|Shares Out. (in M):||38||P/E||14.3x||12.3x|
|Market Cap (in $M):||362||P/FCF||5.1%||9.4%|
|Net Debt (in $M):||-68||EBIT||22||24|
We are recommending a long position in Lumenis Ltd. (Nasdaq: LMNS), with a 1 year forward price target of $14.38/share or 50% upside relative to 7/7/14 trading price of $9.57. Lumenis is an Israel-based global manufacturer and marketer of energy-based therapeutic applications (primarily surgical lasers) with exposure to three primary end markets: Surgical, Ophthalmic, and Aesthetic:
The shares currently trade at a 2015 year forward P/E of 12.3x (ex cash), EV/EBITDA of 9.8x (we note the company has minimal tax, working capital and capex requirements), and free cash flow yield of 9% (ex cash) based on our LTM June 2015 forecast (which is below consensus). We believe the Company is well positioned to take share in the large and growing addressable markets (Est. $4B across current indications) were its products compete. The Company has more than doubled EBITDA since 2011 and grown revenue at a 12% CAGR over the same period. We believe the cadence of new product introductions over the 2013 – 2015 period, investments in sales and R&D, emerging market exposure, and superior positioning vs. alternative technologies will allow the company to continue to take share, sustain revenue growth, and potentially expand margins over the next 2 – 4 years. Additionally, the Company’s diversity across end markets, products, and geographies should partially smooth volatility/mitigate earnings risk.
Large and Growing Addressable Markets: Lumenis’ products participate in addressable markets aggregating to >$4B. Primary drivers of these markets include: a growing trend towards minimally invasive procedures, favorable global demographics from an aging patient population, and growing wealth in emerging markets leading to increasing surgical volumes and adoption of discretionary aesthetic procedures. Lumenis’ Surgical markets are over $1.8bn for lasers alone and the company is taking share from non-laser based therapies in key areas like BPH. The core BPH, ENT, and stones markets are all between $600-800mn annually. We believe the Company’s Surgical end markets are growing in the HSD% range. The global Aesthetics market for device-based treatments is over $2 billion and growing in the HSD% range. The Ophthalmology capital equipment market is near $300mn (not including refractive lasers) and is growing in the LSD-MSD% range. These markets are highly fragmented and Lumenis has ample room to take share, as it only has about 5% share in Aesthetics and 20% share in key Ophthalmology segments.
New Product Introductions: 2013 and 2014 will be the most robust product development cycle in over a decade for the Company. The Company had 6 product launches in 2013 and is expected to launch 1-2 new products in each of its major markets in 2014. Additionally, there is speculation that the Company may enter the body countering segments of the aesthetics market in 2015. We highlight some of the recent and prospective product launches below:
Positioned to Gain Share: We believe the Company’s premium positioning, strong brand recognition, recent initiatives, and competitive advantages vs. existing treatments should enable the company to gain share over the long term:
Emerging Markets Exposure Enhances Growth Prospects: LMNS is well positioned in APAC, where its revenue has doubled over the past five years and now accounts for more than one-third of total revenue. Rapid growth in APAC has been driven by strong growth in emerging markets like India and China. The latter is now LMNS’s second-largest single market by sales. APAC revenue has been the key source of LMNS’s overall top-line growth in the past two years, growing 23% in 2012 and 15% in 2013 constant currency. While growth in APAC can be volatile, we see LMNS’s strong foothold in APAC as a boost to its overall growth potential.
Geographic and Product Diversity: As of December 31, 2013, the Company had 87 Lumenis medical laser product families and associated accessories registered in over 50 countries. Lumenis owns more than 300 cleared 510(k) pre- market notification submissions, and more than 950 active international product registrations (including 50 in Japan and more than 140 in APAC). The Company generates ~40% of its revenue from its Surgical segment, 38% from its Aesthetic segment, and 23% from its Opthalmic segment. Lumenis also benefits from a diverse global footprint with 2013 sales by geography as follows: the Americas (35%); Asia Pacific (32%); Europe, Middle East, and Africa; (18%), and Japan (15%). In total, emerging markets accounted for around 40% of sales last year, the majority of which stemmed from China. Additionally, sales of our consumables represented ~15% of 2013 revenue, and services represented ~20% of 2013 revenue. The Company estimates recurring revenues accounted for 31%, 32% and 33% of our total revenues for the years ended December 31, 2011, 2012 and 2013, respectively.
Relatively new management team: The majority of LMNS’s senior executives, including the CEO and CFO, joined the company in 2012, and do not have a long history in running the company. While the new management has demonstrated a commitment and ability to improve execution in this short time, it will take time for them build credibility.
Company has provided limited visibility on pipeline: While LMNS plans to launch 1-2 new products or applications per business segment in 2014, the company has provided limited detail into the nature of its product pipeline. Additionally, from a business perspective, with the majority of its revenue stemming from capital equipment, the preview of new equipment will likely discourage sales reps from promoting and customers from purchasing existing products.
Dependency on capital equipment and elective procedure volumes: Nearly 70% of LMNS revenue is from capital equipment, which is a higher price tag purchase made by hospitals and physicians. Demand for devices, which typically carry higher average selling price (ASP) can be lumpy and usually slows in an uncertain macro environment. Additionally, the Aesthetics segment represents 39% of sales and tends to follow consumer discretionary spending patterns. On the Surgical and Opthalmic portions of the business, many of the Company’s procedures are not urgent (though many are necessary) and can be deferred, and are thus classified as “elective.” Certain macro trends like higher deductible insurance plans in the US can cause weaker 1H volumes before deductibles are used up and people go to the doctor. Also, factors like unemployment can have a meaningful impact on non-urgent procedures.
Limited liquidity and IPO lock-up expiration: Prior to the IPO, Lumenis had a dual class share structure, comprised of both “Ordinary shares” and “B shares.” During the IPO, 6.25mn new B shares were issued, but approximately 25.8mn Ordinary shares and 3.2mn other B shares (issued to selling stockholders as a dividend prior to IPO) will be locked up for 180 days. Upon expiration of the lockup period, all Ordinary shares will convert to the new B share class (only B shares will remain), and a total of ~29mn shares will become unlocked. We estimate that 60-65% of B shares will still be controlled by financial sponsors upon lock-up expiration, which could ultimately decide to sell shares. The timing and/or magnitude of potential sales by financial sponsors are unknown. Additionally, while the Company has a $363M fully diluted market cap the current float is extremely limited and in line with a sub $100M company.
Valuation and Financials
We value the company using a DCF approach with the following assumptions: 9% unlevered cost of capital, 3% perpetual growth, and no debt in the terminal year. Our target price implies a 6% FCF yield in the terminal year. Note that our forecasts are generally lower than consensus ($37M of 2017 Net Income and $1.03 of 2017 EPS) as we forecast lower growth and provide for minimal margin expansion (we also do not add back SBC). Our revenue growth forecast is lower than consensus as we do not have enough visbility into the nature and cadence of new product introductions to quantify share gain or give the company to much credit beyond market growth. Our margins are lower as we believe the Company's investments in sales and R&D will limit operating leverage. However, we believe consensus estimates are credible given the Company's recent track record of generating growth, cadence of management initiatives, and track record of expanding margins. We provide a summary of financial model below: