I've recently discussed the key reasons why I think the strengths and opportunities of LivaNova (NASDAQ:LIVN) has been overlooked by the market, so in this article I will analyze why I think this company offers a compelling risk/reward at current valuation of 12.5x P/E 2018, using a SOTP to demonstrate that the market is ignoring the value of the Neuromodulation and Cardiopulmonary franchises, which are two key pillars of LivaNova’s long term strategy.
I have assigned a different valuation to each LivaNova's franchises and I made the assumptions that CRM will suffer from competition and present highest profitability.
- Cardiopulmonary. As I wrote in my previous article, this has always been the strongest franchise of the old Sorin, but recently the company has suffered for a warning letter on a minor component of this franchise, called 3T Cooler.
I strongly believe that any issues in this division will be temporary, given the leading market shares that the company enjoys in this space, especially in the oxygenators and heart-lung machines environments.
Unfortunately, it’s impossible to find competitors for LivaNova in this space to be used as proxy for the SOTP. Thus, I think the most reliable source of comparison is the old historical multiples at which Sorin traded before the merger with Cyberonics. As seen by the graph below, historically Sorin has traded at around 15x NTM P/E and I used this valuation as a good proxy for the valuation of the Cardiopulmonary franchise.
- Hearth Valves (HV). As I discussed previously, the long term opportunities for LivaNova in this environment are related to the success of their sutureless valves, called Perceval. Despite I strongly believe that the excellent clinical profile of this product has been overlooked by the market, it’s worth noting that LivaNova hasn't a full portfolio of products to compete with the big players in this space. Thus, I believe that LivaNova will remain a niche player in the HV market, focusing their efforts only in the sutureless valves market.
For these reasons, I assigned to this franchise a valuation of 14x NTM P/E, at 40% discount to a big player in this space as Edwards Lifesciences Corp (NYSE:EV).
- Neuromodulation. I discussed in my previous article why I think Neuromodulation is the strongest franchise of the company and I believe the next wave of innovations coming from LivaNova in this space, from their next generation device (SenTiva), will further reinforce their leadership in this market.
Unfortunately, it’s impossible to find competitors for LivaNova in this space to be used as proxy for the SOTP. Thus, I think the most reliable source of comparison is the old historical multiples at which Cyberonics traded before the merger with Sorin. As seen by the graph below, historically Cyberonics has traded at around 24x NTM P/E, but I assigned a valuation of around 20x P/E to be more conservative.
- Cardiac Rhythm Management. As discussed in my previous article, CRM is the weakest franchise of LivaNova and I would not bet on the ability of the company to be able to show sales growth in this market over the coming years. This market is highly competitive and LivaNova hasn't the scale and a portfolio of products to compete with the big players.
For these reasons, I assigned to this franchise a valuation of 10x NTM P/E, at 40% discount to a big player in this space as Medtronic (NYSE:MDT)
Source: My Own Valuation Model
This analysis shows that even assuming a depressed 10x P/E valuation to the CRM assets and a valuation of 14x P/E (at discount to key players) for Heart Valves, the stock is undervalued by at least 20%.
Thus, the market is totally missing the quality of Cardiopulmonary and Neuromodulation franchises that should at least trade in line with the historical multiples of the respective companies before the merger.
Worst Case DCF Valuation
Lastly, I modeled also a downside scenario to assess what is a worst case valuation for the company. The key differences in terms of assumptions are:
- I assume revenue growth of only 2-3% in 2018-2022, compared to 5-6% assumed in my base case analysis in my previous article, which is below consensus. There are two key reasons behind this assumption:
- I assume that the company will not be able to restructure its CRM franchise, showing declining sales growth in this division for the next 5 years.
- I assume a steady decline of the leadership of LivaNova in the Cardiopulmonary space.
- I assume no improvement in the EBITDA margin over 5 years, which is materially below consensus.
- I assume a 0% perpetuity growth rate and 9x EBITDA exit multiple.
As a result of these assumptions, my estimate for 2019 revenue is 3% below consensus and my estimate for 2019 EBITDA is 19% below consensus.
Source: Consensus Comparison vs. My Own Valuation Model
Under this worst-case scenario, LivaNova is slightly overvalued by approximately 9% (Perpetuity Growth Method) bit still undervalued by approximately 4% (EBITDA Multiple Method), as shown by the following analysis:
How LivaNova can unlock value for the shareholders?
I think an easy way to unlock value for the investors is a disposal of the CRM business. From my SOTP, the value of the CRM franchise is around $ 8.50 per share, thus assigning no debt to this business and considering that LivaNova has around 49 millions of shares outstanding, the EV of the CRM business in my SOTP is around $ 400M.
It’s reasonable to assume that the value of this business for a strategic acquires could be greater than our analysis, because there will be cost synergies in terms of SG&A and R&D (e.g. eliminating duplications) or revenue synergies (e.g. LIVN has a good presence in Japan and Europe, while it’s not an active player in US).
Thus, it’s realistic that a disposal of the CRM business could be worth around $500/600M, with three clear benefits to the investment case:
- It would simplify the investment case, focusing the execution efforts on the key franchises, as Neuromodulation or Heart Valves where the company has differentiated products.
- It gives the ability to invest proceeds in further M&A to strengthen its core Cardiac Surgery business.
- It gives the possibility to give back the money to the shareholders, with an accelerated share buyback, if the company will not found any attractive M&A target.
With solid management execution and the opportunity to unlock value for the investors with a disposal of the weak CRM franchise, I think LivaNova offers a compelling risk/reward proposition and I would chase the company in 2017.
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.
Additional disclosure: Not investment advice