Globus Medical Stock: Back Pains (NYSE:GMED)

It has been six years since I last covered Globus Medical (NYSE:GMED), believing it was time to buy the solid growth play on substantial dips. I believed that the company has been a stead grower, which faced some headwinds at the time, as I concluded to become a buyer on dips.

A Recap

Globus Medical is a producer of musculoskeletal implants used for patients who suffer from spine disorders. The company went public in 2012, with shares priced at $12 per share at the time. Given the growth, profitability and strong balance sheet, the situation from the outset looked quite compelling.

At the time, the company had launched 150 products since its founding in 2003, addressing a broad range of product categories for patients suffering from spine disorders. The company operated an Innovative Fusion segment, focusing on surgical procedures. Disruptive Technologies focused on novel surgical procedures and intervention at an earlier point in care.

The company was clearly outgrowing the general market, taking market share from much larger players like Medtronic (MDT) Synthes (part of Johnson & Johnson (JNJ)), as well as NuVasive (NUVA) and Stryker (SYK), among others.

Globus posted revenues of $386 million in 2012 as sales had doubled since 2008. The company posted fat operating profits of around $115 million, as margins of 30% worked down to an earnings power of around $0.80 per share. Ending 2012 with $200 million in net cash, or about $2 per share, valuations were very friendly at the IPO price of $12.

Between 2012 and 2017, shares had doubled from $12 to $25 per share. Following solid growth since the public offering, the company had grown sales to roughly $550 million, as margins were stable around 30% and net cash balances had risen to $3.50 per share, with growth being in part the result of bolt-on dealmaking.

With shares starting 2017 at $27 per share, a $2.3 billion operating asset valuation came down to just 3.7 times sales as the valuation multiple increased to 20 times earnings, adjusted for net cash, still a reasonable multiple given the growth reported.

Doing Well

Unfortunately, no dips arrived since my constructive stance at $27 early in 2017. What happened has been a very gradual increase in the share price to a high around $85 in 2021. After seeing a pullback to the mid-fifties last summer, shares had rallied to the $80 mark in early February again.

In February of last year, Globus posted its 2021 results, with revenues up 21% to $958 million. The company posted a GAAP profit of $149 million, or $1.44 per share with adjusted earnings posted at $2.04 per share, as these adjustments look quite fair. Operating with a net cash position of a billion, this was equal to about $10 per share based on 104 million shares outstanding on a diluted basis.

With shares trading around the $70 mark, the unleveraged assets traded at $60, about 30 times earnings as the share price performance has outpaced the actual growth in earnings per share. The company guided for rather flattish 2022 results, even as sales were expected to grow to $1.02 billion, adjusted earnings per share were seen flat at $2.10 per share.

The company announced an expansion of the share buyback program in March. The first two quarters of the year were largely in line with expectations, as the company reiterated its full year guidance on both fronts. Amidst higher taxes and the strong dollar, the company cut the full year earnings guidance to $2.03 per share, down seven cents, while maintaining the full year sales outlook at $1.02 billion.

Share buybacks made that the share count was reduced slightly to 101 million shares, reducing the net cash position to $905 million. With shares trading at $80 in February, the resulting $8.1 billion equity valuation comes down to a $7.2 billion enterprise valuation, equal to 7 times sales, and about 35 times earnings, more than full multiples.

A Deal Gone Bad

In the first half of February, shares of Globus Medical fell from $80 to $60, shedding about $2 billion in equity value in the process. The reason for this is simple, that is the announcement of an all-stock deal to acquire NuVasive. Investors in NuVasive stand to receive 0.75 shares of Globus Medical, resulting in an implied value of $57.72 per share, or $3.1 billion equity value. If the deal was to proceed, investors in NuVasive could end up owning 28% of the shares of the combination.

The deal is hugely significant as NuVasive announced preliminary 2022 sales growth numbers with revenues reported at $1.14 billion, with sales growth in line with Globus, while its revenue base is even higher. So, given this exchange ratio and $170 million in anticipated synergies in year three, the situation looks quite compelling, leaving one wondering why shares lost $2 billion in response to a $3.1 billion deal. One reason for caution is that NuVasive is only posting very modest GAAP profits, albeit that adjusted profits of around $100 million a year look reasonable, albeit less than half those reported by Globus.

Another reason is that analysts claimed that both companies have different cultures and that M&A in the sector has typically not played out, while the combination will focus on slower-growing categories. That said, added scale is needed as the deal is set to create a $2 billion business operating in the huge $50 billion addressable market.

With a pro forma share count of 140 million shares, the $60 valuation boils down to $8.4 billion, as a net cash position remains intact. This resulted in a $7.5 billion enterprise valuation, for a business with more than $2 billion in sales. At $60, net cash is likely down to about $6 per share based on the positioning of Globus, as the convertible loans from NuVasive make the pro forma share count hard to read into.

What Now?

The reality is that Globus looked a bit steep from the get-go, as the pullback seems like a huge overreaction. While I am naturally attracted to such overreactions, it is the high valuation from the get-go, the uncertain situation following the deal announcement, and the actual uncertainty on deal closing which prevents me from getting upbeat here. After all, shares of NuVasive are down about ten percent since the deal announcement.

Hence, we find ourselves in a very interesting situation. The core business is posting sales at around $2 per share, yet some dilution is likely seen. With shares trading at $60 and subtracting about $6 per share in net cash, valuations remain demanding at about 27 times earnings, or a bit more if dilution will be incurred.

That said, pre-tax synergies of $170 million could add about a dollar to earnings per share post-taxes, creating a roadmap for earnings of $3 per share, but the market is clearly discounting this, by the nature of the shares trading here.

Hence, shares remain an interesting name to watch, as I look forward to learning more about deal progression in the months to come.