NARI - A Win-Win Scenario From The AngioDynamics And Merit Medical Deal

2023-06-14 16:42:19 ET

Summary

• AngioDynamics and Merit Medical came together for a $100M transaction that will transfer ANGO's hemodialysis and BioSentry products to Merit.
• Merit is gaining more scale and adding specialty products in an already-important dialysis business, and this should create greater leverage when WRAPSODY hits the market.
• AngioDynamics continues its drive toward faster-growing technology-driven products, and the added cash could support further growth-boosting M&A.
• AngioDynamics has too many execution issues offsetting an otherwise cheap-looking valuation, while Merit Medical's strong execution offsets a valuation that is starting to look a little rich.

Investors often tend toward zero-sum thinking when it comes to M&A transactions, assuming that there has to be a winner and a loser in every deal. The truth is more complicated, though, and it's not all that rare for deals to be "win-win" opportunities for both parties, with a deal serving two different needs. I believe this to be the case with the recent transaction between AngioDynamics ( ANGO ) and Merit Medical ( MMSI ), as the former looks to continue its transition toward faster-growing technology-driven opportunities and the latter looks to drive better scale in a business segment that could become even more significant upon the future commercialization of its WRAPSODY platform.

These two companies are at very different places in terms of their valuation and performance. Merit has meaningfully resolved prior concerns around innovation-driven growth, margins, and M&A and has seen meaningful rerating since late 2019. AngioDynamics, meanwhile, has struggled to resolve longstanding execution issues and rebuilding investor confidence around its new technology-driven growth plans, and the shares have lagged significantly over the same time period.

While it's easier to make a conventional valuation argument in favor of AngioDyanmics shares, value without the capacity to execute isn't much value at all, and I believe the company has a lot to prove before a meaningful sustained rerating. By the same token, while I'm tempted toward a "let your winners run" stance with Merit Medical, the valuation isn't as accommodating now as it was at the time of my last update .

A Transaction In Hemodialysis - More Scale for Merit And More Cash (And Maybe More Growth) For AngioDynamics

These two med-techs came together roughly a week ago on a transaction that I believe makes at least some sense for both parties. AngioDynamics has agreed to sell its hemodialysis product portfolio as well as the BioSentry product line to Merit Medical in exchange for $100M in cash.

AngioDynamics has disclosed that this collection of assets generated around $32M in revenue in FY'23, and while the company does not consistently provide explicit disclosure of product segment revenues, I believe these assets have grown at an annualized rate of around 4% or so over the last five years (notwithstanding more significant growth from Dialysis in recent quarters). Given the growth, what I can extrapolate about profitability from prior disclosures and management's updated guidance, I believe the 3x multiple is reasonable and consistent with how the market frequently values profitable slower-growing med-tech businesses.

For AngioDynamics, this deal continues a transformation toward more technology-driven products. The company has been prioritizing faster-growing opportunities like AlphaVac, Auryon, and NanoKnife (collectively described as Medical Technology) and looking at slower-growing Medical Devices (including Dialysis and BioSentry) more as a source of margin and cash flow to fund the R&D and marketing efforts needed to affect this shift. Although the deal is dilutive, it should improve the revenue growth rate and does give management more cash with which to add other growth opportunities via M&A.

This deal is more about scale for Merit Medical. Merit has a meaningful existing dialysis business and the addition of the AngioDynamics will add some invaluable scale, further rounding out the product portfolio and adding some specialty products. With Merit still looking forward to the eventual launch of its WRAPSODY product - its first PMA-based product and a potentially significant breakthrough in reducing stenosis/occlusion in access grafts - this added scale should help Merit maximize the leverage it can gain through the eventual launch of WRAPSODY. It's also a reasonably-priced acquisition to expand an already-profitable business that could also benefit from Merit's greater scale outside the U.S.

AngioDynamics - A Lot Of Work Is Left To Do To Improve Operations And Reputation

Since my last update on AngioDynamics , wherein I mentioned that management really needed to start improving on its execution to rebuild sentiment, things have not improved. The last quarter's results weren't disastrous, but revenue was disappointing, driven by weakness in the AngioVac business (an important part of the growth plan) that management finally acknowledged was due at least in part to execution issues on their part.

I have questioned in the past whether weakness at AngioVac had less to do with hospital staffing issues (which management cited as the main driver) and potentially more to do with share gains from Inari ( NARI ), Penumbra ( PEN ), and others. While it is almost certainly both, it does seem as if marketing limitations and competitive share loss are emerging as significant drivers, and this further undermines an already-shaky growth thesis predicated on execution, and it also leads me to wonder how much of the company's prior decision to pursue the deep vein thrombosis market through its Auryon laser atherectomy platform versus its AlphaVac technology is being driven by its competitive positioning in aspiration-based technology.

It's not all bad news. Auryon is growing well, and while I do think intravascular lithotripsy (as pursued by Shockwave ( SWAV ), among others) is a better overall approach, I do think there is still a large addressable opportunity for AngioDynamics. Likewise, NanoKnife is still a worthwhile platform to follow, with important clinical trials underway that, if successful, could drive meaningful revenue growth in a few years.

For Merit, "More Of The Same" Is Fine

In contrast to AngioDynamics, Merit continues to deliver on a thesis of improved execution (internal growth, margins, et al.) and discipline (particularly with respect to M&A) that has already driven a meaningful re-rating. Revenue rose 10% in the last quarter, beating expectations by about 6%, with the company seeing good results everywhere outside of its Custom Solutions business (where higher comps tied to the pandemic are still a factor).

I like Merit's acquisition of AngioDynamics' hemodialysis and BioSentry products, as well as its nearly $33M acquisition of the Surfacer Inside-Out Access Catheter from Bluegrass Vascular Technologies , and I believe adding scale and specialty products in hemodialysis makes sense in the context of a future launch of WRAPSODY and dialysis products becoming a larger overall part of the business. I also like the fact that management has shown a lot of discipline on M&A - declining to chase deals during prior periods of frothy valuations.

There are still some important unknowns that will impact Merit's future. While the CEO has extended his employment contract to run through the end of 2025, the company knows it must plan for a time when Fred Lampropoulos is no longer the CEO and succession planning is underway. There are also still unknowns as to how aggressively the company will pursue future product development gated by FDA 510(k) and PMA approvals.

Management has been embracing more internal product innovation and openly acknowledges the greater revenue, growth, and margin potential of these generally more innovative devices (like the WRAPSODY), but these devices are also more expensive to develop and carry more risk. Threading that needle of boosting the core long-term growth and margin potential without overspending on R&D is not always easy, but so far management has been executing well.

The Outlook

I've adjusted my models for both companies to account for this recent deal, as well as recent performance trends at the companies themselves. That leads me to modestly higher fair value estimates for Merit Medical on cash flow and EV/revenue (including a low-to-mid-$80's target based on a 4x forward multiple), and a lower fair value estimate for AngioDynamics.

In the latter case, I've cut my forward revenue estimate from 2.5x to 1.75x to account for ongoing execution and margin issues, as the Street is seldom munificent towards small-cap med-techs with weak revenue growth, poor margins, and ongoing execution problems. With that, I struggle to argue for a fair value much above $16, though I do acknowledge potential fair values in the $20's if and when management can resolve these challenges.

The Bottom Line

While AngioDynamics could offer a meaningful upside from here, I believe that upside is gated by demonstrated improvements in execution from management, and I'm not willing to extend much benefit of the doubt there. The shares could well jump if the next quarter or two are better than I expect, but betting on sudden turnarounds from companies with long-standing execution issues has generally not worked out so well.

Turning to Merit Medical, I don't see much undervaluation now, and that is an issue. That said, I think the arrow is pointing "up" here, and it can be frustrating to sell out of ongoing turnaround/self-improvement stories too soon. I'd certainly consider some stops or a partial sell-down of a position, but I don't think Merit has maximized its potential just yet.

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