InMode Stock: Small Cap Big Moat

Summary

• InMode shares have traded down over 20% in the last month.
• Using a DCF into 2025, we can see what sort of growth the market is pricing in after rallying several hundred percent over the last 18 months.
• Considering InMode has no debt and is growing in the high double digits with strong margins suggests its products are in demand and are capable of penetrating new markets.

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Business Model

Growing revenues from $153M in 2019 to being on target to hit $346M in 2021 while also expanding EBIT margins from 38% (2019) to 48% (estimate for 2021) is beyond impressive. I came across InMode (NASDAQ:INMD) in May 2020 (since sold my position) and I maintain this is easily one of the most impressive small caps I have ever come across.

Below, I will try to expand on previous writings from other writers but I will try to focus more on the modelling side to see what the market has priced in after a 300% 12-month rally, or an 800% rally from March 2020 lows. InMode is trading at 40x EV/EBITDA (LTM), indicating a decent amount of growth is still priced in.

InMode has been able to utilise their novel radio frequency technology for a number of minimally invasive medical procedures. InMode has a number of platforms and hand-held devices that cover body/face treatments, skin treatments, gynaecology treatments, etc.

Bipolar RF allows for energy and temperature to be controlled on the inside and outside of the body. This means sub-dermal fat can be reduced or repositioned without noticeable scarring on the patient (also promotes collagen production), this can be done at a variety of depths depending on tissue thickness and which device is used. InMode's patent portfolio will last at a minimum until 2027, and if current patents are approved, the newer products will last until 2038.

InMode also designs and manufacturers laser equipment as a way to complement their product line which can be used for hair removal or treating vascular lesions, although the majority of products are built around bipolar RF technology.

InMode provides clinics with attractive ROI for their purchases. Surgeons in the US typically purchase an InMode platform on a 5-year finance agreement.

According to the management, contract repayments (including interest) and disposables for treatments is roughly $5,000 per month depending on number of treatments. The average price for a minimally invasive treatment is between $5,000 and $7,000, meaning cash flow wise surgeons can break even with one or two treatments monthly. Additional treatments in the month serve as gross profit for the surgeon. The majority of surgeons break even on their purchases in less than a year (typically 7 months). These are very rough estimates from management, however, it illustrates a compelling offering for clinics.

Based on Q3 results, 73% of revenue came from minimally invasive surgical technology, 18% from hands-free devices and 9% from laser/non-invasive platforms. InMode distributes in over 70 countries, however, the majority of revenue comes from doctors in the US. Doctors have the option of upgrading their equipment as InMode releases additional devices but revenue is predominantly driven by new customers.

Research and Development

You would think looking at InMode's explosive growth that their R&D budget would have been rather impressive also. This isn't the case, in fact, over the last 3 years, R&D has never been more than 5% of total revenue. Significantly more is spent on Sales and Marketing which includes paying for trade shows/industry events, office visits, professional journals, base level sales salaries and commissions, SBC for employees, paid media, etc. Interestingly management says this will continue to decrease as a percentage of total revenue over time as the dollar amount spent on S&M increases.

Below summarises operating expenses as a percentage of revenue over the last 3 years and 9 months ending September 2021.

Source: Created By Author

R&D on product categories or projects are not tracked on a single project basis. Management guides R&D spending will vary depending on new product launches, however, the CEO has previously stated that they do not think it's wise to undergo aggressive engineering efforts as this could hurt the current portfolio, rather 2 new platforms and 2 new handheld devices per year is the rough target. A small team of 16 members based in Israel is responsible for InMode's R&D efforts which include enhancement of existing products as well as developing on new products. There are 15 projects in the pipeline of which 3 are aesthetic products, there's also a new ENT platform expected to release in 2022 (dry eye treatment in the works), development of male urology product/treatment plus several others.

Overall, the pipeline is strong and should support top-line growth as new platforms are released, however, I'm not sure these new platforms will be as popular as other current minimally invasive platforms/handheld devices. Regardless, I like the fact management is trying to enter into new markets like male urology and ophthalmology.

Continued Expansion/Growth

InMode still has room to expand globally which will come with further regulatory approval from domestic medical authorities and as InMode grows their exclusive distribution network for areas where they have no direct sales team.

Management has subsidiaries in countries where they feel the opportunity is better captured with a direct sales team.

Source: 20-F Filing

InMode recently set up a direct sales team in China at their subsidiary in Guangzhou as management feels the region will be better captured with employee representatives as opposed to having an exclusive distribution agreement with retailers. InMode only has 3 products approved for treatment in China with several other products awaiting approval from the National Medical Products Administration in China (no timeline).

With a rapidly fast-growing middle class, China would be a key region for InMode's long-term growth as the US and other regions mature over time.

Overall, management continues to grow their teams across their 11 subsidiaries, with a focus on building up sales presence which is still relatively small in some counties. The company only employs 311 people (likely more when the next 20-F is released) of which most are based in Israel and the US.

In Europe alone, it's estimated between 2021 and 2028 the non-invasive aesthetic treatment market is expected to reach $5.83 billion in 2028, up from $2.33 billion in 2021 indicating a 13.9% CAGR. This is only for a small part of InMode's revenue mix, but overall, the market for RF-based medical devices for aesthetic treatment is expected to triple in value for the next 3 years, suggesting a long growth runway.

Below also illustrates market size forecast for RF devices used in ablation.

Source: Grand View Research

Non-invasive and minimally invasive aesthetic treatments have gained popularity in the past few years, mainly a result of being low cost, less downtime, little to no scarring, less painful, etc. Also, RF-based treatment for fat reduction has low rate of complications. Furthermore, RF-based treatment is known to stimulate collagen in the skin making the skin firmer. This technology is still relatively new which is why InMode's growth is so impressive.

InMode is growing much faster than the industry indicating a strong demand for their products. This has been helped by InMode's S&M department and the fact they are actively involved in educating and training new customers.

However, as a previous author pointed out, there are historical examples of companies with rapid growth in the minimally/non-invasive aesthetic treatment market that experienced a poor performance after years of strong sales. However, InMode has several patents, an attractive pipeline and is comfortable discussing new ways they can utilise RF for different treatments.

In the social media world, there appears to be an increased focus on body image in both teens and adults resulting in them being more open to the idea of aesthetic treatment as they get older. I believe the effect of social media is a big factor in the forecasts above.

Financial Model

The idea of this DCF is to use current analysts' consensus for FY21 and then apply a CAGR for the remaining years to determine what growth the market has priced in. I do not agree with discounting back 10 years' worth of cash flows as you run the risk of being too conservative or too optimistic the further out in time you go. Therefore, I will use a 5-year DCF (really a 4-year considering we are near the end of 2021).

Below are the overall assumptions for margins, I am keeping GP constant at 85% and EBIT at 48%, then lowering by 1.5% each year. I expect increased spending in R&D as efforts are focused on specific treatments hence why I am lowering the margin. Furthermore, I expect stronger S&M spending as regions open up fully allowing for S&M teams to travel to industry events and promote which they haven't been able to do yet in all their regions, this is partly why EBIT margin is so strong in 2021. With the new Omicron variant, the S&M budget may not increase as much as I expect but I will still assume slight margin compression in order to remain conservative.

InMode has been growing like a SaaS company with margins better than a SaaS company. This is a result of being a lightweight operation where they outsource manufacturing to companies in Israel (domestic manufacturing for tax benefits), so I am keeping the margin still very healthy above 40%.

I have also used an 11.5% tax rate as their previous decade-long tax benefits from the Israel government are set to expire. Considering industry growth overall, InMode's unique offering, product pipeline and room for global expansion, I will use a 25% revenue CAGR from FY21 onwards. This is above Wall Street consensus for FY22 which is 21.8% revenue growth.

Source: Created By Author

I am increasing both D&A faster than analyst consensus after FY21, below I also do the same for CapEx.

Source: Created By Author

I consider this a fair forecast. I see some bottom line pressure due to increased taxes in 2022, however, FCF growth will remain strong. Also, I'm not accounting for finance income.

Below are additional assumptions to determine InMode's intrinsic value.

Source: Created By Author

Source: Created By Author

This discount rate of 12.08% may be on the harsh side, particularly when we consider InMode has zero debt. If they did take on debt, it would lower their cost of capital. Therefore, below I will show changes in WACC.

I'm using a 3% risk-free rate in anticipation of a higher interest rates over the coming years as inflation runs (3% gives enough cushion).

Instead of using an exact target price, below I will show how the intrinsic value per share changes if we lower WACC and if we increase top-line growth, all else being equal.

Source: Created By Author

Depending on your growth assumptions, InMode could be overvalued if you believe the company is going to grow sales slower than 25%. At 35% revenue CAGR, InMode appears quite attractive, however, you would have to assume Wall Street is being too conservative.

Personally, I believe InMode is priced fairly as I think a 10% WACC is appropriately forward looking.

Key Risks

Although InMode has impressive propriety technology that's now translating into incredible margins and top-line growth, a lot of growth is now priced into the valuation. InMode's MOAT-like characteristics and approved patents are impressive but that doesn't mean valuation goes out the window.

Management themselves were surprised as to how strong their performance has been so far in 2021. Going forward, if management misses on consensus, there could be an adjustment to valuation as a more modest growth rate is priced in.

Additionally, the emergence of the new Omicron variant has the potential to setback InMode's progress by a few quarters depending on what data comes out in the next few weeks regarding vaccine efficacy. If clinics are forced to close in multiple regions as a result of data indicating lower levels of vaccine efficacy against the new variant, Q1 and Q2 could see temporary poor performance.

Lastly, depending on how the next few months play out, we could see both faster taper and more aggressive hikes. The economic consequences of another lockdown and what that means for inflation (supply chain driven or not) and interest rates are worrying. The Fed doesn't have the capacity to act on weakening economic data as the bazooka has already been used. Rather, I feel the risk is that WACC is going to increase faster than previously thought leading to valuation compression.

Conclusion

The market has now realised InMode's unique offering and has priced in growth appropriately. I was lucky enough to buy InMode in May 2020 pre-split around $27. I was expecting decent growth after covid settled which the company could sit through due to a strong balance sheet. It was very much a set it and forget it play. By pure luck, the company delivered results significantly more impressive than I was expecting, and the stock rallied dramatically. I reduced, then exited the position during Q3 2021 (not expecting better guidance in Q3), putting my profits into other opportunities.

I do not want to own a business at its fair value with relevant amount of growth priced in as there are opportunities in the market to buy companies with far more attractive risk/reward characteristics. I would argue my forecast is fair and the result indicates InMode is priced in and around its intrinsic value.

However, now as InMode is selling off (down 20% in one month), I am keeping an eye out to see if the sell-off accelerates as it could offer an opportunity to reopen a position.

If you believe InMode can sustain 30-35% or more revenue growth over the next 4 years (or longer - Patent expires 2027), then InMode is a no-brainer; however, the best investments tend to be ones where conservative assumptions are made and the model suggests attractive upside.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.