Description

Orthofix is a leading global spine and orthopedics company with a comprehensive portfolio of biologics, innovative spinal hardware, bone growth therapies, specialized orthopedic solutions, and a leading surgical navigation system.

The company is comprised of two reporting segments:

1.  Global Spine (~$630 million 2023 revenue): represents the largest division within OFIX and is made up of four different businesses: 
   1.  Bone Growth Therapies: manufactures, distributes, and provides support services for bone growth stimulation devices that enhance bone fusion. 
   2.  Spinal Implants: designs, develops, and markets a portfolio of motion preservation and fixation implant products used in spinal surgical procedures.
   3.  Enabling Technologies: offers image-guided surgical solutions and a surgical navigation system.
   4.  Biologics: consists of a broad range of advanced and traditional bone graft substitutes designed to improve bone fusion rates following a wide range of orthopedic surgeries, including spine, hip, and extremities procedures. 

2.  Global Orthopedics (~$115 2023 revenue): Offers products and solutions for limb deformity correction and complex limb reconstruction with a focus on use in trauma, pediatrics, and foot and ankle procedures.

The company has a market capitalization and enterprise value of ~$544 and ~$633 million, respectively. The company has guided 2024 revenue and EBITDA of ~$792 and ~$65 million, respectively.

How we got here / Why this opportunity exists:

In September 2023, OFIX shares dropped more than 40% following the sudden firing for cause of the CEO, CFO, and Chief Legal Officer. It’s rare for an executive to be fired for cause in corporate America, so having three executives fired for cause on the same day is quite unique, and obviously investors assumed the worst. For background, Orthofix is the result of a recent all-stock merger of equals between Orthofix and SeaSpine Holdings, two companies focused on designing and manufacturing orthopedics and spine products. The top executives of SeaSpine became the top executives of the new combined company. The company was in the middle of the merger integration when the firing took place, complicating things even further, both operationally and optically. In the press release announcing the executive departures, the company made clear the firings were unrelated to the company’s strategy and operations but were due to inappropriate conduct (our diligence confirms this to be the case).

Prior to merging with SeaSpine, in early 2023, the legacy Orthofix business was a relatively low growth but highly profitable business (2018 Adj. EBITDA of $91 million) that traded at a healthy 12x forward EBITDA, and as high as $60 per share ($1.2 billion enterprise value). However, following the board’s decision to seek higher growth, the company started to excessively invest in the business and became bloated with excessive costs, causing profitability and the share price to decline to around $20 per share in early 2023. After failing to achieve its growth targets, Orthofix’s board chose to do what we believe was a mistake: execute on this all-stock merger of equals with SeaSpine, a high growth but unprofitable spinal implant business that was running out of money at that point. We believe the merger was a mistake because Orthofix overpaid for Seaspine using its undervalued shares. 

Also, as additional background, it’s interesting to note that the company had received a $24 acquisition offer from a private equity firm in the period following the SeaSpine merger announcement but before the closing of the transaction. Orthofix’s board could have picked the $24 offer or tried to negotiate a higher offer from that private equity bidder, but instead didn’t even engage with the private equity firm and chose to close on the SeaSpine merger. Instead of monetizing the legacy Orthofix at a premium valuation, the board used its undervalued currency to overpay for SeaSpine. 

Fast forward to today, the cast of characters has completely changed for the better in our opinion. The company hired a new CEO and CFO who we believe are both good executives based on our channel checks. The new CEO, Massimo Calafiore, joined OFIX following his recent stint as the CEO of LimaCorporate S.p.A., a privately held global orthopedics company that he turned around and sold to Enovis Corporation. Prior to LimaCorporate S.p.A, Massimo spent his entire career in orthopedics and spine where he was the Executive Vice President and Chief Commercial Officer of NuVasive. The new CFO, Julie Andrews, has spent most of her career in the medical device sector and has a track record of value creation. Most recently, Julie was the Senior Vice President, Global Finance for Wright Medical, a global medical device company focused on extremities and biologics. Our diligence suggest that Julie was an important leader in running this business and was part of the team that created value at Wright Medical, which had a ~$700 million market cap when she joined in May 2012 and was later acquired by Stryker in 2020 for $5.4 billion (market cap of ~$4 billion at acquisition).

The board has also changed significantly. On December 12, 2023, Orthofix and Engine Capital announced a cooperation agreement, which involved the immediate appointment of three new independent directors selected by Engine, the establishment of a strategy committee chaired by one of the Engine directors, and the appointment of a new chairman at the next annual meeting to be selected from among the three new Engine directors. Three legacy directors will step down at the upcoming annual meeting.

Investment Thesis:

1.  Material value exists within the Orthofix portfolio: There are several businesses inside the OFIX portfolio that have significant value. For instance, one of the crown jewels within the portfolio is the bone growth therapies (“BGT”) business. BGT is an industry leader (~40% market share) with ~$200M of sales, ~40%+ EBITDA margins, and is highly free cash flow generative. That business alone could potentially be sold for more than Orthofix’s current enterprise value, in our opinion. Another highly valuable business  is the company’s legacy biologics business, which has an exclusive partnership with MTF Biologics (“MTF”). OFIX receives marketing fees through its collaboration with MTF for the sale of certain biologics products, which means that MTF (not OFIX) is responsible for processing the biologics, maintaining inventory, and invoicing hospitals & surgery centers. This capital light business drives extremely high profit margins and is an industry leader in the biologics space. The Global Orthopedics business is another hidden gem within the portfolio that we believe has been mismanaged for years and has significant potential. Lastly, it’s worth noting that OFIX owns various technologies that we believe will serve as growth drivers for the company going forward.

2.  Material room for operational improvement: Long-term shareholders have suffered through material value destruction over the years caused by poor strategic decisions and poor operational execution. The combination of a refreshed board and a new management team gives us confidence that material changes are underway. We believe there are several value creation opportunities available for the company going forward, including: 1) rightsizing the company’s cost-structure (e.g., unprofitable product/SKU rationalization, SG&A optimization), 2) restructuring the spine implants business to have a more profitable product portfolio, 3) investing in and growing businesses that have been neglected and mismanaged for years (e.g., the global orthopedics business), and 4) improving free cash flow generation (e.g., improving asset utilization and DSO efficiencies). At the time of the merger, the prior management had guided towards 2025 revenue and EBITDA of $1,000 million and $150 million, respectively, implying a 15% EBITDA margin. While we don’t believe that these numbers will happen in 2025, we do think that this margin profile is achievable when the company reaches $1,000 million which is likely to occur closer to 2027. Management intends to present long-term targets at an analyst day in September.

3.  Attractive Valuation: Using consensus numbers, OFIX is trading at ~0.7x 2026E revenue of ~$905 million. We think this valuation is too depressed for the portfolio of businesses and technologies inside OFIX. As an additional point of reference, in doing our sum of the parts analysis, we struggled to find relevant comparable businesses with valuations below ~1x sales.

Given that the company has gone through so much change and since management is only several months into their roles, forecasting the business is not obvious. We think it’s worth mentioning that through conversations with the new CFO we’ve learned that she believes there is significant opportunity in OFIX, but wants to keep her forecasts conservative in order to “under promise and over deliver”. 

For these reasons, we believe OFIX shares are set up well for investors over the next 2-3 years as this turnaround plays out, and as new management executes. From a valuation perspective, we look at OFIX a couple of different ways.

•  Sum of the parts (“SOTP”) Valuation: As referenced above, on a SOTP basis we believe OFIX is worth much more than where the stock currently trades today. Given the complexity of modeling out the various businesses inside the company, one simple approach we take in doing a SOTP is valuing the Global Orthopedics business separately from the rest of the company. Since the Global Orthopedics business has plenty of valuable technology and growth potential, but doesn’t contribute any EBITDA, we think this approach makes sense. Under this valuation framework we get ~$21 per share when we apply 2x revenue (using ~$115M of 2023 revenue for conservative purposes) to the Global Orthopedics business and then apply 8x to ~$85M of EBITDA for the rest of the OFIX business for conservative purposes. It is worth noting that we believe there is a good chance that the Global Orthopedics segment could be monetized over the next 24 months after management improves it operationally. 
•  EV/ Sales Valuation: Assuming OFIX trades at 1.0x to 1.5x our 2026 sales of $905 million, it would imply a share price of ~$21 to ~$33 over the next couple of years.
•  EV/ EBITDA Valuation: Assuming 2027 EBITDA of $125 million (still shy of the $150 million reference above) and applying an 8x multiple yields ~$24 per share. In a takeout, we believe at least a 10x multiple would be warranted and that would yield ~$30 pe. r share. We believe that this is what we are playing for in a 3-year timeframe. It’s worth noting that both the CEO and CFO recently exited prior roles by selling their companies.  

In our valuation frameworks referenced above, we assume ~$15M of incremental FCF burn and no incremental FCF generation through December 2025 for conservative purposes (For reference, management has stated that the business will be FCF positive in Q4 2024).

Risks:

Poor business execution, weaker sales growth / business disruption from the departure of the former CEO

Catalyst

Business execution: consistent top-line growth, margin accretion, and an inflection towards positive FCF generation, upcoming investor day in Fall 2024, refinancing the existing term loan at a lower rate, sale of the Global Orthopedics division or sale of the entire company.