  • Acquired manufacturing assets, assumed two property leases for manufacturing facilities, and hired more 100 employees from Novavax. The deal will boost Paragon's manufacturing capabilities and support vaccine candidates in development at Novavax.

The recent partnerships highlight both Catalent's new leadership position in gene therapy manufacturing services and the relatively lower-risk nature of the investment. Not every partner will announce successful results from clinical trials, but Paragon Gene Therapy will monetize the partnerships regardless of outcome. Of course, those that succeed will need higher volumes of AAV vectors, which will create larger revenue streams for longer periods of time. It's a win-win.

An overlooked leader in gene therapy

Catalent isn't a household name, and isn't even a well-known name among gene therapy stocks. But investors interested in the potential of corrective or curative genetic medicines shouldn't overlook the stock. The recent acquisition of Paragon Bioservices immediately made Catalent one of the most important companies in the space. Its growing list of customers are certainly aware of that, and it may only be a matter of time before Wall Street catches on.