Published on The Value Lab 9/2/22
LivaNova (NASDAQ:LIVN) is one of our smaller, VC style holdings where we are betting on a peculiar option that is remarkably undervalued despite how the markets these days value growth. As explained in our last article, the DTD opportunity for LivaNova is structurally more likely to succeed in becoming reimbursable, thereby allowing for superb ASPs, and positioning the company for incredible growth. Moreover, the financial profile of the company is stabilised, with success in several vagus nerve stimulation (VNS) trials focused on heart and head likely to rocket the company into substantial scale and profitability. The market opportunities are large, with many trials trudging through their various phases to deliver scale and growth. With neuromodulation being an attractive area, and ASPs being very high in these treatment areas, the upside is notable.
In terms of the financials, we should understand where we are today, and how much margin current performance gives us in our thesis. As of now, the only products that are marketed for LIVN are the cardiopulmonary products, which command very weak margins, are not strong growers, and are generally not very interesting, and the first neuromodulation product for epilepsy. The epilepsy product proves to some extent of the potential success in the platform with strong profitability and growth rates.
With the cardiopulmonary products being relatively uninteresting, almost all the growth is being contributed to by the epilepsy products compared to 2019 figures.
While neuromodulation, at the moment only including epilepsy, accounts for about 50% of revenue, its margin is much higher at around 40%, and has more than 2x the operating income of cardiopulmonary.
Assuming costs for corporate are shared equally between the two divisions, we have neuromodulation operating income at about $38 million per quarter, or around $160 million annualised. For cardiopulmonary it'll be about $40 million annually.
The three trials are all in neuromodulation. The recovery trial is for difficult to treat depression, so a last line therapy with meaningful prevalence. We went into detail on this last segment, showing that the business option implied a low ASP less than $400, with the 2005 FDA approval and revival study for reimbursement means that the probability this works out for them from a regulatory point of view is very high. Turns out the ASP is over $2,000, and therefore peak sales could be substantial.
At a 40% margin, that would mean $500 million a year from DTD, which would bring total neuromodulation EBIT up to almost $600 million annually at this point. This can be expected to start developing in 2024 when reconsideration for reimbursement takes place.
The second trial is the OSPREY trial which is looking to get a VNS product for sleep apnea approved. As is the case for VNS therapies, all of which being quite invasive, they are last line. The prevalences are high on the most unmet need basis, and with a substantial ASP around $1,000, we can expect a rough approximation of $1 billion in sales here too at a hypothetical peak. We can add another $400 million to the EBIT, which will start to develop after approval expected in 2024.
Finally we have a VNS product for heart failure. ART is a system for regulating heart failure, where heart failure is a large source of absenteeism and morbidity in the US. Again, with similar ASPs we can achieve substantial sales in this area.
Perhaps another $100 million could be added annually to EBIT in the event of a successful trial. As it is in early stages, no timeline is yet given.
In addition to the neuromodulation trials, there is also the circulatory support product which is growing quickly from its initial launch. Considering the market caps and profitability of companies like Abiomed (ABMD), the product could also be an attractive contributor once it achieves scale. However, even just on the basis of the neuromodulation trials, the EBIT for LivaNova could surpass the $1 billion mark. With its most major potential blockbuster, the DTD VNS product, already being close to reconsideration for reimbursement, at least $400 million could be added to the bottom line. For a business that already generates about $120 million in EBIT annually, and with an EV around $5 billion, the implied multiple on just current businesses + DTD is already less than 10x. With the OSPREY and ART trials also potentially adding meaningfully to the income, not to mention regulatory support with ABMD being a reference of high profitability for a business already annualizing $60 million in sales at very early stages, the multiple continues to fall on future EBIT constituting a margin of safety. While the OSPREY and ART trials are more regular, and thus have the typical likelihoods of failing trials as any other invasive medtech product constituting your typical risks, the peculiarity of the DTD revival constitutes the edge here. With depression continuing to be a major societal problem, LIVN is well positioned at a modest valuation.
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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.