Inogen: Investors Should Take A Breath

Aug. 09, 2019 8:16 PM ETInogen, Inc. (INGN)1 Comment

Summary

  • Inogen has real operating challenges at hand, yet valuations become cheaper by the day.
  • I like the collapse in the valuation as the company has some real potential.
  • At these levels, I am willing to make a reasonable bet.
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Inogen (NASDAQ:INGN) has seen the share price implosion continue in recent weeks and months, while this was of the market's darlings last year. While momentum seen last year was clearly not sustainable, the question is if the situation has reversed to the other side.

The company has seen solid sales momentum in recent years yet has failed to deliver on operating leverage. The market potential is clear, but so is competition, pricing pressure, and headwinds in reimbursement policies. In January, I reviewed the situation in greater detail as I saw appeal improving, yet never acted to acquire a position of any significance.

The Business

Inogen changes the way in which patients are being delivered oxygen in everyday life. The stationary oxygen concentrator is outdated as the portable version offered by Inogen weighs less than 3 pounds. Furthermore, it can function up to 5 hours without changing batteries.

The mission of the company is that of oxygen being anytime and anywhere available while it should be cost efficient. COPD is ever more prevalent with 30 million Americans impacted already and many more across the globe as the quality of air, or better lack of quality, makes that COPD is unfortunately on the rise.

The more than $2,000 retail price is not very cheap, yet the solution can have a dramatic positive impact on the quality of life of patients, as penetration rates of portable devices have already risen towards 20% of the market. As a leader in the portable segment, Inogen has grown from a $10 million business a decade ago to where it stands today, with sales surpassing $350 million per annum. While this run-up is very impressive, operating margins have been stable around 10%.

The company only went public in 2014 when shares were trading at just $16 per share. Shares started the year of 2018 at $120 as steady revenue growth translated into a higher equity valuation. Momentum even pushed shares up to a high of $300 in September of last year. Fast forwarding less than a year ahead in time, shares are down 85% of their value at $45 currently.

The Growth Story

For the year 2017, the company grew sales some 23% to $249 million. The company guided for a small acceleration in revenue growth in 2018, with sales initially seen at $298-308 million. Throughout last year, the company raised the guidance as sales actually hit $358 million, marking 43% growth year on year, with unit sales up 55%. Much of the growth acceleration has been fuelled by a sales and marketing budget which nearly doubled, although the company was effective as keeping general costs flattish.

Operating earnings of $38 million translate into margins just north of 10%. Not taking into account net interest income and working with a 20% tax assumption, that more or less works down to $30 million, or about $1.30 per share. Needless to say that valuations were sky high at $300, with equity valued at $6.8 billion at its peak.

A somewhat cautious view toward future growth and reversal of the momentum seen in the first nine months of 2018 meant that shares ended the year at $130 and kept falling ever since. Alongside the release of the 2018 results, the company guided for 2019 sales to come in at $430-440 million, suggesting 21% growth. Margins were expected to take a small beating as the adjusted EBITDA guidance of $67-71 million implies about 9-16% year-on-year growth.

Based on a share count of 22.5 million shares trading just above the $100 mark, I was getting more upbeat in January as the equity valuation dropped to $2.2 billion and to $2.0 billion if we account for net cash balances, meaning that forward sales multiples fell below 5 times. Furthermore, earnings power could come in just shy of $2, which still resulted in a 50 times earnings multiple, yet given the growth of sales and potential for some leverage down the line, that made it look that appeal was improving quickly.

Shares fell to levels in their $70s in May as the company released the first quarter results. Revenue growth slowed down to just 14% amidst an 11% increase in volumes. With sales and marketing expenses on the rise, operating earnings were cut nearly in half to $4.9 million. Alongside the earnings release, the company updated the full year guidance to $410 million, plus or minus $5 million. That marked a $25 million markdown from the initial guidance, as the midpoint of the operating earnings guidance was cut by $5 million to $43 million.

Second Quarter Results - Another Bombshell

The second quarter earnings report revealed that revenue growth has come to a near standstill, with sales up merely 4% year over year, attributed to lack of sales force productivity. The fall in operating earnings, from $14 million in the quarter last year to about $12 million, was reasonable, in my opinion.

The company has now cut the sales guidance to $370-375 million, more or less suggesting flattish sales trends in the second half of the year. The midpoint of the operating earnings guidance will fall from $43 million to $27 million, which looks more dramatic than it is. This comes as the company has incurred more than $5 million in costs related to an announced acquisition.

The company has reached a deal to acquire New Aera in a $70 million deal, with earn-outs potentially hitting another $31 million. New Aera makes innovative non-invasive ventilators for people suffering from various lung diseases, including an FDA approved system. The first sales are not expected to be recognised before 2020.

Due to poor results, shares have now fallen to $45 per share, and equity is valued exactly at $1.00 billion. After taking into account $256 million in net cash balances ahead of the New Aera deal, and about $185 million thereafter, operating assets are valued at $815 million, or just 2.2 times sales. Working with the adjusted $32 million operating earnings number, net earnings should still come in at above $25 million, for about $1.15 per share. Again, shares are not cheap on earnings multiples (at around 40 times earnings), yet based on the potential, it seems pretty fair at these levels, certainly if the company can return to double digit revenue growth for 2020, which they claim is credible.

That is highly susceptible, given the uncertainty in the professional segment and reimbursement environment only getting worse, while the patients who are more wealthier themselves have already been able to pay this out-of-pocket expense. Competition is furthermore a real threat, yet the company is far from reporting absurd margins as increased innovation (including through the latest acquisition) and a cheaper valuation makes that a potential acquisition by a competitor becomes more likely by the day as well.

Hence, I am willing to establish a 50% position at these levels as I think that the long-term potential and leadership position is worthwhile at these levels, although this remains an above-average investment story.

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This article was written by

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The writer is a long term value investor and M.Sc graduate in Financial Markets with over 10 years experience. Value can be found in both long and short ideas and uses options to enhance the risk-return profile of investment ideas. Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice.

Disclosure: I am/we are long INGN. 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.

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