Globus Medical (NYSE:GMED) is a producer of musculoskeletal implants used for patients suffering from spine disorders. The company has only been public since the summer of 2012 when its shares were sold at $12 per share to the general public. That proved to be a very appealing price for the company, which at the time was already profitable, showed strong growth and operated with a rock-solid balance sheet.
The market quickly seemed to realize this as well, as shares rose to $20 in 2014, and ever since, shares have largely traded around the $25 mark.
The company continues to show decent growth, and has made nice bolt-on deals, yet 2016 was a disappointing year. Growth came to a near halt on the back of disappointing sales force performance and pricing pressure. Despite these challenges, shares of Globus continue to trade near their highs as the valuation still looks reasonable, with the strong balance sheet still allowing for potential further upside.
What Is Globus?
Globus Medical is a company which develops and sells products which aids patients who suffer from spine disorders. Being founded in 2003, the company has launched over 150 products which address a broad array of categories.
The company has split up its products across the Innovative Fusion and Disruptive Technologies segments. Innovative Fusion focuses on spine fusion surgical procedures, correcting problems with the interlocking bones which make up the spine (individual vertebrae). Disruptive Technologies includes novel surgical procedures, improvements to current procedures, and intervention at an earlier moment in care.
The company continues to develop new products as R&D expenses total 7% of annual sales. Key new focus areas include trauma and robotics, although investments into these areas still have to pay off.
Based on the growth performance in the period 2012-2015, it is evident that the company is outgrowing the overall market, in part resulting from its high pace of innovation. Despite the excellent (past) growth, Globus is still facing competition from much larger competitors including Medtronic (NYSE:MDT), Synthes (part of J&J (NYSE:JNJ)), NuVasive (NASDAQ:NUVA), Stryker (NYSE:SYK) and Zimmer (NYSE:ZBH), among others.
Medtronic at +$100 billion valuation is a diversified medical device manufacturer which trades around four times sales. NuVasive trades at a similar multiple as Stryker and Zimmer Biomet trade around five times sales.
Going Back To 2012
At the time of the IPO, the prospects for Globus looked very good. Revenues for 2012 would come in at $386 million, representing growth of more than 16% on an annual basis, as sales more than doubled compared to 2008. The company was very profitable and posted operating profits of $115 million for margins of 30% of sales. This resulted in after-tax profits of $74 million, equivalent to $0.80 per share.
As the company ended 2012 with over $200 million in net cash, little over $2 per share, the IPO price of $12 looked very appealing. If cash was excluded, the market valued operating assets at just 12-13 times earnings. That is a very low multiple given the growth reported and industry prospects of course.
Market Realizes The Potential In 2013
The $12 IPO price looked low with the benefit of hindsight as shares rose to $20 by the end of 2013, to levels of around $25 in both 2014, 2015 and at the current moment.
Continued growth and the low valuation from the start were key drivers behind the strong returns, notably in 2013. Top-line sales were up 12% that year, coming in at $434 million. Reported operating margins fell toward 24% on the back of $23 million in litigation provisions. The company furthermore announced a small $16 million acquisition, but ended the year with growing net cash balances of $275 million, or close to $3 per share.
Top-line growth slowed down to a still solid 9% in 2014, as revenues grew towards $474 million. On the back of litigation expenses falling rather sharply, margins improved towards 29% again, as net earnings of $92 million translated into earnings of $1 per share. With cash balances exceeding $3 per share, the market awarded the company a 22 times earnings multiple at $25 per share, net of cash.
2015 was a very good year, as top-line sales growth accelerated towards 15%, with revenues coming in at $545 million, as margins surpassed the 30% mark again. Reported margins benefited from an $11 million reversal of litigation expenses, which had been taken in 2013. The strong growth in sales for 2015 was in part the result of the 2014 acquisition of Transplant Technologies, a $36 million deal. Globus furthermore bought Branch Medical Group in early 2015 for $57 million.
Despite these bolt-on deals, Globus ended 2015 with net cash balances of around $3.50 per share.
Last year has been somewhat more challenging for Globus Medical after sales were up 15% in 2015, although largely driven by dealmaking. First-quarter revenues were up by 5.8%, although the strong dollar shaved off 40 basis points from the reported growth rate.
The company reiterated the guidance for the year, predicting that revenues would come in at $583 million, up 7% compared to 2015. Earnings were seen at $1.20 per share. The continuation of retaining earnings, and not engaging in share buybacks or dividends, resulted in net cash balances ballooning to $377 million.
The second-quarter results, as released in July of last year, were causing some nerves among investors as growth slowed down to just 2.9%. As a result of the slower growth, Globus cut the full-year revenue outlook by $8 million towards $575 million.
The company announced another deal alongside the quarterly results, acquiring Alphatec Holdings in an $80 million cash deal. That deal gives the company access to Japan, thereby boosting the international sales network. Alphatec was and is expected to contribute roughly $40 million to 2017 sales. Expanding the international presence is important, as 90% of sales are still derived at home. On the back of the disappointing results and deal, shares fell to $22 per share.
Investors really grew worried in November, as Globus revealed a 1.0% fall in quarterly sales on an annual basis, with the full-year sales guidance being cut to $560 million. This bad news prompted shares to retreat towards the $20 mark. With cash holdings still exceeding $3 per share, despite the purchase of Alphatec, earnings multiples were rapidly falling to the mid-teens again.
The Current Valuation - Reasonable & Plenty Of Firepower
Unfortunately, shares have rallied rather sharply from the lows of around $20 in November to current levels of $27, being the highest level ever, despite the challenging sales trends.
This gives the company a valuation of roughly $2.6 billion, or $2.3 billion if net cash is subtracted, equivalent to 3.7 times projected sales for 2017. With EBITDA running at roughly $200 million a year, those multiples come in at roughly 11 times. Based on the adjusted earnings of $1.20 per share foreseen for 2016, shares trade at 20 times earnings net of cash holdings.
While the multiples look fair, given the struggling sales trends, it is important to understand just how much firepower Globus has left. As the company holds over $300 million in net cash, and generates $200 million in EBITDA, it could borrow $500 million and still operate with just a very modest amount of leverage. Half a billion would be sufficient to buy back a fifth of the outstanding share base, just to illustrate, but more likely is the route of pursuing additional dealmaking.
Globus released preliminary fourth-quarter results for 2016 at the start of 2017. These numbers reveal that fourth-quarter sales came in at $151.6 million, as annual revenues of $560 million just surpass the previously lowered guidance.
As sales came in at $142.6 million in Q4 of 2015, and factoring in $10 million in sales being contributed by Alphatec, organic growth is still close to being flat. The same trends which resulted in disappointing third-quarter results are likely to blame, including price competition, slower industry growth and disappointing execution of Globus's sales force, an issue which has limited growth throughout 2016.
The good news is that the company maintains the 2017 guidance with sales at $625 million as earnings are seen at $1.27 per share. Excluding net cash holdings and shares trading at $27, operating assets are valued at nearly 20 times earnings again.
Potential upside results from expansion of the business and the very strong balance sheet. It can furthermore not be ruled out that Globus might become an acquisition target as the industry has seen quite a lot of M&A activity in recent years. Alternatively, the company could buy another $100 million in sales with its current net cash balance for a revenue number of $750 million going forward.
A 4-5 times sales multiple, at which the rest of its peers are trading, would yield a $3.0-3.7 billion valuation, equivalent to $32-38 per share. While these potential returns are appealing, I am very much aware of the rhetoric about pricing in the wider industry, lower growth momentum as of late, and recent run-up in the shares.
Yet, I like the structural growth and fair valuation of the company, making me a buyer if shares dip toward the $25 mark again.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.