Milan Court Decision Does Not Change LivaNova Bullish Story

Nov. 16, 2021 4:35 PM ETLivaNova PLC (LIVN)

Summary

  • The courts in Milan ruled that LivaNova would be liable for $519 million in damages in connection with a former parent company from Sorin with which it merged years ago.
  • While they appeal the ruling, it really changes nothing in the LivaNova story which remains fully about the treatment resistant depression opportunity.
  • Other parts of the portfolio, even cardiovascular, are doing better than expected too thanks to a recovery in procedure volumes and end-of-service implant replacements.
  • With the recovery, they are getting closer to profitability even with the current business constitution, but DTD remains the main catalyst for driving returns.
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Human heart with blood vessels

Rasi Bhadramani/iStock via Getty Images

LivaNova (NASDAQ:LIVN) is a company that we've been holding for a while now as part of our 'mad money' allocation in our overall value portfolio. While more speculative, there is no question that LivaNova offers a value like special situations thesis, where the possibility of achieving reimbursement from insurance for its treatment resistant depression products is a 'back from the dead' opportunity thanks to long-term users of the neuromodulation product. In other news, the cardiovascular products are also improving in performance, making some headway towards profitability. The overall neuromodulation segment is also doing well. As it is currently constituted, the business is making strides towards profitability, and with the treatment resistant depression opportunity inbound, there is likely more money to be made so we maintain our position, even in spite of recent legal headwinds announced.

Q3 Results and DTD Update

Most of the results were reported with respect to 2019, as 2020 was highly impacted by COVID-19 due to the slowdown in procedures. The neuromodulation business is performing well, with epilepsy leading the charge and helping sales recover to 2019 levels, beating out 2020 levels.

LIVN Neuromodulation sales

(Source: LIVN Q3 Pres Earnings)

The slowdown in procedures means that the overall sales this year are forecast to be up 25%-30% compared to 2020 results, with a tailwind being provided by the backlog of procedures built up in 2020 as hospital capacity was directed to COVID-19. This slowdown in procedures, especially around when the Delta variant started spreading while having become a beneficial backlog now has been a problem for one of the other main drivers of our thesis, i.e., the difficult-to-treat depression products (DTD). The procedure slowdown has meant that building up the study in order to prove insurance eligibility has been delayed, and the outcome of approval that we expect is consequently also delayed. Therefore, that catalyst of returns is further out than we had hoped.

LIVN Cardiovascular Sales

(Source: LIVN Q3 Pres Earnings)

The cardiovascular business made good progress relative to 2020, managing to stay in line despite the divestment of the rather weak heart valves business. This segment, which is one of the culprits for LivaNova's inability to make standing profits, has thankfully improved in profitability, meaning restructuring efforts are evidently paying off. This segment is being buoyed mainly by the recovery in cardiac procedures that didn't take place in 2020, with oxygenators and heart-lung machines selling well, but also LifeSPARC related to respiratory distress with 45% of volumes being related to COVID-19 patients. In summary, across segments revenue is actually up 5% relative to 2019 driven by neuromodulation with those tailwinds due to backlog generated in 2020, as well as the general situation of end-of-service terms for older implants that need to be replaced keeping the backlog at the same level as in Q2.

LIVN adjusted segment operating income and margin

(Source: LIVN Q3 Pres Earnings)

VNS treatments of ANTHEM and OSPREY are also at the initial stages of trial and could be nice additions to the portfolio for heart failure and sleep apnea markets respectively.

Legal Update

There were some outstanding legal issues that LivaNova had to deal with, and they have now reared their ugly heads. In connection with business being done by Sorin, which became LivaNova after it merged with Cyberonics, some environmental liabilities amounting to $519 million which were being contested have become ruled as the responsibility of the company. Naturally, they will try to fight this ruling, but what is important to investors is that the ruling does not really affect the state of the business and the attractiveness of the business option. Even adding $519 million to the current EV as an outstanding financial obligation, we still see that the implied market opportunity for DTD is still massive.

LIVN valuation

(Source: VTS)

The argument remains much the same as before. The dollar value of managing the disease implied by the residual business value of the DTD neuromodulation opportunity looks small, given how debilitating depression is.

Valuation and Conclusions

LivaNova is clearly not without its risks. It's not very cash generative yet due to low underlying profitability of the cardiovascular segments, and it had to equity finance to retire its loans. Thankfully, there are not too many loans left, with more than 70% being nixed with help of the equity offering. Moreover, LivaNova is producing a little bit of free cash flow as of this quarter.

LivaNova adjusted free cash flow

(Source: LIVN Q3 Pres Earnings)

With a recovery in procedures, both the segments should continue to see profitability improvements, and with the full launch of the DTD product in neuromodulation, that more successful segment should claim more of the mix. That is if the DTD opportunity develops as expected, with no further delays, which is another risk that might keep the business from getting that important return catalyst and source of free cash flow. But overall, the thesis remains much the same, and we continue to be optimistic about the company in the limited exposure that we have.

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This article was written by

Author of The Value Lab
A long-only voice with eclipsing growth through 2020 and 2022 bear markets.

Valkyrie Trading Society seeks to provide a consistent and honest voice through this blog and our Marketplace Service, the Value Lab, with a focus on high conviction and obscure developed market ideas.

DISCLOSURE: All of our articles and communications, including on the Value Lab, are only opinions and should not be treated as investment advice. We are not investment advisors. Consult an investment professional and take care to do your own due diligence.

DISCLOSURE: Some of Valkyrie's former and/or current members also have contributed individually or through shared accounts on Seeking Alpha. Currently: Guney Kaya contributes on his own now, and members have contributed on Mare Evidence Lab.

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Disclosure: I/we have a beneficial long position in the shares of LIVN either through stock ownership, options, or other derivatives. 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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