magicmine
It’s really for the best that Seeking Alpha doesn’t offer any ASMR with its articles because the appropriate soundtrack for this part of the article for Integra LifeSciences Holdings Corporation (NASDAQ:IART), where I often discuss the performance since my last article, would be the sounds of retching and dry heaving.
I pointed out my issues and concerns then about management’s ability to execute and hit its own timelines (particularly regarding reopening a manufacturing facility), and lo and behold, that plant isn’t going to reopen in 2024 at all. Down another 15% since my last article, though with a brief run back into the low-$40’s along the way, Integra’s biggest issue is the fact that the company simply has no credibility with the Street anymore. While the pending retirement of the CEO does add uncertainty to the mix, I frankly think any change here is a positive and I do still see a path forward to mid-single-digit revenue.
If things don’t get worse and there aren’t substantial downward revisions from here, these shares are cheap by pretty much all the metrics I watch. As anybody who ever tried cheap scotch can tell you, though, there is a difference between “cheap” and “undervalued,” and these shares are really only suitable for investors with the patience to wait out the ongoing struggles to get the business back on track.
Boston Remains Out Of The Picture For Now
It’s been more than a year since Integra announced a global recall for all tissue products produced at their Boston facility and shut down production for remediation. With the facility shut, there has been a significant negative impact to the business, with Tissue Technologies revenue down 15% in the last quarter as the company cannot manufacture and ship products like SurgiMend or Primatrix (significant products for the company with applications in areas like chronic wound management, burn care, and plastic/recon surgery).
Management’s plans to reopen the plant this year came to nothing when a third-party audit revealed still more issues to address. With that, the company no longer expects to have the plant in operation this year.
This has been a frustrating blunder to watch play out over the past year. Facility remediation is never easy, and it’s even harder in cases like this where endotoxin contamination is in play, but investors are already out of patience with this issue.
Expectations Could Still Be Too High
Even with the guidance revisions tied to not having the Boston facility in 2024 in place, management’s guidance for the second half of 2024 could still prove too aggressive. Simply put, management is looking for a fairly significant ramp in the second half (roughly $80M, or about 5% of total revenue expected this year), and that’s a big move for a business that doesn’t have a lot of historical seasonality.
Looking at the drivers, I’m on board with the idea that the resolution of Integra Skin supply chain problems will be a meaningful positive – it’s a significant product for the company and the company has been under-shipping to demand because of supply limitations.
The other big driver, working through a high level of backorders in the Codman business, is one I’m less confident about. I don’t want to beat a dead horse here, but the reality is that there have been various operational execution issues at Integra for some time now, so I have less than full confidence that the company will completely deliver on this one.
The Acclarent Acquisition Is Okay … I Guess
Back in December 2023, Integra announced the acquisition of Johnson & Johnson’s (JNJ) ENT business, ACCLARENT (“Acclarent”). Integra agreed to pay $275M in cash and up to $5M in milestones for a business that should generate around $107M in revenue this year (management closed the deal on April 1 and guided to $80M in incremental revenue for the remainder of 2024) and grow at a mid-to-high single-digit clip.
Acclarent is a solid business, with most of the revenue coming from disposables like balloon catheters for sinus, tube, and airway treatment (including Acclarent AERA for eustachian tube treatment and Relieva Spinplus NAV). It’s a mature, established, and scaled-up business, though it is a U.S.-only operation.
There’s minimal synergy here with Integra’s existing business. Integra sells a few tools into ENT (MicroFrance), but that’s about it. Integra management mentioned how ENT and neuro are anatomically close, which is technically true, and it’s likewise true that about 20% of brain tumors are located at the base of the skull and often require the involvement/help of an ENT, but that seems like a stretch to me.
I see this as a ho-hum acquisition for Integra that should earn a decent enough return on capital (management is expecting a 10%-plus ROI by year 5), though I do see the potential to leverage the business in Integra’s overseas markets and wring out some extra growth and profit leverage. At around 2.5x to 2.6x revenue, I don’t think Integra is overpaying, and if anything, the Street may be relieved that they’re not making another high-multiple deal in their tissue business.
The Outlook
Integra has a lot of work ahead to improve its reputation, and the CEO electing to retire for “personal reasons” is arguably for the best. A new strategic vision could be at least part of what Integra LifeSciences Holdings Corporation needs to deliver on at least some of the potential here.
My expectations for FY ’24 are below the average, but not by a lot, and I’m expecting 5% growth in FY ’25. While the eventual reopening of the Boston facility should lift expectations at some point, it’s not as if those patients can be backlogged, so this is revenue that’s gone for good. The company is profitable, as shown by its Q1 2024 earnings of $0.55 per share, with guidance of an adjusted profit range of $3.01 to $3.11 per share for FY 2024.
I expect around 4% to 5% long-term revenue growth from Integra, with the Codman neurosurgery operations offering steady, though not exciting growth and likewise for the Acclarent ENT operations. There is certainly the potential for Tissue Technologies to generate higher growth rates, and lift overall revenue growth, but “potential” only gets you so far.
On margins, my expectations have come down meaningfully due to the ongoing issues with Boston, and I’m now looking for around 21% EBITDA margin in both FY’24 and FY ’25 and improvement to 22%+ in FY ’26. Free cash flow will be pressured in the near term by lower profitability, but I do think mid-to-high-teens FCF margins are possible down the line and mid-teens FCF margin can support high teens FCF growth from 2023’s lower starting point (representative like-for-like growth would be closer to 10%).
As far as IART shares go, the valuation is interesting. Even with my lower revenue and margin estimates (and higher discount rate), the shares trade below my estimated fair value on discounted cash flow. Likewise, on multiples-based approaches like growth/margin-driven EV/EBITDA or P/E. A P/E multiple of 10x would be at the low end of the range, and on the lowest published estimate would still give a $30 price target. A 2.6x forward revenue multiple, which includes a 20% discount to what would otherwise be a “fair” multiple for a company with similar growth and margin prospects, gets me to the mid-$30’s.
Debt is still rather high here, with a roughly 4.2x ratio of net debt to my ’24 EBITDA estimate (including the Acclarent deal), and it would take the next seven years of my estimated free cash flows to zero that out. Management has nevertheless elected to announce a small ($50M) buyback.
The Bottom Line
“How much worse can it get?” are some of the most dangerous words in investing, so I don’t want to leave the impression that all the bad news is already in the share price, and it can’t get worse for Integra shareholders. I do find the price today more interesting, though, and while I’d rather own CONMED (CNMD) or Haemonetics (HAE) among recently beaten-down med-techs, I will admit this name is worth watching as a turnaround candidate.