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I freely admit to not having been the biggest fan of Enovis (NYSE:ENOV) since the company that used to be Colfax split into Enovis and ESAB (ESAB). My issues with Enovis have largely been centered on aggressive growth guidance, a slow-growing Prevention & Recovery business, the risk of increased competition in the Recon space, and some accounting/reporting decisions I don’t like.
And, honestly, skepticism has been the right call so far, as Enovis has continued to generate lackluster results – the 8% or so decline since my last update is a little weaker than the broader med-tech space, though not any worse than Zimmer Biomet (ZBH) and actually better than Smith & Nephew (SNN).
I’m starting to warm up to this name. I still have my issues with several parts of the story, but I’ve liked the company’s M&A program and even with the drag from the slow-growing Prevention & Recovery business, it does still seem as though the shares are undervalued. If management can execute on the synergy opportunities coming with its LimaCorporate buy, I do think better days lie ahead.
Acquiring LimaCorporate Shifts The Mix Further And Creates Some Synergy Opportunities
Enovis recently announced its largest deal as an independent company with the EUR 800M acquisition of LimaCorporate, an Italian manufacturer of recon products, including hip, knee, and shoulder implants. Enovis will pay EUR 700M in cash upfront and will issue stock within 18 months to cover the remainder of the purchase price.
Enovis is acquiring about $300M of annual revenue growing at a double-digit rate (first half revenue rose 18%) and generating attractive margins (an adjusted EBITDA margin of 27.5%). Only about 16% of LimaCorporate’s revenue comes from the U.S. (most of the rest is generated in Europe) and the business mix is split between extremities (40%), hips (34%), and knees (22%). In addition to its implant offerings, LimaCorporate also offers trabecular titanium and 3D printing capabilities, with its ProMade system allowing surgeons to customize designs for a patient’s particular needs.
While LimaCorporate is growing at a very healthy rate, it’s a tiny player in its markets with low single-digit share. Technology offerings like ProMade are interesting, and 3D-printed implants have been growing as a category, but not all surgeons have the time or inclination to go this route instead of off-the-shelf implants. Moreover, LimaCorporate’s growth is not necessarily so much a byproduct of superior product performance as growing adoption of extremity procedures in many European markets (in years past, patients in these countries were basically just told to “live with it”).
I do think LimaCorporate’s existing sales channels in Europe give Enovis some valuable opportunities to cross-sell its product portfolio (including its foot/ankle products) down the line. I also think Enovis could leverage platforms like ProMade into something more significant over time. Management has said that product overlap/cannibalization shouldn’t be a big issue, but executing on cost synergy opportunities will be critical.
Other Deals Have Also Helped Round Out The Platform
Enovis has been busy this year with M&A even before the LimaCorporate deal. The company previously acquired Seal, a manufacturer of external fixation products, for $28M as well as Novastep for $97M. The company paid up for the latter (around 5x revenue), but that’s not an unreasonable multiple for a company growing at a double-digit rate. Moreover, while Novastep is small today, I like how this further rounds out the foot/ankle portfolio and I think minimally-invasive surgery for bunions is a good niche growth market.
The Story In The Core Operations Has Stayed Largely The Same
Turning to recent results from Enovis, they’ve looked a lot as they have for some time now – good performance in the Recon business and less impressive results from Prevention & Recovery.
Prevention and Recovery has grown 4% in the last two quarters, slightly trailing Ossur (OSSR.CO) in both periods, as volume improvements haven’t really materialized (I’m not surprised, as I thought management guidance/expectations were aggressive here).
I have been impressed with the performance in Recon, with the company logging 17% and 19% growth in the last two quarters, including 20%-plus growth in the hip/knee business and mid-teens growth in extremities. While the U.S. hip & knee market has been performing well of late (up around 15% in Q1 and high single-digits in Q2), helped by improved hospital staffing and a backlog built through the pandemic/post-pandemic disruptions, Enovis has comfortably outperformed the market with newer products like the Empowr knee. The Extremities business has also been performing quite well, with good growth in both shoulders and foot/ankle despite efforts from larger ortho companies to gain share.
Enovis has also been reporting better margins, with adjusted EBITDA margin up more than a point to 15.3% in the second quarter. While I do have my issues with how Enovis calculates adjusted EBITDA (I think there some excluded items that really should stay in there), the company is nevertheless consistent from period to period and is delivering margin leverage (as well as higher estimates for the full year).
The Outlook
Assuming that Enovis can maintain healthy growth rates with LimaCorporate’s assets and drive the expected synergies, I think this deal meaningfully improves the overall profile/product mix of the company. The faster-growing Recon business will be a larger part of the mix (around 45%-50%), and again I do think there are cross-selling opportunities that can leverage LimaCorporate’s sales channels outside the U.S.. I’m also cautiously bullish on what ProMade could become down the line if customizable implants really become a significant category within the ortho market.
Including LimaCorporate, Enovis’s long-term prospective growth rate moves from around 6% to closer to 9% and I think high-teens adjusted EBITDA margins are possible as soon as next year and over the next three to five years. I’m still reluctant to model more than low double-digit FCF margins long-term, but there could be some upside here down the line. This deal does add even more debt to the balance sheet (around 3x prospective EBITDA on a net basis), but I think FCF generation could get to $200M relatively soon and that will help work down that debt.
Discounting those cash flows back, I get a fair value of almost $60 for Enovis shares. The stock looks even cheaper on a growth/margin-driven EV/revenue basis, though slow-growth businesses like Prevention & Recovery usually get a penalty discount in the market, as do high debt levels. Even taking a more conservative line on EBITDA margin (adding back items like MDR costs, stock-based compensation, and so on), I get to a 2.2x forward multiple that supports a $62.50 fair value on my ’24 revenue estimate (including LimaCorporate for the full year). Were I to use a growth-based approach, even with a penalty for Prevention & Recovery I could get a fair value in the high $60’s without much difficulty.
The Bottom Line
I’m at a point now where I find the valuation and share price performance of Enovis to be odd. It’s not the most widely-followed stock, and I can understand why investors may not like the slow-growing Prevention & Recovery business. I can also understand concerns that the ortho market will slow over the coming quarters and/or that rivals will step up their game take back some share (even though Enovis has good share in the faster-growing ambulatory sector).
Even with those negatives taken into consideration, I feel like I have to work to generate fair values below $60. With that, I think this is a name worth a lot more consideration today.
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