LivaNova is losing profit momentum due to higher R&D spending (NASDAQ: LIVN)

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Posted on the Value Lab 10/11/22

Liva Nova (NASDAQ: LIVN) is a business we cover from time to time. Let’s update our models with a significantly lowered price and comment on the developments of the previous quarter, highlighting the key points that we will follow. for the next quarter regarding the LIVN thesis, which remains about the same around the option offered by neuromodulation with several large trials in progress and in particular the difficult to treat depression, a very large market. We find that LIVN is very undervalued.

Q2 Highlights

Let’s take a look at some of the key data for the second quarter, starting with revenue.

LIVN Q2 results

Segment Sales (Q2 2022 Pres)

The income picture is quite easy to explain:

  1. Cardiopulmonary is benefiting from a return to normal in diagnosis and intervention rates as the West overcomes deadly concerns over COVID-19. The markets here are centuries old as the heart-lung machines they sell are used in major and secularly growing treatment areas. Revenue growth is well supported and has overcome pressure from FX as this segment derives over 50% of revenue from markets outside of the US.
  2. Neuromodulation was starting to see some deceleration in volume growth, where the only real product here is the VNS product for epilepsy. Replacement procedures are apparently keeping revenue going, but no new push has come. Currency effects with a stronger dollar also took their toll, but US exposure accounts for over 85% of revenue here. The key questions to discuss neuromodulation later come with the picture of profit.
  3. ACS is really struggling to generate revenue as severe cases of COVID-19 are down. This is a booming market that is shrinking entirely and probably permanently.

Where things get complicated is with profit.

operating result near Q2

Operating result (Q2 2022 Pres)

Profits are generally down, except within companies. The reason is that some one-time legal fees are down very significantly compared to last year. There may be new legal costs associated with Milan’s decision, but that’s currently not easily quantifiable, other than the possibility of $519 million in maximum damages depending on the claim. We use it in the EV to make our valuation of LIVN conservative – it is fully and to the maximum factored into the valuation.

Going back to the segment declines, they are partly due to supply issues, supply chain issues and higher transportation costs. Freight is apparently the biggest pressure, especially in cardiopulmonary, which is a more global business, but in neuromodulation there’s also the issue of higher clinical trial costs because LIVN incorporates more patents on trials to try to get a signal in the data so he can move his trials to insurable and approved products.

Remarks

We calculate that EBIT can more than quadruple if all neuromodulation trials work and reasonable levels of penetration into common treatment areas are managed. So where are we at with each?

  • RECOVER: They implanted the 325th patient and also received confirmation that the study should continue to recruit more patients up to 375 for the RCT study for the DTD implant. They will also start a bipolar depression arm, which is a whole other indication for effective treatment. Apparently, a growing portion of the unipolar study cohort is passing the 6-month mark, by which time the differences between the control and test group should begin to show. Once this difference becomes statistically robust, the RCT currently being recruited can stop and future patients who want the implant can join an open-label study so they can also receive the treatment. Once every patient enrolled in this initial post-closure phase has been observed for the full 12-month period, a final analysis and peer-reviewed paper will be submitted to CMS in hopes that the DTD implant will become a product. insurable. At this point, we hope to have a successful business venture. LIVN expects the RCT to be able to close by the end of the year, which means that a year later we will see the submission to the CMS happen.
  • ANTHEM: In the fourth quarter, the trial plans to enroll its 500th patient. After that, if all the conditions are met, the functional data can be submitted to the FDA. In the same way, this is studied with the help of interim analyzes of patients, first 300, then 400 and now 500, on a periodic basis. The study has been approved by the FDA, so once patients have been fully observed for the implant’s success in regulating hearts using VNS, there is the possibility of final approval and of marketing.
  • OSPREY: The VNS product for sleep apnea is recruiting patients for the trial. The trial must first be approved, in which case it will begin at a similar stage to where ANTHEM is.

While the ANTHEM and OSPREY trials could produce very successful products that would change the profile of the company, let’s focus only on the DTD which is the most important in terms of prevalence and by far the closest to being marketed, since she’s been approved for a decade.

With stock price declines, and even discounting all fair multiples of different companies by 25%, we get the following valuation. We have annualized the EBIT figures.

livanova evaluation

Valuation (VTS)

The implied value per patient assuming that the only relevant market is those on electroconvulsive therapy for their DTD is $3.1k. That’s really not much considering it’s an implant and the price of electroconvulsive therapy, which costs an average of $15,000 a year. If more people were open to the implant, it would come to $100 per patient in value.

Overall, the drop in LIVN stock makes the DTD opportunity highly undervalued. With the other ongoing trials as well, the implied multiple on LIVN is well below 7x EV/EBIT on this potential future revenue, assuming somewhat generous penetration and prevalence. But the DTD situation is enough to make the company quite undervalued, even given the potential liability of the Milan lawsuit.

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