Surgical Instrument & Device Company Valuations – June 2022
Surgical instrument and device companies experienced a significant but short-lived downturn in financial performance during the height of the pandemic but have since continued their growth trajectory. 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.
This article updates our December 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 June 30, 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 June 30, 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 the LTM period, valuations declined, a trend consistent with the overall market declines observed in June 2022. Let’s take a closer look at what industry-specific factors drove down valuations.
Valuation Multiples
Figures 2 and 3 present the industry’s historical trend of revenue and EBITDA multiples.
Figures 2 and 3 show that the median valuation multiples increased through 2020 before declining in 2021 and June 2022. This decline in multiples was nearly universally observed among publicly-traded surgical instruments companies.
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).
The orange line in Figures 4 and 5 represents data as of June 30, 2021. At that time, the industry’s projections suggested substantial revenue and EBITDA growth in 2021, with solid growth coming in 2022 and 2023.
The blue line in Figures 4 and 5 represents information as of June 30, 2022. Actual 2021 revenue and EBITDA growth performed to expectations. Projected growth rates for 2022 through 2024 were generally consistent with those observed the prior year.
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. Figure 6 plots LTM EBITDA multiples against projected NFY+1 EBITDA growth rates.
In Figure 6, EBITDA multiples appear to be impacted by the magnitude of expected growth for NYF+1 (2023). Interestingly, a similar correlation was not observed between LTM EBITDA multiples and NFY growth rates. We could not discern a meaningful relationship between revenue multiples and revenue 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 appeared to be some 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 appears to hold for publicly-traded surgical instrument and device companies, as seen in Figure 8 below.
While inconsistencies exist among the observed data points, companies with greater projected 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 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 measurably impacting valuations. 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.
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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