MedTech – Surgical Instruments: Values Still Hitting New Heights

Nobody is immune: every industry has felt the impact of COVID-19 in some capacity, including medical device manufacturers. Helios Consulting, Inc. recently performed a valuation of a privately-owned medical device manufacturer primarily focused on developing and manufacturing innovative surgical instruments. The company’s management team provided valuable insight into some of the industry-wide trends that impacted their business in recent months. These conversations led me to wonder how they might impact the valuations of large publicly-traded competitors in this space. Read on for a brief summary of my findings.

Important notes: This article examines potential driving factors for valuations of the surgical instruments industry from a financial statement perspective. An actual valuation of a company requires an in-depth analysis of the business operations as well as associated risk factors. These cannot always be directly considered through the data on the financial statements. Also, in order to keep the length manageable, this article will focus on what I interpreted to be the primary value drivers and 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. I focused on U.S. companies that were traded on major exchanges for at least a year with a stock price equivalent of $1 or more. I excluded companies that also develop and produce pharmaceuticals and only focused on the companies that generated positive EBITDA in the latest 12 months (“LTM”). The effective date of this analysis is December 31, 2020.

The surgical instruments and device companies’ median enterprise value (“TEV”), median revenues, and median EBITDA are summarized in Figure 1. Latest fiscal year is notated “LFY”, while the latest 12 months is defined as “LTM”.

Figure 1 illustrates the remarkable hike in industry enterprise values over the last six years, which coincided with consistent improvements in median revenue and EBITDA. Intuitively, the observed improvement in the financial metrics could be attributed to continuing demand for surgical instruments amidst an aging U.S. population, increased average lifespans, and improved access to healthcare (especially internationally). These factors are certainly helping to drive up valuations and financial performance. However, there is another component that has fueled the growth shown in Figure 1: acquisitions. Based on Form 10-K and 10-Q filings, nearly all of the companies analyzed engaged in regular merger and acquisition activity, which is consistent with the consolidation occurring in the broad medical technology space. There are several motivations for the larger players in the industry to absorb their smaller counterparts. One such incentive is that acquisitions allow a company to add new and complementary products to their own portfolios without incurring the costs and uncertainties of developing such products in-house. By leveraging their size, expertise, and market presence, the publicly-traded companies are able to rapidly scale the acquired businesses to generate favorable returns.

While valuations continued to grow in 2020, financial performance declined modestly in the LTM period partially due to a reduced number of elective and non-emergency surgeries in the midst of the pandemic. When financial metrics adjustments are outpaced by enterprise value changes, valuation multiples will increase. This can be viewed in Figures 2 and 3 below, which present the historical trend in revenue and EBITDA multiples. In this case, EBITDA multiples rose sharply in the LTM period because of the swell in enterprise values relative to the slight decline in EBITDA.