Surgical Instrument and Device Company Valuations – December 2021 Update
Surgical instrument and device companies experienced a significant but short-lived downturn during the height of the pandemic but have since continued their growth trajectory. Much of the increase in valuations observed in June 2021 was maintained through the end of the year. This article will explore some of the trends that appear to impact the valuations of publicly-traded surgical instruments and device companies.
This article updates our June 30, 2021 analysis.
Important notes: This article examines potential driving factors for surgical instrument and device company valuations from a financial statement perspective. An actual business valuation requires an in-depth analysis of the business operations and associated risk factors that are not always evident from the data on financial statements. Also, to keep the length manageable, this article will focus on what the author interpreted as the primary value drivers. It will not touch on every observation in the data. For a quick read on the basic concepts of risk and return and how they apply in the context of this article, please visit: What is Value? and Risk and Return in the Market Approach.
The industry constituents for this analysis are listed below. The effective date of this analysis is December 28, 2021.
Figure 1 summarizes three items for the surgical instruments/device companies:
- Total enterprise value calculated as the sum of market capitalization and interest-bearing debt less cash;
- Median revenues; and
- Median earnings before interest, taxes, depreciation, and amortization (“EBITDA”).
We notate the latest fiscal year as “LFY” (2020), and the latest 12 months as “LTM” (latest available information as of December 28, 2021).
Figure 1 illustrates the industry’s march to ever-higher valuations over the last five fiscal years and the LTM. Until 2019 (LFY-1), the rise in valuations for the surgical instrument and device companies coincided with improvements in their financial performance. In LFY (2020), valuations improved despite muted financial performance for the year, which may be attributed to reduced surgical activity at the height of the pandemic. Valuations continued to rise through the end of 2021, along with financial performance.
Valuation Multiples
Figures 2 and 3 present the historical trend of revenue and EBITDA multiples for the industry.
Based on Figures 2 and 3, the median multiples increased through 2020 before declining in the latest period. This makes sense as given financial performance in the LTM period outpaced growth in valuations.
The Growth Story
Growth often has a strong influence on how companies are valued. Next, we present a summary of the consensus forecasts for each group in Figures 4 and 5 below (note that “NFY” means next fiscal year; NFY = calendar 2020 for most companies).
In Figures 4 and 5, the orange line represents data as of the end of 2020. At that time, projections for the industry suggested modest declines in revenue and EBITDA in 2020. Expectations for 2021 and 2022 indicated a robust post-pandemic recovery.
The blue line in Figures 4 and 5 represents information as of December 28, 2021. Actual 2020 revenue outperformed expectations, while EBITDA declined more sharply. However, expectations continue to paint the picture of a robust post-pandemic recovery.
We looked to identify a meaningful correlation between growth and observed valuation multiples. Companies that generate high levels of growth often trade at higher multiples than their lower growth counterparts. In Figure 6, we plot LTM revenue multiples against projected NFY revenue growth rates.
In Figure 6, revenue multiples appear to be impacted by the magnitude of expected growth for NFY (2021). We were unable to discern a meaningful relationship between EBITDA multiples and EBITDA growth rates.
The Size Story
Larger companies are generally perceived to have lower levels of risk relative to smaller companies. This dynamic can be due to several factors, including improved product or geographic diversification, deeper management teams, access to various distribution channels, and better availability of capital. Revenue multiples are plotted against size (as measured by market capitalization) in Figure 7.
As shown in Figure 7, there did not appear to be a discernable relationship between revenue multiples and size. Similarly, we did not identify any meaningful relationship between size and EBITDA multiples.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. This relationship appears to hold for the publicly-traded surgical instrument and device companies, as seen in Figure 8 below.
While there are inconsistencies among the observed data points, companies with projected EBITDA margins of approximately 25% and less appear to trade at revenue multiples ranging from around 3.0x to 5.0x. Companies with EBITDA margins greater than about 25% seem to trade at valuation multiples of 6.0x and as high as 7.5x. Again, the lack of consistency throughout the dataset suggests that investors are likely considering many factors in their valuations of companies in this industry.
The Leverage Story (***New***)
New to this update, we consider the impact of financial leverage (or the companies’ use of debt) and their impact on the valuation multiples. In the last year, we have noticed an increasing trend of risk mitigation among investors, both in the private and public markets. Therefore, we have included financial leverage among the considerations we analyze to explain the observed valuation multiples.
Debt usage tends to increase financial risk to equity holders. Debt holders have a senior position within a company’s capital structure, and debt servicing occurs before any cash flow benefits (i.e., dividends) are issued to equity holders. Figure 9 plots LTM revenue multiples against their associated interest coverage ratios (as available).
The interest coverage ratio measures a company’s ability to pay its interest obligations. The higher the ratio, the greater its ability to cover its interest expense with its operating income. In Figure 9, there appears to be some correlation between revenue multiples and interest coverage ratios.
Tying it All Together
The trends observed in this article suggest that investors are considering multiple factors and that no single consideration is definitively influencing valuations. A summary of the observations in this article is presented below and compared to our analysis as of December 31, 2020.
We observed greater degrees of correlation between revenue multiples and the various factors discussed in this article, which would suggest that investors may be valuing companies in the industry using revenue multiples. The magnitude of the revenue multiples appeared to be influenced by growth, profitability, and financial risk.
I hope you found this analysis helpful. Any input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.
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