What Would Henry Singleton Do As InMode's CEO?
What would Henry Singleton Do As InMode’s CEO?
Henry Singleton, the legendary CEO of Teledyne profiled in the book ‘The Outsiders’’, has a great track record as a capital allocator. Over his 27-year tenure, Teledyne stock compounded at 20.4% vs 8% for the S&P 500.
Like a snake that sheds its skin, Singleton adapted to different market regimes, for the long-term benefit of its shareholders.
“Singleton believed buying stock at attractive prices was self-catalyzing, analogous to coiling a spring that at some future point would surge forward to realize full value, generating exceptional returns in the process.”
- An excerpt from The Outsiders
“We believe that buyback is something that will have a few days and the market will forget that. And therefore, we are better off keeping the money and looking for M&A opportunity, business development opportunity, things that we can do with the money better than just spending on buying stock.”
- InMode Management
What does InMode (INMD) do?
InMode is a highly profitable medical device manufacturer. Despite a capital-light model, high ROIC, and massive free cash flow, Mr. Market has soured on InMode’s prospects. InMode trades at 11x trailing P/E and 6x EV/Free cash flow. 35% of EV is cash.
Why has Mr. Market Soured on InMode?
The Aesthetic capital equipment business is inherently lumpy. The market is worried about a recession. INMD is also a young business with a small but growing install base. Therefore, recurring consumable sales are only 15% of revenues.
InMode’s contract manufacture partners are in Israel, and the war has created doubts about the availability of components and supplies.
The growing popularity of GLP-1 drugs is adding uncertainty to many consumer end markets.
Lastly, Covid was a big boost for the business, and free cash is 2X vs 2019.
Despite a low valuation, management is reluctant to engage in share repurchases and would prefer to acquire a business with similar margins.
This piece is not a criticism of management. If anything, the management should be applauded for developing a capital-efficient R&D model that is also a free cash flow machine. Additionally, management may be right. In the short term, cheap stocks can always get cheaper.
However, there are capital allocation levers that management can pull to enhance long-term returns. What is the right use of cash?
Why Write This?
We are neither activists nor medical device sector experts. We are shareholders of InMode. We believe the business is undervalued. This piece is a writing exercise to clarify the potential paths management should consider to unlock this discount. Ultimately it is up to management to pursue the right capital allocation strategy. However, we do want management to know they have multiple avenues at their disposal.
To those who aren’t familiar with Teledyne’s history, Singleton presided over Teledyne over three distinct periods.
Acquisitions
The first was the nifty fifty era. Conglomerates and M&A were in favor. Teledyne made an astounding 130 acquisitions in the 60’s. Earnings per share grew 64x.
Buybacks
During the secular bear market of 1966-1982, Singleton did a 180. He deemphasized acquisitions and focused on free cash flow. As valuations plummeted, Teledyne repurchased 90% of shares outstanding in 8 different tender offers.
Dividend and Spin-Offs
In the third and last chapter, Teledyne issued a dividend and spun out different business units to maximize value.
If Singleton was managing InMode, what would he do?
Maintain Status Quo
The easiest decision for Henry or any allocator would be to accept ~$25 million per year in interest income. However, that may not be the best decision.
Buybacks
InMode has $640 million in cash on hand on a market cap of $1.75 B. The enterprise value of the Company is $1.1 B. On trailing earnings of $2.20/share, InMode trades at 10x P/E. However, understanding that the business has a 35-40% free cash flow margin and generates $150 million cash on a less than $100 million invested capital, common sense suggests the business is very cheap.
Ultimately, buybacks work if the stock is undervalued. Today, every valuation metric highlights varying levels of undervaluation. However, buybacks aren’t designed to support a stock. It is an accretive activity that pays off in the future.
Given that InMode has no debt, $650 million dollars of cash, very low working capital, and free cash flow, Singleton would announce a $350 million buyback. Retiring 20% of the stock over the next 18 months at attractive levels would have a handsome payback over the next five years.
Acquisitions
We are exploring some opportunities for M&A. We have nothing to announce yet and nothing to show. We tried a few things, but the prices were too high for us. We try to find something that has the right profitability, although I'm not sure we will find something with 84% gross margin, but something similar, something that complements our technology, something that will be synergy to our business, but we don't want to do it in a rush. Maybe there will be more opportunities, but that's something that we will explore.
-InMode Management
Overall, we believe management’s position is very reasonable. Consumers could reduce spending in the near term, and therefore, M&A valuations could fall.
Singleton would focus on acquiring assets with high recurring revenues and use return on invested Capital, not margins, as a measuring stick. Acquiring high gross margin revenue should not be the ultimate goal. If the macro deteriorated, he would be open to using debt if that enhanced the eventual return.
Dividend
Singleton would agree with management that the business has a long runway for growth in penetrating its target market. International growth is in the early innings. Buybacks should take precedence over dividends.
To conclude, InMode is a good business trading at a cheap valuation. If Henry Singleton was the CEO, he would be an aggressive buyer of his own stock while simultaneously looking to improve the product portfolio.