2023-11-27 22:33:21 ET
Summary
- Shares of TransMedics surged when it reported strong Q3 results and raised full-year guidance.
- The company's Organ Care System has a strong value proposition over cold storage solutions, and this has resulted in significant market share gains over the last two years.
- TransMedics believes OCS can achieve over 10,000 transplants by 2028, which could potentially lead to annual revenues exceeding $1.5 billion.
Shares of TransMedics ( TMDX ) surged after the company reported very strong third quarter results and raised the full-year guidance that includes the initial positive impact from the acquisition of the charter flight company Summit Aviation. The market punished the stock by sending it 60% lower in the months that followed the acquisition announcement, although I should note that a big part of the downside move was the big drop in med-tech stocks that coincided with the acquisition.
I believe this was a bold move by the company that should pay dividends in the following years, both in terms of the number of transplants but also in revenue per transplant and net income.
The value proposition of OCS and the strong uptake that provides initial and strong validation
TransMedics has developed and is successfully commercializing the Organ Care System, or OCS, to address the limitations of cold storage for organ transplants. The OCS is a portable organ perfusion, optimization, and monitoring system that replicates the near-physiologic conditions for donor organs outside the human body. OCS is currently being used in the liver, heart, and lungs, and it could potentially expand to the kidney in the following years.
The rapid uptake in a logistics-constrained market provides the initial validation of the value proposition of OCS. Based on the current guidance, TransMedics expects to cover more than 2,000 transplants in the United States, out of the estimated nearly 16,000 a year.
Over the long run, OCS and the company’s wholly-owned logistics network could considerably expand the total transplant market. The vast majority of organs from deceased donors end up unused – out of approximately 15,000 deceased donors in 2021, more than 12,000 lungs, more than 8,000 hearts, and nearly 6,000 livers were unutilized.
The use of OCS has demonstrated significant increases in the utilization of organs compared to cold storage.
The outcomes are also better, from decreased post-transplant complications to improved survival.
TransMedics has created the National OCS Program, or NOP, that provides end-to-end technology and expert clinical service and enables growth by removing ischemic time and distance limitations and by reducing resource constraints and dry run cost exposure. The company also claims the program offers better management of human capital and clinical resources of the transplant program.
The numbers speak for themselves. As mentioned, the company will deliver more than 2,000 organs in 2023 with a market share that will likely approach 20% on a quarterly basis in the fourth quarter. This has translated into rapid revenue growth.
Throughout this period, the company has been managing expenses and the operating cash burn has been modest.
Acquisition of Summit Aviation
In early August, TransMedics announced the acquisition of Summit Aviation, a “premier U.S. charter flight operator” and that Ben Walton, the founder of Summit, will join the company as VP of Aviation Services. This was a relatively small acquisition, reflected in an $18 million upfront cash payment and a total consideration of $14.9 million, net of cash acquired and working capital adjustments. However, additional investments are required as the fleet will need to be considerably expanded in the following quarters to meet the growing demand.
In the third quarter, TransMedics acquired eight fixed-wing aircraft for $103 million, and the company plans to acquire more in the following quarters to reduce the dependence on third-party transportation providers. On the Q3 earnings call , management said the plan is to grow the fleet to 15-20 planes, which translates to an additional cost of $100 million to $150 million based on the average price of the 8 planes purchased in Q3.
Even if the company spends an additional $150 million on planes in the following quarters, it will remain very well capitalized. It had $427 million in cash and equivalents at the end of Q3, and operating cash burn is very modest. And if it keeps up with the growth rates it delivered in 2023 to date, it should not be too long before it becomes profitable.
The acquisition affects the gross margin profile as logistics have a significantly lower gross margin compared to the OCS, but gross profit dollars should increase with the addition of charter services. The gross margin dropped from 70% in Q2 to 61% in Q3, due to what the company described as “transient inefficiencies related to the Summit acquisition and limited launch of our transplant logistics offering” and management said the margin was also unfavorably impacted by legacy charter operations as it transitions to focus exclusively on transplant services.
Longer-term, the company expects the company-wide gross margin to reach the high 60s, and I would not be surprised if the gross margin ends up in the 70s over time as management is historically very conservative on the guidance side.
There were already some benefits of the acquisition of Summit in the third quarter, but management expects the full effect to be seen in the second half of 2024.
This is a bold move, but it allows TransMedics to control the whole process and to be even more competitive with a full offering to its customers. And more importantly, it clears a big bottleneck for growth as the company has complained it can often be hard to find appropriate transportation.
Long-term opportunity
TransMedics believes OCS can achieve over 10,000 transplants by 2028. That sounds very ambitious if we consider the total market in 2022 was approximately 16,000 organs. But this does not mean the company achieves more than 60% market share by 2028. The market will likely expand as the transportation bottleneck for OCS is cleared with TransMedics handling logistics on its own, and by the expanded utilization that OCS offers. I do not know how much the market can expand, but nearly two-thirds of the three key organs end up unused.
Based on the company’s guidance for more than 2,000 completed transplants in 2023 and the revenue guidance range of $222-230 million for the year, it appears the revenue per transplant is approximately $100,000. Management estimates that the addition of transportation could add at least $25,000 to $30,000 per transplant over shorter distances and that it could go as high as $100,000 per transplant over longer distances.
So, if I add some modest price inflation over the coming years, and if I assume an average transportation service revenue per transplant of $35,000, I get approximately $150,000 per transplant in 2028. And if the company achieves its goal of more than 10,000 transplants in 2028, total revenue could exceed $1.5 billion. The consensus numbers I have do not go beyond 2027, and the estimate for 2027 is $827 million. It seems likely that analysts have not fully appreciated the better-than-expected execution in the last few quarters and that the addition of logistics will increase total revenue per transplant by at least 35-40%. As mentioned, the acquisition dilutes the margins, but gross dollar amounts will still increase and I estimate that logistics could add at least $100 million to TransMedics’ net income by 2028.
Risks
The key risk in the near term is the integration of Summit Aviation and the related execution – whether the company will be able to scale its logistics operations in a timely fashion and take advantage of the opportunity to the full extent. Running a fleet of 15-20 planes does not sound complicated, but there could be some challenges and delays before it becomes fully operational and reliable. TransMedics can always use third parties to transport organs, so, the negative impact would be limited to having the same transportation bottleneck situation that exists today, and revenues were still growing rapidly despite the constraints.
The other important risk is the execution on the OCS side, transportation issues notwithstanding, and competition. There are no guarantees on either front, but so far, so good. Competition in organ preservation for transplantation is classified into two segments – cold storage and cold perfusion technologies and warm perfusion technologies (OCS represents the latter). In cold storage and cold perfusion, the organs are not functioning or metabolically active and this significantly limits donor organ utilization, as shown earlier in the article. TransMedics also claims supply of cold storage and cold perfusion products is fragmented with undifferentiated offerings.
Competition on the warm perfusion side is more important to consider and two other companies are offering single-organ warm perfusion systems for the liver and lung – OrganOx Limited and XVIVO Perfusion AB. To date, there are no significant impacts from these competitors and the addition of internal logistics could prove an important advantage for TransMedics over the long run.
OrganOx still seems to be a far smaller company and has raised a £25 million growth round in July and they claim to have supported more than 2,500 liver transplants across Europe, the U.S., and Australia. Just a few months earlier, TransMedics raised $460 million by issuing convertible notes.
XVIVO is also a smaller company and has generated approximately $14 million in revenues in the third quarter, a 51% Y/Y increase in Swedish Crowns and 42% Y/Y in local currency.
Other risks are on the product and manufacturing side – malfunctions or manufacturing issues could impact the company’s growth rates and reputation.
Conclusion
TransMedics delivered strong growth this year and has significantly increased the full-year revenue guidance range each time it reported quarterly earnings and the same happened last year.
The company also made a very bold move to acquire Summit Aviation and has committed to aggressively invest to expand the fleet of aircraft to support its internal logistics operations instead of relying on third-party charter transport which represented a bottleneck for growth as the business grew over the last few quarters. This move was initially met by market skepticism but should pay off in the long run by allowing full control of the whole process and by increasing total revenues and net income.
For further details see:
TransMedics: Bold Moves And Strong Execution