After a tumultuous first half of 2020 in which shares of InMode (NASDAQ:INMD) have seen excessive volatility, it is time to update the thesis after shares have stabilized again around the $30 mark.
After going public at levels in the mid-teens in August of last year, shares had seen a huge momentum run as valuation was very modest at the time of the IPO, with shares hitting a momentum-induced high of around $55 in November. Shares actually re-tested the IPO price, losing essentially three-quarters of their value as they were trading at $14 and change in March, now trading at around the $30 mark again.
The Thesis
My last take on the company dates back to this premium article in February, as shares fell to levels in the high thirties at the time, as no one could have expected the shares to trade at $15 just a month later.
I noted that the company just reported solid fourth quarter results and outlined a decent outlook for 2020, as reduced valuation multiples and growing net cash were starting to look compelling. At the same time, I reiterated my skepticism on the business model to some extent as it is hard to pick the winners upfront and estimate how longevity the success story and therapies could be. Nonetheless, I was looking to initiate on dips again, as InMode has been a big winner for me in 2019.
InMode is a minimally invasive technology company that has developed and develops human aesthetics therapies. These therapies are based on so-called "energy" methods and focus on the face and body contouring and medical aesthetics. This kind of therapy method has advantages of less pain and scarring compared to other alternatives.
Demographic trends, a greater focus on aesthetics, and general wealth on the increase mean that the demand for these procedures is on the rise. Basically, I was attracted to a strong net cash balance, strong earnings power, but had some doubts about the longevity and sustainability of the business model.
With an operating asset valuation of $325 million at the offer price at $14, shares looked cheap with 2018 sales having doubled to $100 million and the company reporting an adjusted operating profit of $31 million that year. With sales having increased to a run rate of $150 million by the second quarter of 2019 with operating profits totaling $60 million, I pegged net earnings potential around $1.50 per share, creating massive appeal at $14, certainly as the company held and still holds a ton of (net) cash.
As it now turned out, the company ended 2019 with fourth quarter sales of $47 million, with a run rate of nearly $200 million a year and a quarterly operating profit of $18 million that worked down to nearly $75 million in annualised operating profits.
Trading at $40 in February valuations was already coming down a lot. The company reported a basic share count of 33 million shares by the end of 2019 and a diluted share count of nearly 42 million shares. Conservatively, using the latter metric, that valuation included $4.50 per share in net cash. Assuming $18 million in operating profit with a 20% tax rate, that annualised earnings power ran at nearly $1.40 per share, suggesting operating asset valuations have expanded to 25 times.
That higher multiple and the fact that 2020 sales of $190-198 million are basically flat compared to the fourth quarter of 2019 made me a bit cautious. The company guided for $76-80 million in adjusted operating profits, suggesting flattish trends there as well, as I was not automatically a buyer at $40.
Hence, the no-brainer at the time of the IPO turned into a slight premium while sale momentum was rapidly fading, and hence, I concluded to reload on dips in the thirties but warned that the business model was not particularly strong, as I did end up buying a tiny position again around $25 when shares were in free fall in March.
Recent Trends
Mid-March, the company provided an update in the midst of the COVID-19 crisis, citing that demand was in line with targets so far as share traded at $15 at the time. Of course, the COVID-19 crisis has a real impact on surgical procedures coming to a standstill.
First quarter sales, with the quarter ending on March 30, rose 32% year over year to $40 million and change and while this is down from the fourth quarter, this includes almost a month of no activity taking place due to COVID-19. The statement of no or hardly any activity in the final month of the quarter is a bit strange, as the company told investors by mid-March that everything was going to plan.
With the company ramping up marketing and R&D efforts, GAAP operating profits fell from $9.9 million to $6.0 million. Including net interest income and low taxes, the company reported $0.15 or $0.19 in earnings per share, depending on if you use the basic or diluted share count. Annualised, this works down to $0.60-0.80 per share. This marks a big reduction from recent earnings power, as net cash levels have grown to $200 million, or nearly $5 per share, while the company is upbeat on the potential for demand to recover in the coming quarters.
The company actively made a decision to not restructure the business, but actually hired more salespeople in anticipation of recovery at some point down the road and with the world finding itself in a less restrictive state of lockdown, that might be the right choice to make, although it is pretty optimistic as well.
So, basically, the first quarter results are more or less in line with what could have been expected. See the transcript here. Safe to say that as the company is still profitable and operates with $200 million in net cash, the earnings power and now the earnings overhang dictate the valuation of the shares here and now. Posting earnings power which (temporarily) is far lower, the valuation now looks largely fair, in my opinion.
Trading at $30 and taking into account $5 per share in net cash, operating assets are now valued at $25 per share. With normalized earnings power running around $1.50 per share, operating assets now are valued at a market multiple as slower growth provides some challenges to the business model, meaning that shares are largely fairly valued here in my eyes, although I am happy to add some again on further dips.
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