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Write about Company CONMED (NYSE:CNMD) (“Conmed”) in the fall of 2023, I mentioned some concerns about an optimistic attitude towards this small medical technology company in the face of a weak environment for medical technology stocks and concerns. that Conmed could see significant competition from a competitor’s insufflator integrated into the newer Intuitive Surgical, Inc. (ISRG) platform.
Medical technology stocks have since recovered nicely, but Conmed shares were hit hard by the news that the new Intuitive daVinci 5 platform does indeed include a built-in insufflator. Novanta Inc. (NOVEMBER). Conmed shares are now down about 30% since this last article.
Competition with an integrated insufflator will almost certainly have a negative impact on Conmed’s growth and profitability, but I believe this liquidation is excessive. Even integrating fairly pessimistic figures on the impact of AirSeal competition, I I think Conmed can generate enough revenue growth and margins to support a price closer to $95, although I realize the Street will likely need some reassurance before rerating the stock higher.
AirSeal Contributions will be deflated a little
The launch of Intuitive’s new daVinci 5 surgical robot earlier this year confirmed one of the bearish theses on Conmed: the new system indeed includes an integrated insufflator (developed by/with Novanta) which will compete with that of Conmed. AirSeal. As AirSeal has been a very successful product for Conmed (fast growing and high margin), this certainly poses a threat to the company, although I think the reaction has been a bit extreme.
Insufflators are indispensable tools for laparoscopic surgical procedures, and surgeons use them to fill the surgical area with air to improve visualization and access to the procedure. AirSeal generates approximately $175 per procedure from disposables (on top of a $30,000 system), and AirSeal has long been considered a premium product compared to regular insufflators (which cost around $80 per procedure, with an investment component of $15,000 to $20,000), with this premium justified by features such as lower inflation pressures, a valve-free design (which makes the procedure simpler), and proven reductions in surgical times, postoperative surgical stay, and postoperative pain.
Although surgeons can still use AirSeal With the new DaVinci system, this is not necessary: there is a built-in resuscitator they can use instead. I have no doubt that there will be surgeons who will consider this on-board option sufficient for their procedures, and new surgeons might also conclude that they do not need to bother with the learning curve to Air seal. I also imagine that at least some hospital administrators will argue along the line of “good enough” and attempt to improve procedural profitability by turning away from Air seal.
Time will tell what impact this integrated offering will have on AirSeal use. I am sure that it is indeed sufficient for many regular procedures, but I would like to note that it does not appear that the built-in insufflator can match the AirSeal on low pressure functions, i.e. AirSeal could still have an advantage in thoracic procedures where pressures are greater. There are also ease-of-use benefits with AirSeallike the ability to recirculate warm, humidified air that won’t fog up the camera, and AirSeal is still the only insufflator with better clinically validated results. Last but not least, surgeons are creatures of habit and can be very reluctant to abandon routines that have worked for them for many years.
Conmed management chose to guide for 2024 keeping in mind the worst-case scenario which includes a 50% drop in conversion rates with the new robot. I have seen updated estimates that AirSeal could have contributed around 20% of 2023 revenue (I don’t think management ever confirmed the exact amount), and I think the company grew around 20%.
With approximately 60% of AirSeal revenue from robotic procedures, this suggests an impact of around 1% on 2024 revenue and an impact of around 110 basis points on the revenue growth rate – which is not trivial, but not catastrophic either. Looking at how the Street traditionally values medtech growth, that’s about a 0.25x smaller multiple on revenue, or an impact of $16.50/share from the downside of $45/share since the beginning of the year. Even granting this AirSeal had above-average margins (management reported a low gross margin of 70% compared to the company average of 55%+), an annual impact of $0.08/share to around 0, $16/share, making various assumptions about operating margin, seems pretty digestible.
There are still several growth drivers
Even with the headwinds for AirSeal, I still think the Street is losing sight of Conmed’s overall growth potential. According to management comments at sell-side conferences, approximately 40% of the company’s product families are growing double-digits and nearly 50% are growing single-digits (with the remainder declining), and l The business can grow at a low double-digit rate “when everything is working well” versus underlying market growth of 5-7%.
Not only is it AirSeal still a profitable growth product (again, management’s guide for a 50% drop in robotic conversions is what they think is the worst case scenario), but so is Buffalo filter, a smoke evacuation system operated for increased use driven by state-level mandates. Given that in the United States, approximately 25 to 30 million surgical procedures generate smoke each year, at an ASP of $20, the addressable addressable market is growing rapidly, even with a penetration rate well below 100%. . Although I’m sure companies like Novanta and Stryker Company (SYK) will also look to exploit this opportunity, Conmed enjoys a significant share today and, once again, I think surgeons will generally choose to stick with the tools they are familiar with unless/until that there is a clear reason to change.
Beyond these products, there are growth opportunities like in2Bones, an extremity implant company (the integration of which has admittedly been a bit problematic), and BioBracea bioinductive implant for soft tissue repair procedures (such as rotator cuff or ACL tear) that increases tendon/ligament thickness and addresses a potential market opportunity of over $2 billion (approximately 800,000 to 950,000 procedures eligible for an ASP of $2,500).
Perspectives
I am now at the lower end of management’s fiscal 2024 revenue guidance and have made additional revenue reductions that result in an approximately 10% reduction in my long-term revenue estimates ( my income estimate for 2032 is now 11% lower. . I’m doing this out of caution AirSeal growth is significantly affected, as well as some conservatism about the near-term benefits of the in2Bones deal given some integration challenges. My long-term (like-for-like) revenue growth rate increases from 9.2% previously to 7.7%, or just over 6% with the new 2023 starting point.
I model an impact on the margin of approximately one point from a AirSeal and some other mix challenges, but I still expect EBITDA margin to improve by almost two points in FY24 (to over 20.5%), another two points in FY25 and another point in FY26, with operating results margin improving from 14% in FY’23 to 18% in FY’25 and continuing to improve afterwards. This should help push free cash flow margins into the double digits and then into the mid-teens over time, with annualized free cash flow growth hovering around the mid-teens.
Discounted cash flows, growth-oriented multiples, and margin-oriented multiples argue for a fair value higher than the current price. Even if I reduce my forward revenue multiple by 0.75x, which is excessive relative to the impact on the company’s revenue growth and margins, I get a fair value close to $98 on 3x long-term income.
The essential
I think it will take some time for the street to get used to the new reality Air seal and it should be noted that there is still a lot of uncertainty about the actual impact on Conmed’s business. It may be that management guidelines prove too conservative and most surgeons continue to use Air sealor it may be that management is not conservative enough and Air seal usage decreases even more in robotic cases.
I think the Street is already pricing in a much gloomy outlook (falling revenues in the AirSeal robotics company), and I think these stocks are attractive to contrarian investors willing to invest in a thesis that “it’s actually not that bad”, not to mention the other diversified growth opportunities that Conmed offer.
