• JNJ’s agreed acquisition of ABMD at $380 per share came as a surprise to many healthcare focused investors.
• ABMD’s speed of innovation around its Impella segment have been a standout all along, as we’ve previously covered.
• There is still some uncertainty surrounding legal proceedings from selective ABMD shareholders.
• At this point, it’s prudent to rate ABMD a hold until further clarifications on the deal’s finalization are obtained.

Investment Summary

Since our last publication on Abiomed, Inc. (NASDAQ:ABMD) where we had a buy thesis fully intact, there’s been several notable developments in the company’s growth route. We had previously touched on ABMD’s various strengths in return on invested capital (“ROIC”) and the speed of innovation around its core Impella heart pump segment. Turning to the present day, and the key update is Johnson & Johnson (NYSE:JNJ)’s agreed buyout of ABMD in November, for an all-cash consideration of $380 per share, valuing the company at $16.6Bn.

Merger & acquisition (“M&A”) activity in the broad healthcare spectrum ticked up in 2022, with substantial growth in M&A revenues from the previous year. JNJ’s acquisition of ABMD is a large step forward for the latter, who will benefit from JNJ’s deep customer networks and wide distribution capacity. It also reduces the execution risk for ABMD in its further innovations around Impella, which is a meaningful tailwind in the investment debate.

I also encourage you to read our other publications on ABMD [excluding the most recent, and newest to oldest]:

1. Recovery mode activated
2. Valuation drivers justify premium over peers
3. A heartbeat away from next uptick

Net-net, with shares drifting above the $380 purchase price at the time of writing, we believe it’s prudent to rate ABMD a hold at this point in time.

ABMD acquisition from JNJ

Turning first to the deal itself, JNJ agreed to acquire ABMD for $380/share in November. For the healthcare giant JNJ, it offers exposure to the innovative domain within cardiovascular intervention, widening its footprint in heart failure in particular. Following the completion of the transaction, ABMD will continue to operate as a standalone business albeit within JNJ’s med-tech division.

ABMD’s core portfolio of cardiovascular intervention technologies provides JNJ with the opportunity to achieve this, without taking on any additional pipeline risk. For ABMD, it reduces the execution risk, as mentioned, and will help retain EBIT margin in our opinion through various cost synergies.

Also embedded into the deal is a $35/share cash milestone payment, comprised of $17.50/share if ABMD exceeds net sales of $3.7Bn in the first quarter of FY27′ to Q1 FY28′, and a $7.50/share incentive upon the FDA’s approval of the Impella’s use in ST-Segment Elevation Myocardial Infarction (“STEMI”) patients by FY28′.

Moreover, there’s an additional $10/share payable if Impella receives recommendation for use in PCI or STEMI with or without cardiogenic shock. Whilst these are long-term milestones, they serve as appropriate benchmarks for the company going forward.

You can see below ABMD’s sequential outperformance at the top-line in the chart below [Exhibit 1]. We had mentioned such strengths in our previous publications, and the long-term growth trend remains well in situ for ABMD based on this presentation.

Exhibit 1. ABMD sequential revenue upsides, representation of long-term value creation around Impella

This extends vertically down the P&L to its bottom-line fundamentals, whereby the company has outpaced consensus estimates in every earnings print since Q4 FY19. These are impressive growth percentages that point to ABMD’s cash conversion and speed of innovation around its Impella segment, factors we’ve discussed at lengths in prior publications on the company.

Exhibit 2. ABMD EPS upsides vs. consensus a continual pattern since 2019.

It is unsurprising that, along with key differentiators via its Impella segment, that the company stood out to JNJ.

Recent developments

The question really now turns to whether there will be another bidder entering the ABMD acquisition race, or if the $16.6Bn offer remains too large to be beaten. Note, at the time of the offer on November 1, it was a 50% premium to the share price ABMD was trading at. Given this point, we believe it is unlikely another entrant will step up to acquire ABMD.

But it’s not all done yet. As with most prospective M&A’s, there are underlying challenges that still need to be sifted through.

First, JNJ extended the expiration date of its original offer from December 13th to December 21st. It was reported on the 13th that, “approximately 19,279,461 shares of Abiomed, representing approximately 42.75% of the outstanding shares of Abiomed’s common stock, have been validly tendered and not properly withdrawn pursuant to the offer”.

Before this, however, on November 16th–18th, several ABMD shareholders filed lawsuits against ABMD in the United States District Court for the Southern District of New York and the District Court for the District of Delaware. The cases, titled, O’Dell v. ABIOMED, Inc. et al; Coffman v. ABIOMED, Inc. et al.; and Jones v. ABIOMED, Inc. et al., respectively, make allegations against ABMD in violating federal securities laws.

Specifically, the tree complaints allege that ABMD “[filed] a materially incomplete and misleading Solicitation/Recommendation Statement on Schedule 14D-9.” In addition, the company also received 8 demand letters, and a draft complaint, from shareholders raising similar claims regarding the respective disclosures mentioned. ABMD and JNJ both stress that all filings were made correctly.

Whether or not this proves to be a spanner in the works remains to be seen, but it does tell us that the transaction may not close as smoothly as intended. Therefore, we’re keeping a very close eye on how matters unfold. As a reminder, the deal is set to close in Q1 FY23.

In short

Net-net, the JNJ’s purchase of ABMD at $380/share looks to be a reasonable proposition for both parties involved. For ABMD shareholders, depending on your entry price, there’s likely to be a sizeable realized capital gain following the sale. However, there are still some hurdles to bypass before that looks to be a reality, and we’d be very interested as ABMD holders to observe the outcomes of the impeding court cases against the company. Whilst not uncommon in these scenarios, just how much of an overhang it may or may not be is a question we don’t have the answer too. Nonetheless, we look forward to providing additional coverage of the acquisition in the respective weeks and months.

Disclosure: I/we have a beneficial long position in the shares of ABMD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The post A Look At Abiomed Before The $380/Share Buyout From Johnson & Johnson appeared first on Up2info.com.

• Abiomed’s Impella range of micro heart pumps enjoy rising demand in the marketplace.
• The company’s OXY-1 System cardiopulmonary support device has strong growth prospect.
• The company’s revenue will grow at a CAGR of high-single digits in the long term, which will drive the company’s share price significantly higher in the next five years.

Abiomed’s (NASDAQ:ABMD) micro heart pumps enjoy rising demand in the cardiovascular marketplace. I expect the company’s Impella range of micro heart pumps will drive the company’s long-term revenue growth significantly, and its Impella product pipeline will support long-term revenue growth as well. Long-term growth-oriented investors can buy the company’s shares around the current price to maximize their profit.

Abiomed develops heart pump products and oxygenation products for patients who are suffering from severe heart disease and in need of hemodynamic support. Its products are used in cath lab by interventional cardiologists and in the heart surgery suite by cardiac surgeons. The company’s heart pump products work by improving blood flow and/or performing the pumping function of the heart. Its oxygenation products work by providing sufficient oxygenation to respiratory failure patients.

Growth Drivers

Impella Heart Pumps

Abiomed’s Impella micro heart pump product line is its main growth driver. Impella is a percutaneous heart pump that is used to treat CHD (coronary heart disease), and high-risk PCI (percutaneous coronary intervention). Impella has variants which are Impella 2.5, Impella CP, Impella 5.0, Impella LD, Impella 5.5 and Impella RP. These pumps beat competitive products, such as intra-aortic balloon pumps (IABPs) and the TandemHeart device, due to the following reasons:

• Impella helps CHD and PCI patients maintain proper blood circulation in a better way.
• Impella offers continued function irrespective of timing or trigger.
• These pumps offer stability to patients despite the presence of arrhythmias.
• These pumps can pump up to 2.5 to 6 liters of blood per minute, which provides better cardiac output.

According to a report:

The heart pump device market is projected to reach USD 5.5 billion by 2026 from USD 2.1 billion in 2021, at a CAGR of 21.6% from 2021 to 2026. Promising product pipeline, increasing number of product approvals and emerging markets are expected to offer growth opportunities in the market during the forecast period.

Due to the strong growth prospects of the heart pump market, Abiomed’s revenue will continue to grow rapidly in the next five years.

OXY-1 System

Abiomed’s OXY-1 System, which is a compact cardiopulmonary support system, is the company’s another growth driver. The system offers respiratory assistance to patients suffering from cardiogenic shock combined with respiratory failure. The machine’s oxygen concentrator and pump provide oxygenation to venous blood, and as a result, patients get significant respiratory support. The device performs well in the competitive environment and beat competitor products such as traditional ECMO (extracorporeal membrane oxygenation) machines due to its capability to provide uniform blood flow and superior respiratory support. I expect the device will support Abiomed’s long-term revenue growth which primarily comes from Impella.

Competition

The heart pump industry is characterized by tremendous competition. Abiomed’s competitors in this industry include Abbott Laboratories (ABT), Medtronic (MDT), Edwards Lifesciences (EW), Boston Scientific (BSX), LivaNova (LIVN), and Terumo Corporation (OTCPK:TRUMF). Abiomed competes with these companies on the basis of developing innovative heart pump devices, continuity in new product development, and advanced 24 x 7 hospital support.

Abiomed’s primary competitive advantage is that its current strategy of developing devices in the area of circulatory care is supported by substantial expertise in developing heart pump devices. As a result, the company’s heart pump devices enjoy significant demand in the marketplace. The company intends to continue to use its expertise in developing additional circulatory support devices and making enhancements to existing devices, which will support its future revenue growth. The company’s another competitive advantage is that its Impella micro heart pump is the only FDA approved heart pump for high-risk PCI, cardiogenic shock, and right ventricular failure. As a result, Impella and its forthcoming variants will continue to drive Abiomed’s revenue growth.

First Quarter 2023 Financial Results

Abiomed reported first quarter 2023 revenue of $277 million, an increase of 10% year-over-year, compared to $253 million in the prior fiscal year period. Non-GAAP net income per diluted share came in at $1.25, an increase of 13.6% year-over-year, compared to $1.10 in the prior fiscal year period.

The company delivered strong results for the first quarter of fiscal 2023. Top line grew driven by robust sales across the U.S., Europe and Japan. The company’s heart pump product line is witnessing growing adoption since it addresses the challenge of treating heart disease in multiple emergency patient populations in the cath lab and surgical suite. This is driving the company’s revenue growth. The company’s bottom line grew driven by strong patient utilization across the three regions mentioned above. Abiomed 2.0, the new Abiomed with unparalleled focus on innovating heart and lung repairing devices amid hindrances such as hospital labor shortages, supply chain constraints and contrast media shortages, will boost the company’s top and bottom line growth in the next five years. I expect the company’s revenue will grow at a CAGR of high single-digits in this time frame.

The company’s Impella 5.5 surgical heart pump drove its surgical revenue 49% year-over-year in the quarter. The heart pump with SmartAssist software has the ability to drive the company’s long-term revenue growth meaningfully since it provides unique advantages for the chronic heart failure patient population suffering from cardiogenic shock. Impella 5.5 has a game-changing technology which can improve patient outcomes with 75% survival rate across all indications.

Valuation

Click to enlarge

(Data Source: Seeking Alpha)

Abiomed is expensive compared to its peer group companies. The company has a strong balance sheet consisting of cash and equivalents of $180.5 million, and zero debt. The company is expensively priced because its Impella product line enjoys rising demand in the marketplace, which is expected to drive its long-term revenue growth at a CAGR of high single-digits. I expect macroeconomic activities in the next five years will continue to remain strong, and this will support Impella’s long-term demand growth. Abiomed has a strong product pipeline consisting of Impella ECP, Impella XR Sheath and Impella BTR, which will support Impella’s rising demand. Driven by the company’s long-term revenue growth, its share price will see steady appreciation. I believe the company’s shares can be bought around the current price exploiting the current correction in the stock market.

Assuming Abiomed’s revenue will grow at a CAGR of 9% in the next five years, I will find out the company’s long-term (five-year) share price. In the last five years, the company’s revenue has grown at a CAGR of 12%, and I believe in the next five years the company’s revenue will grow at a CAGR of 9% driven by Impella’s rising demand. The company’s trailing 12-month revenue is $1,056.3 million, and at a CAGR of 9% the company’s end-2027 revenue will be $1,625.00 million, or $35.75 per share. In the last three years, the company’s shares have traded between the price to sales multiples of 7.5x and 20x. I expect in the next five years, the company’s price to sales multiple will touch a high of around 15.00x driven by growing demand for Impella heart pumps. Applying a price to sales multiple of 15.00x on Abiomed’s end-2027 revenue per share, I get $536.25 as the company’s end-2027 share price.

Risks

The company derives most of its revenues from sales of its Impella devices and related services. The company anticipates that Impella will continue to drive its revenue growth in the near future. This is a risky affair. If the company cannot diversify its business beyond Impella, such as OXY-1 System, its revenue growth and profitability could be negatively impacted.

The company’s business objectives will be achieved only if its products are accepted and recommended by leading cardiac surgeons and interventional cardiologists. The decisions of these surgeons and cardiologists are influenced by the fact that Abiomed’s products are safe and effective. If the company fails to develop new relationships with leading surgeons and cardiologists, its revenue growth and results of operations could be negatively impacted.

Conclusion

Abiomed’s innovative technology and 24/7 hospital support addresses the growing epidemic of heart disease in a better way compared to competitors. The Impella line of heart pumps outcompetes IABPs and TandemHeart consistently and continues to grab market share from these solutions. As a result, Abiomed’s revenue continues to grow. Long-term investors can buy the company’s shares around the current price.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The post Abiomed: Correction Offers Good Buying Opportunity appeared first on Up2info.com.

• Abiomed came in with another set of robust earnings yesterday, with double-digit growth from top to bottom.
• Earnings remain steady, however, the company exhibits the profitability features investors are paying a premium for.
• Valuations are supporting, and we look to be paying a ~300bps premium for access to the above premia investors are searching for in FY22.
• We remain unchanged on our previous rating of buy and valuation of $388, respectively.

Investment summary

The long-term buy thesis for Abiomed, Inc. (NASDAQ:ABMD) remains fully intact following the company’s Q1 FY23 earnings posted yesterday. After a double-digit gain from the top to bottom line, the company also saw strengths in non-GAAP reconciliations and continued to generate a substantive return on investment, generating an above-average $46 million in NOPAT from last year’s invested capital. Valuations are supportive, and we are paying ~300bps premium to obtain access to these quality factors that investors are paying a premium for in FY22. We reiterate that ABMD is a buy [since October 2020] and valuations remain unchanged at $388 per share.

Exhibit 1. ABMD 6-month price action

Q1 FY23 earnings in-line with long-term cadence

For the first quarter of its FY23, ABMD printed YoY top-line growth of 10% to $277 million. In constant currency (“cc.”), this was a 12% gain over the year. Global product revenue also spiked 10% (12% cc.) with an 11% gain in ex-US turnover. Europe and Japan in particular led sales growth contributing $33 million and $13 million to the top respectively. Whereas US sales were slightly behind with a 9% YoY growth. Underpinning domestic growth was an uptick in patient utilization.

The company saw ~110bps gross margin compression to 81% which saw a down-step in gross profit to $224 million, well above long-term averages. Note, that in Q1 FY22, ABMD acquired the remaining interest in its preCARDIA asset for $82.8 million. In its accounting for preCARDIA, booked the fair value of the acquisition as relating to the acquired in-process R&D asset. It, therefore, capitalized the $115 million expense of the transaction, recognizing it as an asset.

This is important, as in its non-GAAP reconciliation for Q2 FY21, ABMD recognized this in an adjustment to GAAP net income, as seen in the table below from its Q2 FY22 8-K. Instead of printing a loss of $27.5 million, non-GAAP net income was $51 million for the period. It did the same for the loss or gain on its Shockwave Medical investment, recognizing $3.6 million on this position in Q2 FY22.

As a result, its gain from year to year is a little more compressed than it seems on GAAP measures. As seen below, after reconciling non-GAAP net income in both Q2 FY21 and Q2 FY22, the YoY change is around $6 million versus the large jump reported on the income statement.

Exhibit 2. Non-GAAP reconciliations

Management confirmed FY23 guidance and calls for 13-17% growth at the top, calling for ~$1.2 billion in revenue at the upper end. It also forecasts GAAP operating margin to land within 23-24%, which would generate $81 million in operating profit should the company hit this target.

Exhibit 3. ABMD forward earnings forecasts FY23-FY25

Impella continues pumping

The Impella story continues to deliver clinical trial and regulatory momentum for the company. The latest data for the ventricular support system was presented at the Society for Cardiovascular Angiography and Interventions (“SCAI”) 2022 Scientific Sessions. Findings from a large meta-analysis, that demonstrated the link between pre-PCI Impella and improved outcomes for acute myocardial infarction cardiogenic shock (“AMICS”), were illustrated in the International Journal of Cardiology.

The company also advised in its filing that it has received FDA approval for its planned RECOVER IV randomized controlled trial. Per the company’s filing:

“RECOVER IV will compare all-cause mortality at 30 days in patients with STEMI-CS with an Impella-based treatment strategy initiated prior to PCI vs. a non-Impella-based standard of care treatment strategy. The trial is designed to provide the clinical evidence needed to achieve a Class I guideline recommendation for Impella use in AMI cardiogenic shock.”

Profitability continues to be a standout

Investors have turned to bottom-line fundamentals and measures of profitability in FY22. In this vein, ABMD fits the bill and offers attractive economics in the return on its investment. Here we examined the amount of NOPAT generated from the previous year’s invested capital. As seen in Exhibit 3, trends have been shifting upwards for the past 2-years on a sequential basis, with ABMD averaging a $42 million in quarterly NOPAT conversion since FY18. On this return, the 5-year normalized ROIC is 10.92%, well above the industry average and company WACC of 6.7%. As such, ABMD compounds capital at an average of ~11% per quarter, and this is attractive in the current climate with an increasing cost of capital.

Exhibit 3. ABMD return on investment continues to push higher and normalizes at ~11%

Valuation

Shares are trading at a premium to the GICS Industry peer median across numerous multiples. It is priced at more than 9x book value and trades at 13x forward sales. As seen in the table below, ABMD’s peer group is full of high-quality names trading at very respectable valuations.

Exhibit 4. Multiples and comps

Moreover, paying the 9x book value, and corresponding 8.3x enterprise value (“EV”) to book value, would see us theoretically paying $284-$305, with an arithmetic mean of $294. As such, we believe that we could be paying around a fair price for the stock. We are essentially paying a ~300bps premium for an ~11% average quarterly ROIC, ongoing top-bottom line growth and forecasted operating margins to grow in times of cost inflation. Moreover, on a qualitative basis (discussed in our previous analyses here, here, and here) the company’s speed of innovation around the Impella segment continues to be a differentiating factor that weighs in heavily on the forward-looking investment debate. In our previous analyses, we set a price objective for $388 for ABMD and this remains our long-term valuation of the stock.

Exhibit 5.

In short

ABMD continues to exhibit quality equity premia that investors are paying a premium for in FY22. As investors increasingly shift away from rewarding high-beta, high-growth names and back onto bottom-line strengths, ABMD remains differentiated with the economics tied to its Impella segment. It has averaged an ~11% quarterly ROIC over the 5-years to date whilst growing FCF and earnings all the same. We also note the company’s recent clinical trial and regulatory momentum that is likely to inflect onto the share price.

Valuations are also supportive, and for access to all of the above, we are expected to pay a 300bps premium to the company’s book value of equity. It then becomes a question of one’s equity risk budget. We value the stock at $388 per share based on previous analyses that remain largely unchanged. On the culmination of these factors, we rate ABMD a buy.

Disclosure: I/we have a beneficial long position in the shares of ABMD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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• ABMD had a decent quarter where revenues grew nicely but profits languished due to sudden growth in R&D spend.
• Companies like ABMD have to expense R&D, which is not a problem, but a lack of profit growth isn’t great given its valuation.
• The multiple doesn’t offer much of a margin of safety, but we recognise the premier product portfolio.
• Overall, there is a defensive angle for the stock given rate increases, but the valuation is too much of a concern.

Originally published on the Value Lab 14/5/22

Abiomed (NASDAQ:ABMD) makes the Impella portfolio of heart pumps used in various cardiovascular surgeries. The secular angle is strong on the basis that COVID-19 can create cardiovascular issues, but also that lifestyles have contributed to greater incidence of cardiovascular disease. The latest quarter continues to demonstrate that they can grow revenues and that the markets are strong, and they continue to make headway in terms of iterating the product and creating better outcomes. However, the valuation is too stretched, and profit growth being limited by necessary R&D spend is somewhat of a concern. Long periods of outstanding growth are possible, but also required in order for the current multiple to make sense. While the markets are defensive and in principle attractive given economic concerns, we’d look elsewhere on account of the valuation.

Q4 Note

The company just reported their Q4 results a couple of weeks ago. Sequentially, gross margins suffered a bit, but remained strong on a YoY basis. Revenue growth also persisted despite issues with labor shortages in hospitals, which has been a recurring theme for any company that depends on diagnosis or procedure volumes to make sales. The Impella markets are strong, and the strategy of expanding the indications for which they can be used continues unabated, and new products enter the portfolio.

While revenues are growing in the comfortable double digits, and the guidance states that they should continue to do so, profits have languished because of the broadening product initiatives. Impella ECP, but also other clinical trials, are creating R&D expenses that cannot be avoided. In the case of Impella ECP, the return of this R&D investment will likely be high, with the product receiving special FDA designation to fast-track its development and iteration as the smallest and least invasive heart pump for cardiological surgeries ever invented. Gross margin declines have been the other driver of reduced profits, starting already in 2021 year-ending in March. However, the incremental effect has primarily come from the fixed cost base.

Valuation & Conclusions

Having done a TMA analysis on ABMD in our last article, we run it again with the updated figures. Guidance is lower in revenues than what was achieved in 2021, and the profit margins are likewise lower. The former is likely a consequence of the hit to procedure volumes, with 2021 also being a year that was more harangued by COVID-19 and therefore providing a weaker comp. The latter should be due to the R&D ballooning as more work is done to support clinical trials for new indications as well as for the new heart pumps coming to the market. Updating the figures for our TMA with the lower market cap since our last neutral coverage, we get the following results.

In order to justify the current valuation, 9 years of outstanding reinvestment fueled growth is required at the current ROIC-WACC spread in order to justify the current valuation. Is this reasonable? Somewhat. When you get very high multiples like this, it’s not by definition overvalued, and it appears to us that the end-markets for heart pumps remain robust in terms of growth, and the patent protected portfolio of special class medical devices is not one to lack in pricing power or be vulnerable to threats from industry structure. ABMD is a top-quality company, and it is continuing to perform as an innovator and designer of heart pumps. However, given the difficulties in growing profits as R&D expenses mount, and also due to the challenges generally faced by the market, a stretched valuation that depends on perfect execution is not one we’d prefer in the current environment. While the end-markets are resistant to rate hikes and inflation, both of which can hurt disposable income and demand for most products, we are going to continue looking elsewhere for investments.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

If you thought our angle on this company was interesting, you may want to check out our service, The Value Lab. We focus on long-only value strategies, where we try to find international mispriced equities and target a portfolio yield of about 4%. We’ve done really well for ourselves over the last 5 years, but it took getting our hands dirty in international markets. If you are a value-investor, serious about protecting your wealth, our group of buy-side and sell-side experienced analysts will have lots to talk about. Give our no-strings-attached free trial a try to see if it’s for you.

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• Abiomed is a company with a superb product in the mid-market space while what appears on the surface is an extremely high multiple.
• While the multiple appears high at first, it does actually reflect the profile of the company on a more normalised basis, where it is currently experiencing headwinds.
• The secular outlook is obviously intact, but given the high multiple and the unknown length of the medium-term headwinds, it is not an especially compelling opportunity.

Abiomed (NASDAQ:ABMD) is a specialised and leading provider of mechanical circulatory support devices seeing use in the catheter lab. Their business model revolves around obtaining PMAs, which apply to their Impella family of devices which are all Class III and maximally regulated. PMAs enable their products to be used under certain conditions for specific purposes, and the more PMAs they obtain the greater the variety of operations and circumstances involving the device for which patients will be reimbursed. They’ve been doing a great job leveraging their platform into as many cardiology applications as possible, and this has resulted in an attractive and exceptionally cash generative profile which in normal times converts from EBITDA into FCF at 100% rates. The current multiple may appear high, but the economics of the business do in principle justify it. However, medium-term headwinds mean gravity may come into effect, and there is therefore capital risk. We prefer to find good economic profiles in the lower multiple space, and will leave Abiomed to others, although do not consider it overvalued even on an absolute basis.

Secular Outlook and Q2 Report

The chief market for Impella products is the large market of patients of heart disease. Impella pumps provide haemodynamic support in a relatively noninvasive way during high-risk elective or urgent PCI procedures. Exposure to the megatrend of lifestyle-related coronary heart diseases positions Abiomed well for enduring growth where its Impella heart pumps target many procedures related to these health issues. Over the entire Impella family, permission has been given through PMAs to utilise the device to improve blood ejection from the ventricle from hours to days, and in treatment of ongoing cardiogenic shock after infarction or serious surgery. Impella products are also being used with an IDE to assess whether they can reduce infarct size by unloading the ventricles.

The sales have grown, but not profitably on a 6-month basis. Overall operating profitability collapsed due to the rise in SG&A and R&D costs, but those are discretionary and related to direct-to-patient marketing initiatives as well as a desire to further develop their product line. On a 6-month basis the gross profit improvement is a testament to enduring profitability with the gross margin improving as well.

However, the recent quarter recovered the situation in terms of profitability, likely the results of the discretionary marketing initiatives taken primarily in the prior quarter but mainly due to the fact that R&D was not acquired this quarter. Growth is persisting as well on the topline, although we are seeing more limited growth than expected due to the Delta variant having impacted the amount of procedures happening with severe COVID-19 cases taking precedence. With substantial exposure to Texas and Florida, where people were hit particularly hard by the surge, procedure volume growth was more stunted. Moreover, there is a labor shortage in hospitals, in particular with nursing staff, that is a headwind for the company as well. Nonetheless, 18% growth was still delivered YoY in this quarter, with operating profit remaining flat, mainly due to ballooning in marketing expenses.

Valuation

Let’s do a target multiple analysis (TMA), to understand how the cash generative profile and growth expectations can justify the current multiple over 50x. TMA is a process of determining what the fair multiple would be for a company on the basis of DCF inputs, where the EV/EBITDA multiple can be decomposed into factors that relate to cash flows and not just relative measures. Specifically, we observe the growth appreciation period, which is the period of expected outstanding returns over cost of capital. Call it the ‘competitive advantage’ period. Combined with a large spread between WACC and ROIC, we can often justify quite high multiples, since cash flow visibility ends up being quite far-out at outstanding capital return rates. Indeed, this is the case for Abiomed. Based on current prices, we find that the current growth rates of 20% are being forecast into the future by markets for a 9-year GAP assuming the current spread between WACC and ROIC. Given that Abbott Labs (ABT) is the only real competitor in heart pumps, and with PMAs and Class III designation being a massive barrier to entry, that is not unreasonable.

Conclusions

With the above TMA, we see what the market implied assumptions are for ABMD to be trading at fair value. We used 2020 data for the operating profitability and NOPAT as this year is marred by exceptional expensing for R&D and marketing. On that more normalised basis, 9 years of 20% growth are expected by the market in order to justify the current multiple. While not unreasonable given the company’s profile and the secular scope for growth as well as still low penetration, it definitely indicates quite a rich multiple. Also headwinds are real. The 18% growth rate achieved may not hold up in the medium-term, even if it resumes in the long-term, because of issues like labor shortages in hospitals as well as the general declines we have seen in procedure volumes across healthcare due to the focus on COVID-19 related cases and the general scare of getting sick with the virus. Since some years of lesser cash flow growth will affect those present values of cash flows, it will have a real impact on the return profile of the company. We think that the current expectations for the stock are not unreasonable, but are optimistic, and we don’t see any special reason to be optimistic about medium-term prospects. As such, ABMD is a pass at these levels.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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