Republished. Original Source: Baird Equity Research
January 4, 2021
DENTSPLY Sirona (XRAY) announced today it has acquired Byte, a leading direct-to-consumer clear aligner company, for $1.04B (all-cash deal). With this deal, management expects its clear aligner business (Byte+SureSmile) to exceed a $300M run-rate by end of 2021, meaning this fast-growing segment of XRAY's business could account for nearly 10%of company-wide revenue by year end. While leverage ticks back up with this deal (net debt/2021 ebitda ~3.1x), we like the WAMGR play here and, on first pass, believe it makes sense for XRAY longer-term.
XRAY announced today it has acquired Byte, a leading direct-to-consumer clear aligner company, in an all-cash deal for $1.04 billion. While Byte's recent revenue wasn't provided, management expects Byte to generate run-rate sales of at least $200M in 2021.
Management expects immediate accretion - Management is using cash on the balance sheet to fund this deal and expects it to be $0.05 accretive to non-GAAP EPS this year. While we estimate this deal will increase XRAY's net debt to 2021 EBITDA to just over 3x, Byte will also bring with it an NPV tax benefit of ~$160M, which should provide cash flow help to XRAY over coming quarters.
Mutually beneficial WAMGR play. Management will host a call this morning at 7:30am to further discuss this transaction, but on first pass we like this deal for a few reasons:
First, with management estimating the combination of Byte and XRAY’s own SureSmile business could generate run-rate sales exceeding $300M by the end of 2021, we estimate this deal could add at least 100bp to XRAY’s long-term revenue growth rate (conservatively assuming 10-20% annual growth for these combined businesses over next few years).
We also see mutually beneficial opportunities with this deal, as Byte should benefit from XRAY's R&D capabilities (SureSmile tooth movement technology well regarded by docs) and commercial expertise, while XRAY likely benefits from Byte's direct-to-consumer capabilities that could help XRAY better connect patients with its network of dental partners.
We're also encouraged to hear that Byte management will continue to run the Byte business, which is what we'd want to hear when a start-up like this is acquired by a bigger company like XRAY.
DETAILS
Valuation
Our $58 price target on XRAY applies a 22x multiple to our 2022 EPS projection of $2.61. This 22x multiple we’re using to value XRAY is one point below the 23x median EPS multiple at which we estimate XRAYs broader medtech peer group currently trades and is in line with the 22x multiple we’re also using to value XRAY’s closest peer in NVST. Relative to medtech peers, we believe this one-point multiple discount is warranted by the slower demand recovery we expect for dental vs. other medtech areas and the greater secular challenges we see for dental in general vs. many medtech subsectors over coming years. Relative to NVST, we believe both companies currently warrant similar (equal, in our case) multiples as we believe both have similar low- to mid-single-digit top-line and upper-single- to low-double-digit intermediate-term EPS growth opportunities over the next several years.
INVESTMENT THESIS
While we remain concerned about the potential pace of recovery for the global dental market over the next 12-18 months and see reasons to be cautious on XRAY into 4Q-20 (a tough comp driven by strong Primescan demand in last year’s 4Q), we continue to recommend purchase of this stock at current levels for three main reasons.
Primescan/Primemill demand expected to recover early next year. Before the onset of the global COVID-19 pandemic in March, our checks were suggesting Primescan demand was still strong early in the year and that interest from current CEREC owners for Primemill was trending better than we initially anticipated. As the dental market has started to recover in recent months, XRAY has since re-initiated a Primescan and Primemill trade-in program in the U.S. that we're hearing has so far generated reasonable levels of interest and could continue into next year, while management also recently seemed to confirm it is considering expanding these upgrade programs into Europe and Asia/Pac next year (our checks suggest XRAY's has a fairly sizable installed CEREC base in Germany, Japan, and Australia). After underestimating CEREC AC upgrade demand in the midst of the Great Recession back in 2009 and watching Sirona deliver five straight quarters of better-than-expected company-wide growth coming out of the recession, we don't want to underestimate a similar potential recovery for Primescan and Primemill coming out of the recent COVID-19 downturn.
History also suggests near-term risk is greater for basic, rather than high tech, dental equipment. When again using the Great Recession as a proxy, we saw dental consumables revenue across the industry return to growth in 2010 after declining y/y in 2009, with consumables revenue for companies such as HSIC and PDCO higher in 2010 than in 2008. But it took these same companies four years before they were able to get their dental equipment revenue to return to 2008 absolute levels, as dentists remained hesitant to purchase equipment, especially basic equipment that doesn’t offer a practice real financial payback or efficiency gains. Demand for high tech equipment, however, rebounded faster (as evidenced by SIRO’s solid rebound to positive revenue growth by mid-2009), and with XRAY much more levered to high-tech rather than basic equipment and with new high-tech equipment products beyond Primescan and Primemill just recently launching (including the company's larger FOV Axeos 2D/3D imaging system and a new 3D printer under the trade name PrimePrint that we believe could launch over the next few quarters), we again see potential reasons to believe XRAY’s post-COVID dental equipment recovery could surprise investors over coming quarters.
Secular shifts could provide revenue/margin tailwinds for three largest manufacturers. While we’re concerned about the potential pace of recovery in dental demand across the globe into 2021 given continued COVID-19 uncertainties and potential employment/discretionary spending overhangs, we also continue to hear in our checks that large DSOs are inching closer and closer to announcing direct supply agreements with manufacturers, potentially for contracts as soon as 2021. With COVID-19 issues also potentially driving even greater DSO consolidation over time (including potentially driving more private practices to consider selling to a DSO) and more DSOs potentially willing to move towards direct supply agreements once a couple of the larger organizations make such a move, we believe these types of direct moves would have positive revenue and margin implications for dental manufacturers, especially the three largest (XRAY, NVST, 3M) that we believe would be in the best position to directly support these DSOs over time. While revenue/margin contributions from such changes in 2021 would likely be fairly modest for a company such as XRAY (or NVST), we believe this shift in the dental purchasing paradigm would have positive valuation implications for dental manufacturers and potentially create additional valuation headwinds for dealers, thus our more positive bias at present on dental manufacturers over dealers.
Bottom line is we believe that given the views above, and with management recently announcing an expansion of recent restructuring efforts that we estimate could drive an incremental $100M in cost savings on top of the $140M in cost savings prior efforts have generated over the past 18-24 months, we believe a path back toward 2019 margins in 2021 remains. In turn, we believe that could also translate to EPS for XRAY next year that at least rebounds back towards 2019 levels, suggesting shares of XRAY currently trade a bit under 23x our 2021 EPS projection of $2.30. This is in line to a slight discount to broader medtech peers that we estimate are currently trading at 23x current Street EPS assumptions for 2021, which in turn we believe leaves room for XRAY shares to move into the upper-$50s over the coming year.
RISKS & CAVEATS
Risks to achieving our price target objective include: (1.) highly competitive industry, (2.) longer-term potential changes in relationships with dental dealers, as 50% of company-wide revenue is tied to products sold through dental distributors, (3.) financial and integration risk associated with potential future M&A activity, (4.) general macroeconomic risk, especially in the near term as COVID-19 issues raise global macroeconomic questions, and (5.) risk that the coronavirus headwinds that are expected to impact XRAY significantly in 2020 may not resolve as quickly as we currently expect heading into 2021.
COMPANY DESCRIPTION
Dentsply and Sirona completed their merger in February 2016 and brought together the leading manufacturer in consumables (XRAY; ~13% share of ~$19B market) and equipment (Sirona; ~25%share of ~$5.5B market), with the combined company now participating in nearly every major consumables and equipment category in dentistry and typically enjoying the No. 1 or No. 2 worldwide market share position in the major product categories in which it competes.
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Approved on 04 January 2021 08:39EST/ Published on 04 January 2021 08:44 EST.
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