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Republished. Original Source: Baird Equity Research
January 4, 2021
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Following today's call reviewing XRAY's $1.04B acquisition of DTC clear aligner company Byte, we are raising our 2021/2022 EPS projections by $0.05/$0.10, respectively, and our price target to $62 (from $58). While management's lack of 4Q commentary today raises some uncertainties into year-end, we remain buyers of this stock and like this deal as we believe it could add ~150bp to company-wide organic revenue growth near term (100bp+ longer term) and carries limited channel risk (especially with orthodontists, as XRAY has few relationships in this channel anymore).
- XRAY announced 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.
- Our math suggests XRAY paid just over 6x EV/2021 revenue for Byte, or just over 5x after taking into account $160M in NPV of cash tax-related benefits expected with this deal. This 5-6x valuation range is in line with the 5.25x EV/2021 revenue multiple at which we estimate Byte's closest peer in SDC currently trades (SDC not covered at Baird) and makes reasonable sense to us as Byte is at least the third player into the at-home/DTC clear aligner market (after SDC and Candid), so isn't as established as the other players, but also has been generating solid feedback from users (including fewer BBB complaints and a higher overall BBB rating than SDC).
- Overall, we like this deal for XRAY as we believe it could add 150bp to the company's organic revenue growth profile over the next year or two and upward of 100bp+ longer term (see our math over following pages).
- We also see limited doctor/channel risk from this deal as XRAY has limited exposure to the orthodontist channel following last year's exit of the analog brackets and wires business. While we can't completely rule out some friction with this deal in the GP channel for XRAY, we believe management should be able to manage such concerns as Byte could become a good referral source for GP SureSmile users (especially Class II/III cases that might first present to Byte but that would ultimately be better served with SureSmile).
- From a financial perspective, we're updating our model today to include an expected $165M and $238M in 2021/2022 Byte revenue. We're also flowing this revenue through at OM% of just over 10% for 2021/15% for 2022, which (after adjusting for lost interest income from the cash paid for this deal) takes our 2021/2022 EPS projections to $2.35 (+52% y/y) and $2.71 (+16% y/y), respectively.
- Off these higher presumed growth rates and EPS levels, we now believe shares of XRAY warrant a multiple more in line with broader medtech peers (23x NTM EPS), which takes our price target to $62 vs. $58 previously.
We are updating our model following XRAY's acquisition of Byte. Specifically, we're assuming $165M in incremental revenue and ~$18M in incremental EBIT this year, as well as a $227M revenue and $35M EBIT contribution from Byte in 2022. With this deal, our 2022 company-wide organic growth projection moves 140bp higher to +5.2% vs. +3.8% previously, and we believe Byte could continue to add 100-150bp to XRAY's 3-4% long-term revenue growth profile over the next couple/few years and upward of 100bp to growth longer term.
Overall, we like this deal for XRAY given the faster growth profile it provides the company, as well as revenue (and potentially over a longer time period cost) synergies we see possible with this deal. If XRAY can transform itself into a more consistent 4-5% revenue and low-double-digit EPS grower, we believe shares could warrant a modest premium to broader medtech, even after taking into account some of the structural uncertainties we continue to believe across the broader dental industry more generally. For now, however, we're using a multiple more in line with broader medtech (23x) to set our new price target on this stock of $62 (up vs. 22x and $58 previously) as we await evidence of this improved consistency over the next several quarters. But with shares currently trading at $53.32, we still see enough upside to our updated price target to reiterate our Outperform rating today.
Below we try to answer the most common questions we've been getting from investors today about this deal and XRAY's call announcing the transaction:
1. Valuation - did XRAY get a good deal? Management said on today's call it expects Byte revenue to reach a $200M run rate in 2021 and that combined revenue for Byte and SureSmile could exceed a$300M run rate by the end of 2021. From these comments, we are assuming 2021 revenue for Byte of ~$165M (1Q-21 revenue of $32M, building to $50M by 4Q).
If we also assume minimal net debt/cash acquired in this deal, then that would put deal valuation at roughly 6.3x EV/2021 revenue, or 5.3x EV/2021 revenue after taking into account the $160M NPV of tax benefits XRAY is also acquiring in this deal. We estimate that 5-6x valuation range is roughly in line with the 5.25x EV/2021 revenue multiple at which we estimate Byte's closest peer in SDC currently trades (we don't cover SDC, but are using consensus 2021 estimates and SDC's most recent 3Q earnings to estimate current valuation).
We believe valuation in line to just above SDC makes sense, as Byte is at least the third player into the at-home/DTC clear aligner market (after SDC and Candid), so isn't as established as the other players, but also has been generating very good feedback from users (including fewer BBB complaints and a higher overall BBB rating than SDC). Given the volatility associated with shares of SDC over the past 12-15 months since that company's IPO and a potentially uncertain IPO window at the start of 2021, we can also understand Byte being willing to take the certainty of cash in this transaction with XRAY, especially as Byte CEO certainly seemed to make a strong case today for the company wanting to partner with others in the space that believe strongly in innovation and in elevating the entire industry over time.
Net of all the above, we believe deal valuation in this case makes sense from both a Byte and XRAY perspective, at least with the somewhat limited information provided so far.
2. Byte growth potential. In today's press release, management pointed to a 20-25% expected growth rate for the clear aligner market. This view is slightly conservative relative to the 25-30% growth potential we've been assuming for the clear aligner market over the next few years, the mid-20% revenue growth we're modeling for ALGN over the next few years, and the 25-30%+ growth sell-side seems to be projecting for SDC over the next couple years.
That said, with ALGN and SDC the market leaders in their respective clear aligner channels (in-office for ALGN, DTC for SDC), we would expect both these companies to grow at or above market over at least the near-to-intermediate term, meaning we don't have a strong argument against management's 20-25% market growth commentary. We would, however, expect Byte to grow faster than 20-25% in the near term given its smaller base of revenue and as management pointed today to opportunities to potentially take Byte into international markets (beyond small contributions from Australia and Canada Byte has realized in recent quarters) over time.
As such, we believe it's fair to assume Byte revenue grows just over 35% y/y in 2022, which combined with low to mid-teens growth we've been assuming for XRAY's own SureSmile business over the next few years, would put clear aligner revenue growth overall for XRAY at just over 25% annually for each of the next couple/few years. At a $300M run rate by the end of 2021, that would mean clear aligner revenue could approach 7-8% of XRAY's global revenue in 2022 and add roughly 150bp to company-wide organic growth beginning next year.
3. Byte margin profile/deal accretion. As for Byte's margin profile and accretion from this deal, management is calling for this deal to be $0.05 accretive to non-GAAP EPS this year and suggested on today's call that Byte could be accretive to company-wide OM% targets by the end of next year. Focusing just on this $0.05 accretion point at first, we estimate that if lost interest income on the $1.04B in cash paid for this deal totals ~$5M and Byte's effective tax rate is similar to XRAY at the corporate-wide level, then Byte's OM% could approach 10% this year. While higher than the EBIT loss consensus is still calling for when it comes to SDC this year, we believe this 10% OM% makes some sense as Byte is likely spending less than SDC from a DTC/marketing perspective as the third+ player into the DTC clear aligner market overall.
To then assume Byte could be margin accretive to XRAY by the end of 2022, we'd have to believe Byte's OM% would have to at least approach 20% over the entirety of next year and finish at or above 22%by 4Q-22. That admittedly feels like a stretch to us as ALGN's OM% at nearly 10x the current revenue base of Byte is currently in the mid-20% range and as consensus is calling for a low single digit EBIT margin for SDC next year. Our math also suggests that at 35% revenue growth and assuming a steady GM% for Byte next year, the company's absolute level of SG&A spend would have to fall by some 30%vs. 2021 levels to get a near doubling of OM% from this year to next.
Again, with that feeling like a stretch to us at this point, we are instead assuming Byte's OM% improves to 15% next year from 10% this year. Even this, however, adds $0.10 to our pre-deal 2022 EPS projection of $2.61 for XRAY, meaning we are raising our 2022 EPS projection today to $2.71.
4. Channel risk with Byte. We also had investors asking today about risk that XRAY's acquisition of Byte might alienate the company's doctor base, as Byte is essentially attempting to sell clear aligners directly to the patient with no direct involvement from a dentist (although each Byte case is approved by a Byte dentist/orthodontist). While that's certainly a risk with any type of DTC medical device, we remind investors that by discontinuing its analog brackets and wires business in 2020, XRAY has significantly reduced its exposure to the orthodontist market, and instead has planned to rely almost exclusively on the GP channel for its SureSmile/ortho sales going forward. As such, we don't see any real risk to XRAY from this deal when it comes to the orthodontist side of the ortho market.
On the GP side of ortho, we believe XRAY should be able to manage any real risk of channel issues given our belief Byte could serve as a referral source to SureSmile users over time. Specifically, we remind investors that Byte is currently marketed for fairly modest Class I correction needs, whereas XRAY's SureSmile system can also address a portion of Class II and III ortho needs. As such, we could imagine scenarios in which potential Byte customers find out through the impression they send to the company that while they aren't a good candidate for Byte, they could be a better candidate for SureSmile, with Byte then recommending a SureSmile provider (and likely offering some sort of promotional price for that SureSmile case).
In this type of scenario, we believe SureSmile docs could actually benefit from Byte-related referrals, and if many of these patients would not have presented to the dental office to begin with, those patients would likely then represent additive cases for the GP provider. We believe such referral opportunities could help offset any concerns SureSmile GP users might have about XRAY owning Byte over time.
5. 4Q commentary lacking. Management did not make any comments on today's call about 4Q and was not doing callbacks following today's deal-related call, ostensibly given the company is in its 4Q quiet period. That admittedly raises questions about 4Q, especially in the context of the exceedingly tough 27.5% U.S. growth comp the company comes up against this quarter and the continued COVID uncertainties all of dental continued to face into year-end. From that perspective, we don't disagree with investors who asked today if management's lack of commentary on the quarter was a concern. That's especially true as we were already a bit concerned about XRAY's 4Q results heading into today's call, as evidenced by the fact that XRAY was the only dental name whose 4Q numbers we didn't raise as part of our 2021 Dental Outlook note published earlier today (HERE).
That said, we also assume management knew going into today's call where the Street was sitting for 2021 EPS ($2.33) and would not have called out $0.05 in expected 2021 accretion from Byte if it wasn't comfortable with Street's baseline earnings assumption for the New Year. As such, while we weren't feeling 100% comfortable about XRAY's 4Q results even before today's call, this $0.05 accretion commentary for 2021 makes us feel better about the upcoming year and gives us the confidence to add this $0.05 accretion to our pre-call 2021 EPS projection of $2.30, moving our 2021 EPS projection to$2.35 today.
Estimate Changes/Valuation
We highlight below the changes we are making to our 2021 and 2022 projections for XRAY following today's news regarding the company's year-end acquisition of Byte. Our price target moves to $62 as we now apply a 23x multiple, up vs. 22x previously, to our new 2022 EPS projection of $2.71. While we previously believed this stock warranted a modest discount to broader medtech, we are comfortable that after taking into account a point or two of likely revenue growth accretion from Byte, shares of XRAY can instead trade more in line with the 23x median NTM P/E multiple at which XRAY's broader medtech peers currently trade.
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.
1. Primescan/Primemill demand expected to recover early this year. Before the onset of the global COVID-19 pandemic last 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. With the dental market starting to recover by mid-2020 and with further improvements expected this year, we expect Primescan upgrade demand to rebound and management to run its first-ever Primemill upgrade program in the U.S. over coming quarters. We also expect management to expand these upgrade programs into Europe and Asia/Pac by later this year (our checks suggest XRAY's has a fairly sizable installed CEREC base in Germany, Japan, and Australia), and 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.
2. 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.
3. Byte deal adds to long-term growth profile. XRAY announced today is 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, with our math suggesting this deal could add nearly 150bp to the company's organic revenue growth profile over the next couple years and upward of 100bp annually longer term. With this faster potential growth for XRAY, we believe shares should warrant a multiple more in line with broader medtech peers over time, a point or two higher than the multiple at which this stock has traded in recent years.
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, a path back toward 2019 margins in 2021 remains. Add in the $0.05 in accretion we now expect this year from Byte, and we are comfortable with our $2.35 (+52% y/y) updated EPS projection for this year. And when also applying a 23x multiple to our updated 2022 EPS projection of $2.71 to better reflect the median 23x multiple at which XRAY's broader medtech peers currently trade, we now see a path for this stock into the low $60s this year, nicely above today's current $53.32 stock price and enough upside to leave our Outperform rating unchanged.
RISK & 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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Republished. Original Source: Baird Equity Research
January 4, 2021
Following today's call reviewing XRAY's $1.04B acquisition of DTC clear aligner company Byte, we are raising our 2021/2022 EPS projections by $0.05/$0.10, respectively, and our price target to $62 (from $58). While management's lack of 4Q commentary today raises some uncertainties into year-end, we remain buyers of this stock and like this deal as we believe it could add ~150bp to company-wide organic revenue growth near term (100bp+ longer term) and carries limited channel risk (especially with orthodontists, as XRAY has few relationships in this channel anymore).
- XRAY announced 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.
- Our math suggests XRAY paid just over 6x EV/2021 revenue for Byte, or just over 5x after taking into account $160M in NPV of cash tax-related benefits expected with this deal. This 5-6x valuation range is in line with the 5.25x EV/2021 revenue multiple at which we estimate Byte's closest peer in SDC currently trades (SDC not covered at Baird) and makes reasonable sense to us as Byte is at least the third player into the at-home/DTC clear aligner market (after SDC and Candid), so isn't as established as the other players, but also has been generating solid feedback from users (including fewer BBB complaints and a higher overall BBB rating than SDC).
- Overall, we like this deal for XRAY as we believe it could add 150bp to the company's organic revenue growth profile over the next year or two and upward of 100bp+ longer term (see our math over following pages).
- We also see limited doctor/channel risk from this deal as XRAY has limited exposure to the orthodontist channel following last year's exit of the analog brackets and wires business. While we can't completely rule out some friction with this deal in the GP channel for XRAY, we believe management should be able to manage such concerns as Byte could become a good referral source for GP SureSmile users (especially Class II/III cases that might first present to Byte but that would ultimately be better served with SureSmile).
- From a financial perspective, we're updating our model today to include an expected $165M and $238M in 2021/2022 Byte revenue. We're also flowing this revenue through at OM% of just over 10% for 2021/15% for 2022, which (after adjusting for lost interest income from the cash paid for this deal) takes our 2021/2022 EPS projections to $2.35 (+52% y/y) and $2.71 (+16% y/y), respectively.
- Off these higher presumed growth rates and EPS levels, we now believe shares of XRAY warrant a multiple more in line with broader medtech peers (23x NTM EPS), which takes our price target to $62 vs. $58 previously.
We are updating our model following XRAY's acquisition of Byte. Specifically, we're assuming $165M in incremental revenue and ~$18M in incremental EBIT this year, as well as a $227M revenue and $35M EBIT contribution from Byte in 2022. With this deal, our 2022 company-wide organic growth projection moves 140bp higher to +5.2% vs. +3.8% previously, and we believe Byte could continue to add 100-150bp to XRAY's 3-4% long-term revenue growth profile over the next couple/few years and upward of 100bp to growth longer term.
Overall, we like this deal for XRAY given the faster growth profile it provides the company, as well as revenue (and potentially over a longer time period cost) synergies we see possible with this deal. If XRAY can transform itself into a more consistent 4-5% revenue and low-double-digit EPS grower, we believe shares could warrant a modest premium to broader medtech, even after taking into account some of the structural uncertainties we continue to believe across the broader dental industry more generally. For now, however, we're using a multiple more in line with broader medtech (23x) to set our new price target on this stock of $62 (up vs. 22x and $58 previously) as we await evidence of this improved consistency over the next several quarters. But with shares currently trading at $53.32, we still see enough upside to our updated price target to reiterate our Outperform rating today.
Below we try to answer the most common questions we've been getting from investors today about this deal and XRAY's call announcing the transaction:
1. Valuation - did XRAY get a good deal? Management said on today's call it expects Byte revenue to reach a $200M run rate in 2021 and that combined revenue for Byte and SureSmile could exceed a$300M run rate by the end of 2021. From these comments, we are assuming 2021 revenue for Byte of ~$165M (1Q-21 revenue of $32M, building to $50M by 4Q).
If we also assume minimal net debt/cash acquired in this deal, then that would put deal valuation at roughly 6.3x EV/2021 revenue, or 5.3x EV/2021 revenue after taking into account the $160M NPV of tax benefits XRAY is also acquiring in this deal. We estimate that 5-6x valuation range is roughly in line with the 5.25x EV/2021 revenue multiple at which we estimate Byte's closest peer in SDC currently trades (we don't cover SDC, but are using consensus 2021 estimates and SDC's most recent 3Q earnings to estimate current valuation).
We believe valuation in line to just above SDC makes sense, as Byte is at least the third player into the at-home/DTC clear aligner market (after SDC and Candid), so isn't as established as the other players, but also has been generating very good feedback from users (including fewer BBB complaints and a higher overall BBB rating than SDC). Given the volatility associated with shares of SDC over the past 12-15 months since that company's IPO and a potentially uncertain IPO window at the start of 2021, we can also understand Byte being willing to take the certainty of cash in this transaction with XRAY, especially as Byte CEO certainly seemed to make a strong case today for the company wanting to partner with others in the space that believe strongly in innovation and in elevating the entire industry over time.
Net of all the above, we believe deal valuation in this case makes sense from both a Byte and XRAY perspective, at least with the somewhat limited information provided so far.
2. Byte growth potential. In today's press release, management pointed to a 20-25% expected growth rate for the clear aligner market. This view is slightly conservative relative to the 25-30% growth potential we've been assuming for the clear aligner market over the next few years, the mid-20% revenue growth we're modeling for ALGN over the next few years, and the 25-30%+ growth sell-side seems to be projecting for SDC over the next couple years.
That said, with ALGN and SDC the market leaders in their respective clear aligner channels (in-office for ALGN, DTC for SDC), we would expect both these companies to grow at or above market over at least the near-to-intermediate term, meaning we don't have a strong argument against management's 20-25% market growth commentary. We would, however, expect Byte to grow faster than 20-25% in the near term given its smaller base of revenue and as management pointed today to opportunities to potentially take Byte into international markets (beyond small contributions from Australia and Canada Byte has realized in recent quarters) over time.
As such, we believe it's fair to assume Byte revenue grows just over 35% y/y in 2022, which combined with low to mid-teens growth we've been assuming for XRAY's own SureSmile business over the next few years, would put clear aligner revenue growth overall for XRAY at just over 25% annually for each of the next couple/few years. At a $300M run rate by the end of 2021, that would mean clear aligner revenue could approach 7-8% of XRAY's global revenue in 2022 and add roughly 150bp to company-wide organic growth beginning next year.
3. Byte margin profile/deal accretion. As for Byte's margin profile and accretion from this deal, management is calling for this deal to be $0.05 accretive to non-GAAP EPS this year and suggested on today's call that Byte could be accretive to company-wide OM% targets by the end of next year. Focusing just on this $0.05 accretion point at first, we estimate that if lost interest income on the $1.04B in cash paid for this deal totals ~$5M and Byte's effective tax rate is similar to XRAY at the corporate-wide level, then Byte's OM% could approach 10% this year. While higher than the EBIT loss consensus is still calling for when it comes to SDC this year, we believe this 10% OM% makes some sense as Byte is likely spending less than SDC from a DTC/marketing perspective as the third+ player into the DTC clear aligner market overall.
To then assume Byte could be margin accretive to XRAY by the end of 2022, we'd have to believe Byte's OM% would have to at least approach 20% over the entirety of next year and finish at or above 22%by 4Q-22. That admittedly feels like a stretch to us as ALGN's OM% at nearly 10x the current revenue base of Byte is currently in the mid-20% range and as consensus is calling for a low single digit EBIT margin for SDC next year. Our math also suggests that at 35% revenue growth and assuming a steady GM% for Byte next year, the company's absolute level of SG&A spend would have to fall by some 30%vs. 2021 levels to get a near doubling of OM% from this year to next.
Again, with that feeling like a stretch to us at this point, we are instead assuming Byte's OM% improves to 15% next year from 10% this year. Even this, however, adds $0.10 to our pre-deal 2022 EPS projection of $2.61 for XRAY, meaning we are raising our 2022 EPS projection today to $2.71.
4. Channel risk with Byte. We also had investors asking today about risk that XRAY's acquisition of Byte might alienate the company's doctor base, as Byte is essentially attempting to sell clear aligners directly to the patient with no direct involvement from a dentist (although each Byte case is approved by a Byte dentist/orthodontist). While that's certainly a risk with any type of DTC medical device, we remind investors that by discontinuing its analog brackets and wires business in 2020, XRAY has significantly reduced its exposure to the orthodontist market, and instead has planned to rely almost exclusively on the GP channel for its SureSmile/ortho sales going forward. As such, we don't see any real risk to XRAY from this deal when it comes to the orthodontist side of the ortho market.
On the GP side of ortho, we believe XRAY should be able to manage any real risk of channel issues given our belief Byte could serve as a referral source to SureSmile users over time. Specifically, we remind investors that Byte is currently marketed for fairly modest Class I correction needs, whereas XRAY's SureSmile system can also address a portion of Class II and III ortho needs. As such, we could imagine scenarios in which potential Byte customers find out through the impression they send to the company that while they aren't a good candidate for Byte, they could be a better candidate for SureSmile, with Byte then recommending a SureSmile provider (and likely offering some sort of promotional price for that SureSmile case).
In this type of scenario, we believe SureSmile docs could actually benefit from Byte-related referrals, and if many of these patients would not have presented to the dental office to begin with, those patients would likely then represent additive cases for the GP provider. We believe such referral opportunities could help offset any concerns SureSmile GP users might have about XRAY owning Byte over time.
5. 4Q commentary lacking. Management did not make any comments on today's call about 4Q and was not doing callbacks following today's deal-related call, ostensibly given the company is in its 4Q quiet period. That admittedly raises questions about 4Q, especially in the context of the exceedingly tough 27.5% U.S. growth comp the company comes up against this quarter and the continued COVID uncertainties all of dental continued to face into year-end. From that perspective, we don't disagree with investors who asked today if management's lack of commentary on the quarter was a concern. That's especially true as we were already a bit concerned about XRAY's 4Q results heading into today's call, as evidenced by the fact that XRAY was the only dental name whose 4Q numbers we didn't raise as part of our 2021 Dental Outlook note published earlier today (HERE).
That said, we also assume management knew going into today's call where the Street was sitting for 2021 EPS ($2.33) and would not have called out $0.05 in expected 2021 accretion from Byte if it wasn't comfortable with Street's baseline earnings assumption for the New Year. As such, while we weren't feeling 100% comfortable about XRAY's 4Q results even before today's call, this $0.05 accretion commentary for 2021 makes us feel better about the upcoming year and gives us the confidence to add this $0.05 accretion to our pre-call 2021 EPS projection of $2.30, moving our 2021 EPS projection to$2.35 today.
Estimate Changes/Valuation
We highlight below the changes we are making to our 2021 and 2022 projections for XRAY following today's news regarding the company's year-end acquisition of Byte. Our price target moves to $62 as we now apply a 23x multiple, up vs. 22x previously, to our new 2022 EPS projection of $2.71. While we previously believed this stock warranted a modest discount to broader medtech, we are comfortable that after taking into account a point or two of likely revenue growth accretion from Byte, shares of XRAY can instead trade more in line with the 23x median NTM P/E multiple at which XRAY's broader medtech peers currently trade.
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.
1. Primescan/Primemill demand expected to recover early this year. Before the onset of the global COVID-19 pandemic last 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. With the dental market starting to recover by mid-2020 and with further improvements expected this year, we expect Primescan upgrade demand to rebound and management to run its first-ever Primemill upgrade program in the U.S. over coming quarters. We also expect management to expand these upgrade programs into Europe and Asia/Pac by later this year (our checks suggest XRAY's has a fairly sizable installed CEREC base in Germany, Japan, and Australia), and 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.
2. 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.
3. Byte deal adds to long-term growth profile. XRAY announced today is 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, with our math suggesting this deal could add nearly 150bp to the company's organic revenue growth profile over the next couple years and upward of 100bp annually longer term. With this faster potential growth for XRAY, we believe shares should warrant a multiple more in line with broader medtech peers over time, a point or two higher than the multiple at which this stock has traded in recent years.
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, a path back toward 2019 margins in 2021 remains. Add in the $0.05 in accretion we now expect this year from Byte, and we are comfortable with our $2.35 (+52% y/y) updated EPS projection for this year. And when also applying a 23x multiple to our updated 2022 EPS projection of $2.71 to better reflect the median 23x multiple at which XRAY's broader medtech peers currently trade, we now see a path for this stock into the low $60s this year, nicely above today's current $53.32 stock price and enough upside to leave our Outperform rating unchanged.
RISK & 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.
Appendix - Important Disclosures and Analyst Certification
Approved on 04 January 2021 08:39EST/ Published on 04 January 2021 08:44 EST.
1 Robert W. Baird & Co. Incorporated makes a market in the securities of XRAY.
Appendix – Important Disclosures and Analyst Certification
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