INGN - Inogen: Gasping After Strategic Choices Drive Steep Sales And Margin Declines (Rating Downgrade)

2023-10-13 23:58:49 ET

Summary

• Inogen has struggled to recover from post-pandemic disruptions and successfully implement a mixed purchase and rental business model.
• The DTC business has been hit hard by salesforce departures, and management is once again looking to rebuild the sales ranks.
• Inogen's rental business is growing, but the company's decision to prioritize higher-value channels has led to significant share loss and price pressure in the B2B channel from lower-cost rivals.
• The recent acquisition of Physio-Assist offers an interesting potential market opportunity in at-home bronchiectasis care, but won't contribute meaningfully for a while.
• Inogen trades below adjusted net cash, highlighting just how little the Street thinks of the company's future prospects.

It’s not that often that you see a company trading at a negative enterprise value or below net cash per share, and when it happens it’s almost always a sign of serious distress and investor skepticism. And so it is with Inogen (INGN), as this manufacturer of portable oxygen concentrators (or POCs) has struggled to recover from post-pandemic disruptions and navigate a migration toward a mixed purchase and rental business model.

Inogen shares have been absolutely hammered since my last update on the company, falling about 85% as the company has struggled mightily on almost every level. On the positive side, the company still has a credible portfolio of POCs serving a market that should continue to grow. On the negative side, the product portfolio may be the only credible thing here, as there’s zero apparent confidence in management as it looks to rebuild its direct-to-consumer business and recover share and margin across its business.

At this point, Inogen looks like a binary idea. If the company can return to profitability in five years and contain negative free cash flow to $20M or less a year, it doesn’t take much in the way of growth assumptions or multiples to drive a fair value well above today’s price. The flip side is that there may be no recovery and the company may not be able to regain the share it’s lost to cheaper rivals, likely eventually leading to a fire sale to another company.

Very Little Is Going Well Today

Looking at the last few quarters, and particularly the second quarter results from August, the closest thing to good news I can find is that the rental business continues to grow, the domestic B2B segment is recovering, and margins are getting worse at a slower rate.

Revenue declined 18.5% in the quarter against a relatively easy comp of +3.6% in the prior year’s quarter. Direct to consumer sales were down 34% and the company is seeing real pressure from salesforce attrition. For better or worse, the POC sales process tends to be high-touch (or high-pressure, depending upon your point of view) and the company has seen its salesforce headcount fall from over 300 to less than 200, undermining the company’s DTC effort.

I’ll make an aside here that this is one of the aspects of the story that most concerns me – when commission-driven sales reps decide that there are greener pastures, it doesn’t usually speak well to what’s going on with the business they’re leaving. Management is once more talking about restructuring and rebuilding the salesforce, hiring reps to get the count back into the 200’s, but that’s not going to be a quick fix as new reps need time to learn and gain experience.

Elsewhere, the domestic BSB business grew 63% in the last quarter but still sits about 25% to 30% below normal pre-pandemic quarterly levels. Inogen has lost significant business in this channel as a result of post-pandemic supply issues – the company couldn’t get the semiconductors they needed and prioritized its most lucrative sales options. Into that gap came lower-cost competitors that have been quite happy to compete on price, and Inogen is looking at a long path back to regaining that share (and taking some hits pricing and margin along the way).

On the more positive side, the rental business continues to grow. Net patients were up almost 12% in the last quarter, closing in on 50,000 and with around 20% annualized growth over the last two years.

Margins still remain under serious pressure. Gross margin fell four points year over year and about two points quarter over quarter to 40.7%, the third-worst gross margin number in over eight years and well off prior norms in the high 40%’s.

A Recent Acquisition Is Interesting, But Won’t Contribute Meaningfully For A While

Back in July Inogen announced the acquisition of Physio-Assist for $32M in cash and potential earn-outs of up to $13M. Physio-Assist is a French medical device company that has developed and launched Simeox , a device that helps mobilize secretions for patients suffering with bronchiectasis. This is a chronic lung condition where inflammation and infection have led to thickened bronchi that are no longer able to remove drain and remove normal secretion, leading to a buildup of mucus in the lungs (which can provide a fertile ground for bacteria, leading to more infection and inflammation).

One of the most common methods of managing this condition is active daily clearing – a 20-30 minute process of breathing exercises and coughing meant to loosen the mucus and force it out. It sounds unpleasant and it is; I have a friend with this condition and the morning ritual of clearing is definitely a quality of life limitation.

What Simeox offers is an at-home mechanical system that achieves reduced mucus viscosity and assisted transport/clearing. The device is not currently available in the U.S., and while there are two randomized clinical trials underway, it will take a few years to get this device to the market. With over 300,000 patients in the U.S. alone, this is a real market opportunity; a little searching around the web suggests that Simeox sells for around $6,000 in at least some markets, suggesting a nearly $2B addressable market – not every person with bronchiectasis needs this device (and reimbursement will be have to be established), but I believe it’s still a real market. I’d likewise note that Hill-Rom launched its Volara not long before its acquisition by Baxter (BAX), so Inogen won’t be blazing an entirely new trail here.

The Outlook

Between the pressures on the DTC business and the need to rebuild the domestic B2B business, I don’t think Inogen is likely to reclaim its past revenue high-water mark ($377M last year) until 2026 (though annualized numbers in 2H’25 should be close). Likewise, I don’t expect a positive operating margin or positive EBITDA margin until 2026 as the company reinvests and rebuilds the business, and EBITDA margin in FY’27 may still only be in the low-to-mid single-digits.

Resetting for the price, market share, and margin pressures, I’m looking for over $400M in revenue in FY’27 and longer-term growth around 5%-6% starting from that 2022 high-water mark. It will take time to rebuild back to sustained positive free cash flow, but I believe 10% margins are possible in 10 years.

Whatever assumptions I use, the shares look undervalued and that’s why I say this is basically a binary stock. The market is pricing this business as if there’s little chance it will survive, let alone generate meaningful profits in the future, and I can’t say that isn’t a potential outcome here.

If management can stabilize the business, though, regain share in the domestic B2B channel, rebuild the DTC effort, continue growing the rental business, and successfully diversify the business, the shares would almost certainly respond positively. On the subject of diversification, in addition to the Physio-Assist deal, management is looking at other product development and M&A options to build a broader respiratory care portfolio.

It's also important to note that Inogen will still have close to $140M in cash after the Physio-Assist deal (the earn-outs would be paid in the future). Provided that annual free cash flow consumption from here is less than $20M/year, Inogen has a fairly long runway to repair the business. Of course, the company could lose even more share, see sales fall even further, and see even more erosion in margins – I mention this only as a reminder that the cash buys some time, but all of these pieces are interconnected.

The Bottom Line

I couldn’t have been more wrong with my expectation back in early 2022 that management would stabilize and rebuild this business through 2023. The business is in far more precarious shape now and it remains to be seen whether this dual DTC/rental strategy can work and whether management can recover from share losses and price pressure in the B2B channel. If the answer is “yes”, these shares will likely trade higher in a year or two, but only very risk tolerant investors should consider this name even though it trades below current net cash.

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