Replacement joints and complementary products for the extremities make up one of the best growth markets within orthopedics, but it’s not an easy market in which to sustain success – small, innovative startups are disrupting the market (including hiring away reps), while more established players like Stryker (SYK) and Wright Medical (WMGI) look to press their advantages in product development and spread of products available. It was always going to be challenging for Integra LifeSciences (IART) to become a leader here, but the company really couldn’t build on its deals and has finally thrown in the towel.
Such was the performance of the extremities business that this could be addition by subtraction for Integra. At a minimum, the $200M net cash inflow reduces debt and puts management a little closer to being able to resume its growth-by-M&A strategy. All told, Integra is a tough call – the company’s neuro and wound care businesses aren’t bad, and the shares look a little undervalued, but this isn’t a particularly fast-growing company and small/mid-cap med-techs that aren’t double-digit revenue growth stories can be left behind at times.
Bailing Out Of Extremities
Integra and Smith & Nephew (NYSE:SNN) announced on Tuesday that Integra had agreed to sell its extremities business to Smith & Nephew for $240 million, or a net payment of $198.5M after Integra makes a $40 million payment to the Consortium of Focused Orthopedists. This is a full sale, with Smith & Nephew buying Integra’s portfolio of ankle, shoulder, hand, and wrist products.
Integra’s extremities business was largely cobbled together through M&A, including the acquisition of some former Tornier products that Wright Medical had to sell when those two companies merged about five years ago. Unfortunately, Integra was never able to really build on what it bought. Internal product development was hit-or-miss, and Integra was having a hard time holding on to quality reps that were being aggressively recruited by startups.
With that, revenue peaked at around $99 million in 2017 and slid to $90 million before COVID-19 hammered elective procedure counts this year, and the company underperformed the high single-digit growth of the underlying market. Although Integra didn’t disclose much detailed information about the business, I believe the extremities business hovered around breakeven on a lack of scale and real sales leverage.
On a standalone basis, the 2.67x multiple Smith & Nephew is paying is a little high. It’s well below the multiple of deals like Stryker-Wright Medical and Stryker-SBi, but no-growth med-tech usually sells for closer to 2x (and sometimes well below that level). Given that the performance of this business was, at least in my opinion, compromised by an inconsistent sales effort, I can see a justification for paying more based upon the business performing better under Smith & Nephew’s management and doing so relatively quickly.
Although Integra had not announced it was looking to sell, this deal isn’t a total surprise. Smith & Nephew is widely thought to have been the “Company C” whose interest in Wright Medical prompted Stryker to make its bid for that company, and extremities is a gap in their portfolio. There was also a “Company E” involved with Wright Medical that supposedly proposed a merger of equals, and the sizes match up for Integra to have been that company. If those assumptions are accurate, this sale makes a lot of sense, as Integra may have realized they really didn’t have the scale to be a long-term player in extremities.
Worthwhile Opportunities With What’s Left
Integra has long been something of a “hodgepodge” of businesses, but there are some valuable assets on a going forward basis. The neurosurgery business has good opportunities (and scale) in areas like dural repair, tissue ablation, and CSF management, as well as neuromonitoring. The wound care business is a tough one (and Smith & Nephew is rival here), but I like Integra’s product portfolio in chronic, complex, and burn wound management.
I also expect Integra to continue to look for growth opportunities through M&A. I think management has learned its lesson about chasing growth without scale, though, and I would expect future deals to be more focused on neuro and wound care, or at least closely adjacent to those markets.
Integra’s second quarter was better than expected, but still hit hard by COVID-19, with a 31% decline in revenue. I was honestly a bit surprised that the neuro business was down as much as it was (27%), given the less elective nature of the procedures, but then, the wound care business held up better than I’d expected (helped, perhaps, by leverage to non-deferrable areas like burn treatment).
I believe Integra can drive mid-single-digit revenue growth, and I expect (but do not model) some incremental M&A boost on top of that. I don’t see Integra hitting its prior target of $2 billion in revenue in 2022 (especially with the extremities sale), but the 28%-30% EBITDA margin target looks doable.
Integra isn’t particularly cheap on cash flow, but that’s not unusual with med-tech (especially smaller med-tech). Looking at the revenue growth and near-term margin potential, though, I think 4x forward sales is a fair multiple, and Integra shares currently trade about 10% below that.
The Bottom Line
My feelings on Integra are basically “meh”; the company’s M&A strategy has had some definite ups and downs (the lack of success in extremities, some integration hiccups with the Codman deal, et al), but I think the neuro and wound care franchises are no worse than respectable. I don’t see enough of a discount to get excited here, though, so this is more of a name to watch for me.
Disclosure: I am/we are long WMGI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.