Surgical Instrument & Device Company Valuations – December 2022

Surgical instrument and device companies experienced a significant but short-lived downturn in financial performance during the height of the pandemic but subsequently resumed their growth trajectory. Demand for elective surgeries accumulated during the pandemic, driving a swift recovery for companies in this industry sector. Valuations continued a steady climb through the end of 2021 but have since declined in 2022. This article will explore some of the trends that appear to impact the valuations of publicly-traded surgical instruments and device companies

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 only sometimes 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 only touch on some observations 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 29, 2022.

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” (2021) and the latest 12 months as “LTM” (latest available information as of December 29, 2022).

Figure 1 illustrates the industry’s march to ever-higher valuations over the last five fiscal years, which mostly coincided with improvements in financial performance. In 2022, however, valuations declined, a trend consistent with the overall market declines observed in December 2022.

However, the medtech industry faces some significant headwinds, which likely impacted the decline in market values in 2022. Capital raised by smaller medical technology companies generally declined approximately 35% during the 12 months ended June 30, 2022 – reflected in a slowdown in initial public offerings and special-purpose acquisition company (SPAC) deals. This is important because most of the innovation in the medtech space is driven by the smaller companies in the industry.

Looking to 2023, challenges for the medtech industry remain. Overall merger and acquisition activity and the availability of innovation capital remain subdued. There is growing pressure on research and development efforts, and investors are generally more risk-averse in the more uncertain macroeconomic environment. Further, according to IQVIA, “deglobalization and reshoring are gaining traction across the whole value chain.” Trade restrictions between the U.S. and China, the COVID-19 pandemic, and the Russia-Ukraine war have highlighted the importance of maintaining a diverse supplier base and proper control over inventory levels.

Let’s look at what performance and risk factors drove down valuations.

Valuation Multiples

Figures 2 and 3 present the industry’s historical trend of revenue and EBITDA multiples.

Fig. 2 – Trend of historical median revenue multiples

Fig. 3 – Trend of historical median EBITDA multiples

Figures 2 and 3 show that the median valuation multiples increased through 2020 before declining in 2021. Revenue multiples continued to fall through the end of 2022, while EBITDA multiples were consistent with those observed towards the end of 2021.

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 2022 for most companies).

Fig. 4 – Comparison of historical and projected revenue growth: prior year vs. current year

Fig. 5 - Comparison of historical and projected EBITDA growth: prior year vs. current year

The orange line in Figures 4 and 5 represents data as of December 2021. At that time, projections for the industry suggested strong growth in revenue and EBITDA in 2021, with solid growth rates continuing into 2022 and 2023.

The blue line in Figures 4 and 5 represents information as of December 2022. Actual 2021 revenue and EBITDA growth generally performed to expectations. Projected growth rates for 2022 through 2024 have decreased compared to those observed a year earlier.

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. Figures 6 and 7 plot NFY revenue and EBITDA multiples against projected NFY+1 revenue and EBITDA growth rates, respectively.

Fig. 6 – Chart plotting revenue multiples against projected revenue growth rates

Fig. 7 – Chart plotting EBITDA multiples against projected EBITDA growth rates

Based on the dispersion of the data points in Figures 6 and 7, projected growth did not appear to have a measurable impact on the magnitude of valuation multiples.

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 8.

As shown in Figure 8, there is a tendency for larger companies to trade at higher valuation multiples. However, we identified some dispersion in the revenue multiples among the smallest companies.

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 holds for publicly-traded surgical instrument and device companies, as seen in Figure 9 below.

While inconsistencies exist among the observed data points, companies with greater profit margins appeared to trade at higher revenue multiples.

The Leverage Story

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 10 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 10, 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. Interestingly, there is now a stronger correlation between risk-related financial ratios (i.e., size, profitability, and leverage) and valuation multiples vs. growth. A summary of the observations in this article is presented below and compared to our December 2021 analysis.

The relationships between valuation multiples and each factor noted above included some dispersion in the observed data points. This would suggest that valuations of companies in the industry may give more critical consideration to certain factors than others (such as an increased focus on risk mitigation and less consideration of growth rates).

I hope this analysis is helpful to you. Any input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.