Description

Summary

ZimVie (ZIMV US) is the 6th largest orthopedics company in the world and the 5th largest dental implant producer with 2,700 employees. It was spun off from Zimmer Biomet in February 2022 and the shares have sold off 80% since the first day of trading. The primary culprits were spin-off selling pressure, reduced management guidance in March 2022 and forward sales by Zimmer Biomet causing the shares to drop further in September. 

ZimVie’s business is stable, gross margins are 65%, and net debt/EBITDA of 3.0x is far below the covenant limit of 6.0x. Fundamentals are improving as elective surgery activity is recovering after the pandemic. Current EV/Sales of 0.75x is far below the peer group’s 3.3x. Peer group margins are coles to 20%. Even at a 10% operating margin and a peer group 15x EV/EBIT multiple, ZimVie will end up at an EV of US$1.6 billion, a market cap of US$1.2 billion and a value per share of US$46/share. I don’t mean to minimize the risks of investing in a leveraged entity, but I consider the risk-reward to be favorable at this point. 

Introduction

I first heard of this idea from the blogger who runs globalstockpicking.com website out of Hong Kong.

ZimVie was created through M&A spanning over three decades, including EBI in 1988, 3i, Lanx, Abbott Spine, Zfx, Implant Concierge and 3diemme. 

Today, ZimVie has two businesses: Spine and dental, with ~70% of revenues from the United States and the rest mostly from European markets. 

Spine (59% of pre-COVID revenues): Spinal surgery solutions to treat patients with back or neck pain from tumors, deformities, injury or degenerative disease. Products include implants, surgery instrumentation, biologics and bone healing tech which are sold to hospitals and surgical centers. Previously part of Zimmer before its merger with Biomet. 

Key products include: 

• Core and complex: spinal fusion products that connect two or more vertebrae in the spine to improve stability, correct deformity or reduce pain. ZimVie uses rods, hooks, plates and cages to achieve this. Low single digit growth in the segment. 

• Minimally invasive procedures: surgeries done through smaller incisions using specialized surgical instruments and imaging technology. 

• Motion preservation devices: normal spinal fusion products limit mobility for the patient. Artificial motion preservation discs help to restore and maintain mobility in the spine. 

• Enabling technologies: navigation tech and robotics to enable precision surgery. 

One of ZimVie’s flagship products is The Tether, which is the only FDA-approved device for anterior vertebral body tethering to correct progressive idiopathic scoliosis. But growth is fastest in motion preservation devices such as ZimVie’s Mobi-C product, or products for minimally invasive procedures. The industry grows in the mid-single digits. Innovations such as the Virage navigation system could help achieve higher growth. 

In the spine segment, ZimVie’s agents are independent, whereas it uses direct sales representatives for its overseas business. 

ZimVie’s spine market share has dropped somewhat over the past five years, losing to smaller competitors such as Globus and Alphatec. 

Dental (41% of pre-COVID revenues): Dental tooth replacements and restoration products for patients missing teeth. ZimVie also sells biomaterials solutions for soft tissue and bone rehabilitation. Previously part of Biomet before its merger with Zimmer. 

Key products include: 

• Dental implant solutions: Implants, surgical tools, abutments - anything needed to complete implant-based tooth replacements. 

• Biomaterials: Bone graft substitutes, membranes and tissue regenerative products to help patients with insufficient bone tissue. The bone tissue is sourced from elsewhere in the patient (allograft), other human donors, animals or synthetic materials. 

• Digital dentistry: Enabling technologies such as intra-oral scanners, desktop scanners, 3D printers, CAD/CAM materials, treatment planning software, etc. These technologies help reduce the cost of treatments. 

The dental implant industry grows in the mid-single digits, though faster in the digital dentistry workflow solutions industry where ZimVie is trying to expand. New products such as the next-generation TSX dental implant, the T3 Pro tapered implant and the Encode Emergence abutments could help speed up growth. 

93% of sales agents are direct and the remaining 7% via distributors. 

In the dental segment, ZimVie is doing well against competitors such as Straumann, Dentsply Sirona and Henry Schein. 

Reasons for the spin-off

According to Zimmer Biomet’s management, the rationale behind the spin-off was to enhance management focus and alignment, reduce complexity and re-ignite growth for the dental and spine businesses. 

In practice, it’s clear that Zimmer Biomet wanted to refocus its own business towards the higher growth core orthopedic business, leaving the slower-growth spine and dental businesses in a separate entity. 

Zimmer Biomet’s decision to retain a 20% shareholding in ZimVie was odd. In the Form 10 information statement, Zimmer Biomet stated that it wanted to retain a 20% stake that could be used to accelerate debt reduction. And it also guided that it would sell its shares in ZimVie as soon as possible after the shares became registered 6 months after the spin-off in September 2022 according to SEC Rule 144. On 1 September, Zimmer Biomet entered into a forward sales agreement with investment banks to sell its entire 19.6% stake in ZimVie. From the latest 10Q report:

"On September 1, 2022, we entered into a forward exchange agreement and pledge agreement (collectively the “Forward Exchange Agreement”) with the same financial institution to deliver to them our 5.1 million shares of ZimVie common stock in the first quarter of 2023. It is likely that the financial institution has entered into hedging transactions, which may include selling the ZimVie shares in the market, in anticipation of receiving the shares in the first quarter of 2023."

It’s also worth mentioning that 76 million shares have already changed hands since the spin-off, ~3x ZimVie’s total share count of 26 million shares. So every Zimmer Biomet who received unwanted ZimVie shares through the spin-off has most likely already sold down his or her shares. 

Management

ZimVie’s CEO is Vafa Jamali, who was previously with Medtronic, Covidien (acquired by Medtronic), Cardinal Health, Allegiance Healthcare, Baxter and Searle. He’s been involved with several spin-offs in the past. Jamali received RSUs and stock options, vesting across four-year periods from the grant date. 

CFO Richard Heppenstall was previously CFO of orthopedic bracing company Breg as well as Orthofix. But this is his first stint as a public company CFO. 

Zimmer Biomet’s former spine and dental business managers have both joined ZimVie, creating continuity for both subsidiaries. 

Worth mentioning is that Medtronics previous Chief Medical Officer Richard Kunst is an independent board director, which could presage cooperation with Medtronics in the future. 

Valuation

ZimVie’s industry exposure and product profile suggests underlying growth in the low-to-mid-single digits. 

Trailing revenues were weak with -16% YoY decrease in spin revenue and -4% decrease in dental revenue. But the numbers are distorted by: 

• ZimVie’s exits from certain unprofitable markets, hurting revenues but presumably benefitting operating profit

• Cost pricing pressure for spine products, and those are already easing

• Transition agreement with Zimmer Biomet whereby operating profits are passed through rather than accounted as revenue. Such operating profits will again be accounted as revenue after the transition agreement ends, sometime before March 2025. 

Total segment EBIT pre-COVID was about US$130 million. But the entity is also incurring SBC of about US$30 million for US$100 million net, implying a full-recovery EV/EBIT of around 7x vs around 15x for the peer group, which would imply an intrinsic value for ZimVie of US$37/share. Sell-side is expecting well below US$100 million for the next calendar year. 

While reported numbers differ from those of the sell-side in their treatment of intangibles, these are non-recurring expenses and do not accurately represent any depreciation in the underlying business value in my view. 

The real upside is in ZimVie’s margins, with peer group OPM closer to 20% and 28% for Zimmer Biomet’s own, though arguably higher quality businesses.

In the Form 10 disclosure, ZimVie stated that post-spinoff it would focus on cost savings initiatives to improve the company's margins: 

"As an independent company, we intend to focus on delivering operating efficiencies through cost saving initiatives in order to improve our margins"

At a 15% operating margins we could be looking at a private market value of around 15x US$150 million in operating profit = US$2.3 billion EV, close to US$1 million per employee and an intrinsic value per share close to US$70/share. Management has not given guidance of where margins are likely to end up. But with 65% gross margins, ZimVie has room to manoeuvre. 

The bottom line is that ZimVie's EV/Sales of 0.75x is out of line vs the peer group and ZimVie's probable path towards higher operating margins. The peer group trades at 3.6x EV/Sales and previous transactions in the industry such as DePuy Synthes were done closer to 5x EV/Sales. 

Further, it's clear that some of the selling pressure in 2Q2022 was related to technicals related to the spin-off. And the selling pressure sinece August 2022 was most likely due to investment banks selling shares received through Zimmer Biomet's forward sales of its 20% stake. We're now close to the end of that selling pressure, explaining ZimVie's current low valuation. 

Risks

The Term A loan’s coupon is based on the SOFR interbank rate rate plus a spread, which means that interest expense will vary with short-term interest rates. 

Today, ZimVie has net debt of US$434 million vs EBITDA of US$140-150 million for a multiple of around 3x vs the credit facility’s covenant ceiling of 6.0x. Interest expense of US$31 million per year is equivalent to an EBITDA coverage ratio of 4.7x, which seems adequate to me. The Term A Loan facility trades at around 95 cents on the dollar, suggesting that creditors are comfortable with the current capital structure. 

Other risks include:

• Potential declines in reimbursement levels in its key market of the United States. 

• ZimVie does not have a robotic offering in spine, which has been a key source of growth for competitors and the primary reason why it has lost market share in the segment. 

• Some goodwill left in the dental segment which could be subject to write-downs. 

• USD strength

• Supply chain headwinds brought down gross margins until 2021 but those pressures seem to be easing. 

For more information, check out ZimVie’s investor deck and the spin-off Form 10 information statement. And feel free to reach out to me via @Fritz844 on Twitter if you want to contact me directly. 

Catalyst

• The return of elective surgeries post-COVID

• Spin-off / Zimmer Biomet selling pressure easing

• Transition agreement with Zimmer Biomet ending, improving revenue growth optics

• JV or any other type of partnership with Medtronic