MEDTECH — SURGICAL INSTRUMENTS: VALUES STILL HITTING NEW HEIGHTS
Nobody is immune: every industry has felt the impact of COVID-19 in some capacity, including medical device manufacturers. Helios Consulting, Inc. recently performed a valuation of a privately-owned medical device manufacturer primarily focused on developing and manufacturing innovative surgical instruments. The company’s management team provided valuable insight into some of the industry-wide trends that impacted their business in recent months. These conversations led me to wonder how they might impact the valuations of large publicly-traded competitors in this space. Read on for a brief summary of my findings.
This article was first posted in the ValuInsights Industry Blog. Visit us for more valuation insights and resources and follow me on LinkedIn!
Important notes: This article examines potential driving factors for valuations of the surgical instruments industry from a financial statement perspective. An actual valuation of a company requires an in-depth analysis of the business operations as well as associated risk factors. These cannot always be directly considered through the data on the financial statements. Also, in order to keep the length manageable, this article will focus on what I interpreted to be the primary value drivers and will not touch on every observation in the data. For a quick read on the basic concepts of risk and return and how they apply in the context of this article, please visit: What is Value? and Risk and Return in the Market Approach.
The industry constituents for this analysis are listed below. I focused on U.S. companies that were traded on major exchanges for at least a year with a stock price equivalent of $1 or more. I excluded companies that also develop and produce pharmaceuticals and only focused on the companies that generated positive EBITDA in the latest 12 months (“LTM”). The effective date of this analysis is December 31, 2020.
The surgical instruments and device companies’ median enterprise value (“TEV”), median revenues, and median EBITDA are summarized in Figure 1. Latest fiscal year is notated “LFY”, while the latest 12 months is defined as “LTM”.
Figure 1 illustrates the remarkable hike in industry enterprise values over the last six years, which coincided with consistent improvements in median revenue and EBITDA. Intuitively, the observed improvement in the financial metrics could be attributed to continuing demand for surgical instruments amidst an aging U.S. population, increased average lifespans, and improved access to healthcare (especially internationally). These factors are certainly helping to drive up valuations and financial performance. However, there is another component that has fueled the growth shown in Figure 1: acquisitions. Based on Form 10-K and 10-Q filings, nearly all of the companies analyzed engaged in regular merger and acquisition activity, which is consistent with the consolidation occurring in the broad medical technology space. There are several motivations for the larger players in the industry to absorb their smaller counterparts. One such incentive is that acquisitions allow a company to add new and complementary products to their own portfolios without incurring the costs and uncertainties of developing such products in-house. By leveraging their size, expertise, and market presence, the publicly-traded companies are able to rapidly scale the acquired businesses to generate favorable returns.
While valuations continued to grow in 2020, financial performance declined modestly in the LTM period partially due to a reduced number of elective and non-emergency surgeries in the midst of the pandemic. When financial metrics adjustments are outpaced by enterprise value changes, valuation multiples will increase. This can be viewed in Figures 2 and 3 below, which present the historical trend in revenue and EBITDA multiples. In this case, EBITDA multiples rose sharply in the LTM period because of the swell in enterprise values relative to the slight decline in EBITDA.
The Growth Story
Growth often has a strong influence on how companies are valued. A summary of the consensus forecasts for each group is presented in Figures 4 and 5 below (note that “NFY” means next fiscal year; NFY = calendar 2020 for most companies).
It makes sense to focus on growth after the NFY (2020) period, given the timing of this analysis. Strong growth expectations of the industry are likely to have impacted valuations at the end of 2020. To illustrate this impact, LTM EBITDA multiples are plotted in Figure 6 relative to projected EBITDA growth rates in 2022.
The data presented in Figure 6 shows some correlation between projected growth and EBITDA multiples. Unfortunately, there are a limited number of data points to observe, but higher multiples appear to be associated with companies that generate greater levels of growth. There are some inconsistencies in the data, however, which suggest other factors are at play in how these companies are valued in the market, such as the perceived risk of achieving projected growth rates given the current uncertainties in the market.
The Size Story
Larger companies are generally perceived to have lower levels of risk relative to smaller companies. This can be caused by a number of factors, including improved product or geographic diversification, deeper management teams, access to a variety of distribution channels, and better availability of capital. In this case, I did not observe a discernable relationship between size and LTM EBITDA multiples. While this is not to say that size is completely ignored, it appears to be overshadowed by other factors as of the end of 2020.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability since investors are willing to pay more per dollar of revenue. Therefore, higher revenue multiples can usually be observed in companies with higher levels of profitability. This relationship between LTM revenue multiples and LTM EBITDA margins can be observed in Figure 7 below.
In this case, there appears to be some correlation between revenue multiples and EBITDA margins, suggesting that profitability is an important consideration in how investors are valuing companies in the surgical instruments and device industry.
Tying it All Together
The trends observed in this article suggest that valuations of surgical instrument and device companies are impacted primarily by growth and profitability. For many companies in the industry, 2020 represents a temporary dip in demand for surgical instruments and devices. Continued improvements in life expectancy and lower mortality rates are likely to drive additional growth in the industry. Consensus forecasts further indicate a broad expectation among industry analysts for the field to resume its strong growth over the next few years. Based on valuations of the publicly-traded companies in this industry as of the end of 2020, it appears that investors are buying into the story of the industry’s future growth.
I hope you found this analysis helpful. Any and all input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.
Medical device companies are complex organizations with numerous value drivers. The valuation of a company requires an understanding of its risks and that of the industry as a whole, as well as proper interpretation of capital market evidence. Helios Consulting, Inc. is a full-service valuation service provider with the experience needed to guide you through your valuation requirements.
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