Description

Thesis

ZimVie Inc. (NASDAQ: ZIMV) is a medical technology company that has historically operated in the dental and spine industries since going public via a Zimmer Biomet spin-out in early 2022. Historically, ZIMV’s valuation has been hindered by the two overhangs of a large debt burden and a declining spine business that distracted from a healthy dental enterprise.

On December 18th, ZimVie announced a transaction with HIG Capital to sell its entire spine business for $375mm with a $315mm cash consideration and a $60mm PIK seller note. This sale has eliminated both overhangs and made the sum-of-the-parts valuations previously put together by analysts much simpler.

Despite the announcement containing transformative projections for the state of the company post-close, the two analysts that cover ZIMV have not updated their estimates and the stock trades at a steep discount to peers with worse growth and margin profiles (e.g., NVST and XRAY). As a result, we value ZIMV at $48 per share using a 3.0x NTM EV/Sales multiple with mid-single digit growth and industry-level EBITDA margins in 2024.

Segment Overview

As an introduction to its segments, ZimVie’s Dental and Spine segments comprised 52% and 48% of TTM sales, respectively, with Dental contributing 70% of TTM operating profit with Spine being responsible for the remainder. Historically, the Dental market has grown mid-single-digits with a small number of players offering differentiated products. As a result, participants have been able to grow healthily and maintain at least high-teen EBITDA margins even in the face of a tough discretionary spending environment for elective procedures in 2023. In comparison, Spine revenue is projected to decline by 9% in a growing market with single-digit operating margins.

The Dental segment consists of designing, manufacturing, and distributing dental implants, biomaterials, and digital dentistry solutions primarily for reconstructive or aesthetic surgeries. These products are complementary and are often used in the same treatment cycle for a patient. The end markets for these products consist of oral surgery centers, dental service organizations, and dental offices. Distribution is handled almost entirely by a direct sales force with distributors only playing a role in smaller geographies.

Under the Spine segment, ZimVie designs, manufactures, and distributes spinal surgery solutions to treat back or neck pain that develops from degenerative conditions, deformities, or traumatic injuries. The portfolio’s core offerings are the Mobi-C Cervical Disc and The Tether device, which are differentiated by their ability to preserve motion in ways competing products do not. In terms of distribution, the Spine segment utilizes a direct sales force alongside a meaningful number of distributors.

Since inception, the primary overhangs that have held back ZimVie’s performance were its declining spine business that distracted from its dental segment and the $440mm in Net Debt it was burdened with.

Sale of the Spine Segment

As of last month, ZIMV has sold its spine business to HIG Capital and will operate as a dental pure-play moving forward. In the press release covering the sale, ZimVie announced that HIG Capital will be purchasing their Spine business for $375mm. The payment will be split across a $315mm cash payment and a $60mm PIK note to ZimVie yielding 10% with no milestone payments following the transaction. The deal is currently set to close in the first half of 2024 and we are confident of its closure given the track record of HIG Capital alongside the plausible turnaround story that the spine business could produce in a rapidly growing market.

Alongside the press release, ZimVie provided a presentation that outlines performance objectives for the post-deal company in both the short- and long-term. In the first year post-close, ZIMV expects to have more than $450mm in revenue at 15% EBITDA margins and less than $200mm in Net Debt for the go-forward entity. Notably, the debt target excludes any proceeds from the future repayment of the seller note and includes the severance and restructuring costs that will come after the sale.

Additionally, the company expects its dental end markets to grow at a mid-to-high single digit CAGR through 2026, which should represent the baseline growth rate for the dental business moving forward.  Over this time, ZimVie expects to outpace market growth and achieve greater than 20% EBITDA margins with at least 80% FCF conversion.

Analysis of Post-Deal Financials and Go-Forward Estimates

Throughout the last year, there has been a large amount of pressure put on the Dental market for elective procedures given macroeconomic weakness. As a result, ZIMV and its peers underperformed historical growth rates in 2023, where the industry was effective flat-to-down. Despite this, ZIMV continues to take share and has now paved the way for highly visible, above-market growth in 2024.  

Over this time, management has been conservative with guidance to build credibility, which has led to a beat-and-raise cadence over three consecutive quarters with mid-to-high single digit surprises for revenue. We believe this conservatism is why management set a floor of $450mm for 2024 Dental sales as the segment has already exceeded $450mm in sales at a 21% EBITDA margin on a TTM basis. As a result, we estimate robust growth in 2024 at healthier than guided margins as ZIMV management continues to beat-and-raise over conservative guides.

Understated Potential for Growth

ZimVie operates in the high-end of the dental market, where it offers a superior product at a price premium. In 2023, peers have begun to discount products amidst the challenging macroenvironment. On the other hand, ZIMV has a premium product that commands premium pricing and has no intention of discounting, which is evidenced by their gross margins vastly outshining low-end peers, such as NVST and XRAY. Our checks show that, despite peer discounting, ZIMV has continued to grow faster than the market and take share even with a challenging macroeconomic backdrop.

With consensus estimates showing a return to low-single digit growth for peers in 2024, we believe that the dental market will rebound as early as Q4 and ZIMV will continue to outpace its peers going forward. Specifically, we model that Europe will outpace the US in terms of growth at high-single digits and drive top-line performance until the US market fully normalizes.

For the full year of 2024, we expect sales to grow in the low-to-mid single digits (i.e., around 4.5%) with the ability to enter high-single digits should the US market rebound sooner than anticipated. Thus, we believe ZIMV outperforms its lower-quality peers, NVST and XRAY, which have consensus growth rates of 1.5-2%.

Upside to Profitability

Using historical metrics, we can estimate the operating expenses of the go-forward business required to reach 15% EBITDA margins on $450mm in revenue, which illustrates how modest growth can impact EBITDA given the strong gross margins that ZIMV maintains:

The current target of at least 15% EBITDA margins post-close contemplates the restructuring that will be necessary after the transaction to eliminate residual corporate bloat. We believe that the restructuring will consist largely of labor cuts to match the reduced size of the company and are largely low-hanging fruit that have already been identified. Moreover, management has high visibility into future growth, which enables them to confidently set guidance and exceed expectations.

With a nearly 70% gross margin, there is significant operating leverage, where a small improvement in growth will yield much higher EBITDA margins. As ZIMV begins to incorporate more operating efficiencies and can re-focus on growing their Dental business, we believe that the company can quickly expand its operating margins without sacrificing its above-market growth.

Net Debt Reconciliation

The pathway towards driving down Net Debt below $200mm appears relatively straightforward for ZimVie following the transaction. We estimate a modest tax impact of $10mm on the $315mm in cash proceeds from the sale, which would leave ZIMV with roughly $515mm in long-term debt and $380 in cash for a $135mm net debt balance. This implies that ZIMV would have to burn over $65mm in cash over the next five quarters to end 2024 with over $200mm in debt.

Moreover, we believe that the Dental business can achieve nearly 50% EBITDA-to-FCF conversion in 2024, which would yield roughly $45mm in FCF from our $91.3mm EBITDA estimate. Using this assumption, we conservatively estimate a $170mm net debt balance for 2024 once factoring in any cash burn associated with the Spine segment before the deal closes and restructuring costs.

Valuation Framework and Catalysts

With a new focus on Dental, the company can be cleanly comped to its peers, which highlights a significant disconnect in valuation. While outperforming its peers in both growth and profitability, ZIMV is priced at materially lower multiples. We believe that the disconnect will be bridged via the catalysts of the divestiture closing as well as the execution of management’s restructuring initiative, which is likely already in motion. Following this, the company will have a cleaner margin profile and operating structure that will justify a re-rating as investors become more aware of the pure-play dental story.

Peer Group Analysis

The comparable companies for ZIMV can be sorted into two groups: NVST and XRAY as low-growth/low-margin peers and STMN-CH as the best-in-class player. The lower quality comps are currently priced 70% above ZIMV using NTM EV/Sales despite lower gross margins and growth. In comparison, SMTH-CH has significantly higher growth rates and margins, which justifies its impressive multiples.

The disconnect between ZIMV and its peers becomes particularly clear when considering the differences in gross margins. While ZIMV has gross margins 10% above NVST and 25% over XRAY, ZIMV trades significantly lower than either. Meanwhile, STMN trades at over 8.0x NTM EV/Sales with only 6-7% higher gross margins.

We believe that gross margins are the strongest signal of the value proposition for a product and indicate that ZIMV is well ahead of NVST/XRAY while discounted significantly. As ZIMV continues to grow ahead of the market, the growth will flow through to EBITDA on gross margins well ahead of peers, thus leading to rapid margin expansion on the bottom-line with scale.

As ZIMV continues to grow and management optimizes the cost structure of Dental as a standalone business, we see a path to margins near those of STMN-CH over the next several years. In our investing career, we have very seldom seen a stock with this degree of near-term upside. Should ZIMV be able to push its margins closer to STMN-CH, an 8.0x NTM EV/Sales multiple would yield a $140 PT.

Valuation

Given its advantages over peers already reflected in its current financials, we believe ZIMV should trade at a floor 3.0x NTM EV/Sales multiple (n.b., corresponding to 16.0x NTM EV/EBITDA or 25.5x NTM P/E), which would price it at a approximately a single turn of revenue premium to NVST and only two-thirds of a turn premium to XRAY despite having gross margins that are 1000bps and 2500bps greater, respectively. We choose to use a forward EV/Sales multiple in our analysis as we believe there is a clear pathway to margin expansion, yet the time it takes to achieve operating efficiencies could vary. As a result, we believe revenue and growth to best reflect ZIMV’s value. Further, with our operating assumptions, the EV/Sales multiple is equivalent to reasonable EV/EBITDA and P/E multiples relative to peers.

With our estimates serving as a Base case, we build out adjacent Bear and Bull scenarios. In the Bear case, we assume a growth rate of 1.5% with a 2.0x NTM EV/Sales multiple, which would reflect performance in-line with NVST and XRAY. On the other hand, our Bull case uses 7.5% growth and a multiple of 4.0x NTM EV/Sales to reflect performance well above low-quality peers, but still materially lower than STMN-CH.

Exogenous Risk Considerations

Outside of execution-related issues that may impact growth or margins, we observe the following risks to the performance of ZIMV over the course of 2024:

Failure to Close the Spine Asset Sale with HIG Capital

We are confident that the sale will close given HIG’s track record as a PE firm that serially acquires underperforming businesses as turnarounds. Additionally, the ZimVie spine business is an attractive acquisition given its market leadership and differentiation in motion preserving spinal solutions in a strong market. With its focus bifurcated, ZimVie was unable to properly execute in the spine industry. Performance was further hindered by the lack of a strong, direct sales force since ZimVie sold its spine products evenly between direct sales channels and distributors.

Complex Financials Pre- vs. Post-Close

Given the size of the asset being sold, there is a meaningful amount of complexity that will be added to their financials as discontinued operations and restructuring are layered into their reporting. We are confident that management will attempt to clearly distinguish between a pre- and post-close ZIMV using pro-forma figures, but there is still a reasonable chance that the value of the transaction may not be made apparent to consensus and investors until discontinued operations are no longer reported after the close of the deal in 1H24.

Disclaimer: The author of this memorandum presently has a long position in the securities of this issuer and may trade in and out of these positions without notice. This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation. This memorandum is, as of the date posted, not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

The primary catalysts for a re-rating of ZIMV are the closure of the Spine sale, additional consensus coverage, and future earnings, where management will have the opportunity to present more formal guidance for FY24 and illuminate the path to higher margins on their conference call. Each of these catalysts will incrementally draw more attention to the unlocked value of the Dental segment in the go-forward entity.