Integra LifeSciences: M&A Masks Operational Struggles (NASDAQ:IART)

At the start of 2022, I believed it was time for shares of Integra LifeSciences (NASDAQ:IART) to show signs of life again. Very demanding valuations were coming down to more normal levels, or levels which I regarded to be more fair.

On further dips, or following a convincing 2022 outlook, I would consider a position, as a $60 stock at the time did not induce me to get involved based on the status quo. Forwarding nearly two years in time, shares are down a third amidst continued disappointments, as high leverage makes me a bit cautious.

While earnings multiples have come down a great deal, I fear the combination of lack of execution and high leverage, as I require a greater dip before getting involved here.

On Integra

Integra is a leader in neurosurgery, especially plastics and reconstructive surgery, including regenerative and wound care markets. The company generates about $1.5 billion in annual sales, two-thirds of which were generated from the Codman Specialty Surgical unit, with Orthopedics & Tissue Technologies making up for the remainder of sales.

Pre-pandemic, a $57 stock supported a $5 billion equity valuation, as the valuation rose to six billion if one factored in the existing net debt. With adjusted earnings of $237 million reported on a $1.5 billion in sales, a $2.74 per share earnings number worked down to a reasonable 20 times earnings multiple.

The business suffered from the pandemic as a result of the focus on consumables, which obviously fell alongside fewer procedures being performed. During 2020, the business sold its Extremity Orthopedics business in a $240 million deal, only to buy ACell in a $300 million deal later that year.

After a tougher 2020 (for obvious reasons) the 2021 guidance was comforting with sales seen up 12-13% to $1.5 billion with adjusted earnings seen close to $3 per share (to actually top that number), as shares have been trading in at $65-$75 range during 2021 and early 2022. An earnings multiple in the mid-twenties, a $1.2 billion net debt load, and quite large adjustments made to the adjusted earnings, all made me a bit cautious to get involved.

All Downhill

A $65 stock early in 2022 has gradually fallen to current levels of $44 per share, as shares have been trading in a wide $35-$70 range over that period of time.

The demise started in 2022 as the full-year guidance of $1.58-$1.60 billion looked a bit lackluster versus a $1.54 billion revenue number in 2021. Adjusted earnings per share were seen at a midpoint of $3.31 per share, up modestly from earnings of $3.18 per share in 2021, while net debt was reported at around a billion.

Towards the end of 2022, Integra announced the purchase of Surgical Innovation Associates, the developer, marketer, and seller of DuraSorb, a resorbable synthetic matrix for plastic and reconstructive surgery. The deal is valued at a $50 million upfront consideration and will contribute some $5 million in annual sales, with revenues and regulatory milestones having the potential to add another $90 million to the purchase price over time.

Early this year, it became evident that 2022 sales of $1.56 billion came in a touch light versus the guidance, although adjusted earnings of $3.36 per share topped the guidance by a few pennies.

The 2023 guidance was again not too impressive, with sales seen between $1.60 and $1.62 billion and adjusted earnings seen at a midpoint of $3.47 per share. The company suffered recalls in its Boston facility in the second quarter, which prompted the company into cutting the full-year guidance to $1.54-$1.55 billion. Earnings are now seen at a midpoint of $3.14 per share, with the midpoint of the earnings outlook cut further to $3.12 per share following the release of the third quarter results.

Net debt has ticked up to $1.2 billion, translating into a 3.0 times leverage ratio, as debt ticked up due to accelerated share buybacks.

A Substantial Deal

Towards the end of 2023, Integra announced its next deal, this time acquiring Acclarent, which was part of Ethicon, which in turn is part of Johnson & Johnson (JNJ).

Integra will pay $275 million in cash for the innovator and market leader in ENT (ear, nose, throat) procedures, supplying products and technologies. The deal will add $110 million in annual sales, suggesting that a 2.5 times sales multiple has been paid, with gross margins in line with those reported by Integra.

In comparison, the 80 million shares of Integra are valued at $3.6 billion at $45 per share, or $4.8 billion if we factor in net debt. This values the core operations at just over 3 times sales, suggesting the deal comes on the cheaper side.

Pro forma net debt will jump to $1.5 billion, which will push up leverage ratios to 3.5 times EBITDA, assuming that EBITDA margins of the acquired activities are similar to those of Integra. The deal is set to be neutral to 2024 earnings, with earnings per share accretion seen in 2025.

And Now?

A $70 stock post-pandemic has now come down to 2016 levels in the mid-forties, as execution (or better said, lack thereof) has been the main culprit behind the lagging share price. Amidst lackluster organic growth and adjusted earnings, leverage keeps increasing due to M&A efforts and share buybacks.

The stagnation in the share price meant that earnings multiples have compressed to 15 times adjusted earnings. It is the latest deal and a reopening of the Boston facility which can drive growth in 2024, but this is somewhat uncertain and quite frankly badly needed, as leverage has ticked up quite a bit to $1.5 billion on a pro forma basis.

Right now the issue is that lack of growth, despite operating in long-term growth areas. It is missteps in execution, or perhaps lack of focus, which is hurting Integra here.

This makes that a discount is likely warranted as a current $45 share price feels a bit cheap compared to the long-term outlook, although shares have risen some ten dollars from recent lows already.

Amidst all of this, I am taking a more constructive stance, looking to buy a potential new dip in the thirties, but welcoming a bit of progress on the leverage front.