Description
Align Technology and its namesake Invisalign product has defined the clear aligner category for nearly two decades and established a solid competitive advantage. Following a COVID boom, cases shipped to adults have declined but have begun to stabilize in recent quarters.
After years of volatile sentiment and recent COVID boom/bust, the business appears poised for more stable long-term growth as the more predictable teen segment becomes a greater portion of mix, it gains share from braces in the 22m global annual orthodontic starts, and latent pricing power is exerted over time. At ~20x EV/EBITDA, the business does not scream cheap but is below historical averages and has several levers of realistic optionality. A DCF with low double digit growth rates and mid-20s% margins (below LT guidance) implies a value of ~$315/sh.
Business model
ALGN developed a suite of clear aligner technology (scanner, software, aligner manufacturing) which it sells to doctors, who provide Invisalign treatment to patients.
ALGN has an actual competitive advantage, as its database of 17m+ completed cases provides unmatched insight into how teeth move relative to aligner construction. Individual treatment programs are developed between the doctor and ALGN ClinCheck technicians, and when agreed upon, trays are printed. ALGN manufactures at owned facilities, and unlike most DTC competitors, patients meet with doctor monthly to monitor progress and receive new trays. Despite concerns related to competition, Align appears to have a strong moat.
Value proposition
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Enable teeth alignment with similar efficacy to wire braces. Advantages include less visibility, option to remove short-term to eat/ attend social event, better oral hygiene, etc.
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Value to doctors is compelling. Direct margins are healthy, although lower than wire braces. However, Invisalign patients are much “lower touch” in a practice than braces, with fewer visits and no adjusting of wires. This enables greater capacity and requires less labor.
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In the above example braces earn $900 higher direct profit than Invisalign, but factoring in the costs of:
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~25 extra patient visits (inconvenient for patient, labor intensive for doctor)
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Invisalign visits typically require exchanging new trays, brief conversation. Braces include adjusting wires, physical labor, etc.
Despite higher cost to doctor, the net profit to a practice from Invisalign can plausibly surpass braces.
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$4,000 treatment: Invisalign vs. Braces
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Value proposition is strong, and has afforded ALGN ability to raise price in recent quarters. Continued pricing power is a key driver of outperformance.
Competition
Align’s competitive advantage has been highlighted in recent years with startup/ DTC struggling to survive. This is due to Invisalign’s compelling value proposition, the need for an experienced pro directing treatment in most cases, and importance of Align’s software and manufacturing infrastructure. A sampling of competitors include Spark (Envista subsidiary), SmileDirect, ClearCorrect, Byte and several others. All are far smaller than ALGN. The main competitor remains traditional wire braces, which are an estimated 80%+ of orthodontic starts.
Risks
Sustained economic downturn. This is by far the greatest challenge, as adults are discretionary purchasers of orthodontics, and some will delay if concerned about finances. However, long-term adoption trends should remain intact, as people want to feel better about their smile, and the treatment lasts a lifetime if well maintained, making it a prudent investment.
Valuation
Building a rough DCF, assuming growth increases to low double digit and margins recover implies ~$315/sh.
The clear aligner industry is growing high teens or above by most estimates, and management 3-5 year targets as of FY23 are even higher:
Earnings quality is also solid, and free cash flow is accelerating, with $2.8B of the $4.3B cumulative FCF generated since 2001 earned in the last 5 years.
Optionality
ASP increases. Over the years, selling price growth has been minimal, adjusted for mix. Despite ALGN >70% gross margins, there is likely room for price increases over time, as doctors earn >60% gross margins themselves. There has long been a bear case that the business will be disrupted by low cost entrants, which has not happened. For the foreseeable future, growing clear aligners into the standard of care is more important than maximizing short-term revenue. Over time, pricing power is realistic, as ALGN provides much greater value to doctors than it extracts. ALGN has passed increases in recent quarters, and volume remained stable.
Aligner mix shift. As teens become a bigger piece of mix, the overall business should be less susceptible to macro, as adults are more discretionary. Teens are 34% of LTM 3/31/24 volume. By comparison, ALGN estimates the industry has 22m global annual orthodontic starts, including 15m teens (68%). Results should be more predictable as ALGN trends toward industry mix, which may drive a higher multiple.
Increased recurring revenue. With more innovation, product platforms such as iTero scanner and touch up aligner cases drive increased recurring revenue. As predictability grows, so should investors’ confidence which could lead to multiple expansion.
Incentives
Relatively unchanged. Management earns an annual bonus based on 60%/40% revenue/EBIT targets. Goals seem sufficiently challenging, as FY23 was too uncertain to provide revenue guidance, but bonus implied +5-7% revenue. Long-term incentives are primarily driven by 3yr equity performance vs NASDAQ, which is aligned with shareholders.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
Return to growth. With competitive position solidified, investors’ main fear is now the macro environment. If ALGN demonstrates ability to grow in a modest economic climate, valuation will likely improve.