Alcon: Will the allure of medtech spin-off work again? - Part 1
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There is something peculiar about medical device companies spun-out of large pharma parents, a historical analysis will suggest most of them have been largely successful investments with an average return of ~40% in 18 months after the IPO. Of course, idiosyncratic drivers have been different in each case but the key underlying reason is that device segments inside pharma businesses generally struggle, as large pharmaceutical profits, often around a single drug, typically control disproportionate share of management time and financial resources. This blockbuster mentality in pharma tends to overshadow device innovation, which while smaller on a per product basis, tends to be more durable over time. These dynamics lead to less innovation and share losses for medical device businesses within large pharma companies. As standalone entities, these companies are able to refocus on device innovation which ultimately drives revenue growth and stock returns.
The story is no different for Alcon (ticker: ALC), evident by company’s mixed track record and market share losses between 2010 and 2018 (organic revenue growth ~2% per year) under Novartis. Alcon as a segment of Novartis carried similarities to J&J's MD&D segment where an over reliance on pharma and lack of appreciation for device innovation accumulated over years, leading to lack of adequate investment in the business. Alcon ceded its leadership position in IOLs (intra ocular lenses) to J&J in 2016, and did not have requisite production capacity to expand its lead in dailies total 1 contact lenses to the mid-tier price segment of contact lens market.
It is not just innovation cycle that was stifled; execution issues were evident in all domains (marketing, customer service, supply chain etc.). When Mike Ball (current Chairman) stepped in as CEO in January 2016, he described the problems as including (1) supply chain not working – wrong consumables being sent to the wrong hospitals, (2) machines breaking down with no service staff to fix them, and 3) lack of marketing of products because Alcon thought their innovative products would sell themselves.
Before I go any further, I think it will be appropriate to provide an overview of what Alcon does and where it plays within broader medical device segment.
Alcon was founded in 1945 in Fort Worth, Texas, creating the largest eye care device company in the world. The company evolved, significantly, and in 1977 Nestle purchased Alcon to then offer 25% of it in 2002 to the public under the ticker symbol ACL. Through a series of investments, Novartis purchased the company in 2010. Fast forward to 2019, and on April 9 Alcon once again become a publicly traded company. Alcon is a leader in global ophthalmic surgical (#1 position) and vision care market (joint #2 with Cooper Companies). Alcon operates in two segments:
1) Surgical: Accounts for 56% of company’s revenues and 61% of EBIT. In Surgical segment Alcon sell devices, consumables, and implantables for surgical treatment of eye disorders, primarily cataracts (~75% of revenue in this segment is tied to cataract procedures).
2) Vision care: Accounts for 44% revenues, and 39% of EBIT. This segment includes contact lenses and ocular health products, including contact lens solution and drops for dry eye.
Getting back to Alcon story, due to constant under investments Alcon had a disastrous 2015 and 2016. Michael Ball (now Chairman of Alcon) joined as the new CEO in Jan 2016 with the focus to get the growth back to the industry levels (Alcon’s end market is growing at ~5%) and stem market share losses. Under Michael Ball, the first phase of the turnaround strategy occurred in 2016-2017, which included: 1) fixing the foundation and strengthening execution; 2) investing in promotional activity, capital, and systems; 3) reinvigorating the pipeline; 4) strengthening customer relationships; and 5) developing a nimble medical device culture.
Alcon’s operating margin fell from 22.3% in 2015 to 17.1% in 2016 and 16.0% in 2017 as Alcon invested heavily to get the basics for building a successful med device company right. The decision to become a standalone company is to further leverage prior investments and a strong product portfolio while remaining agile to take advantage of strong end market tailwinds. Alcon was publicly listed again in April 2019 and the stock has been flat since then.
Can Alcon be another medical device success story?
Margin re-base and reinvestments have allowed Alcon to build a strong pipeline of products in the surgical business as well as vision care business. Alcon is well positioned to take advantage of favorable industry tailwinds (an aging population, cataract procedure growth ~5%, shift from reusable contact lenses to dailies modality etc.). Additionally, I expect the margin compression to reverse as elevated investment levels normalize and business starts to grow at a rate similar or higher than the end market growth rate. Overall, I expect Alcon to grow EBIT at 11% CAGR and EPS at 14% CAGR over the next five years.
A single post would have been too long to discuss all the growth levers and the appropriate multiple for the stock. Therefore, I have decided to break it in two parts, please refer to Part 2 of the post.
Alcon: Will the allure of medtech spin-off work again? - Part 1
Alcon: Will the allure of medtech spin-off work again? - Part 1
Alcon: Will the allure of medtech spin-off work again? - Part 1
There is something peculiar about medical device companies spun-out of large pharma parents, a historical analysis will suggest most of them have been largely successful investments with an average return of ~40% in 18 months after the IPO. Of course, idiosyncratic drivers have been different in each case but the key underlying reason is that device segments inside pharma businesses generally struggle, as large pharmaceutical profits, often around a single drug, typically control disproportionate share of management time and financial resources. This blockbuster mentality in pharma tends to overshadow device innovation, which while smaller on a per product basis, tends to be more durable over time. These dynamics lead to less innovation and share losses for medical device businesses within large pharma companies. As standalone entities, these companies are able to refocus on device innovation which ultimately drives revenue growth and stock returns.
The story is no different for Alcon (ticker: ALC), evident by company’s mixed track record and market share losses between 2010 and 2018 (organic revenue growth ~2% per year) under Novartis. Alcon as a segment of Novartis carried similarities to J&J's MD&D segment where an over reliance on pharma and lack of appreciation for device innovation accumulated over years, leading to lack of adequate investment in the business. Alcon ceded its leadership position in IOLs (intra ocular lenses) to J&J in 2016, and did not have requisite production capacity to expand its lead in dailies total 1 contact lenses to the mid-tier price segment of contact lens market.
It is not just innovation cycle that was stifled; execution issues were evident in all domains (marketing, customer service, supply chain etc.). When Mike Ball (current Chairman) stepped in as CEO in January 2016, he described the problems as including (1) supply chain not working – wrong consumables being sent to the wrong hospitals, (2) machines breaking down with no service staff to fix them, and 3) lack of marketing of products because Alcon thought their innovative products would sell themselves.
Before I go any further, I think it will be appropriate to provide an overview of what Alcon does and where it plays within broader medical device segment.
Alcon was founded in 1945 in Fort Worth, Texas, creating the largest eye care device company in the world. The company evolved, significantly, and in 1977 Nestle purchased Alcon to then offer 25% of it in 2002 to the public under the ticker symbol ACL. Through a series of investments, Novartis purchased the company in 2010. Fast forward to 2019, and on April 9 Alcon once again become a publicly traded company. Alcon is a leader in global ophthalmic surgical (#1 position) and vision care market (joint #2 with Cooper Companies). Alcon operates in two segments:
1) Surgical: Accounts for 56% of company’s revenues and 61% of EBIT. In Surgical segment Alcon sell devices, consumables, and implantables for surgical treatment of eye disorders, primarily cataracts (~75% of revenue in this segment is tied to cataract procedures).
2) Vision care: Accounts for 44% revenues, and 39% of EBIT. This segment includes contact lenses and ocular health products, including contact lens solution and drops for dry eye.
Getting back to Alcon story, due to constant under investments Alcon had a disastrous 2015 and 2016. Michael Ball (now Chairman of Alcon) joined as the new CEO in Jan 2016 with the focus to get the growth back to the industry levels (Alcon’s end market is growing at ~5%) and stem market share losses. Under Michael Ball, the first phase of the turnaround strategy occurred in 2016-2017, which included: 1) fixing the foundation and strengthening execution; 2) investing in promotional activity, capital, and systems; 3) reinvigorating the pipeline; 4) strengthening customer relationships; and 5) developing a nimble medical device culture.
Alcon’s operating margin fell from 22.3% in 2015 to 17.1% in 2016 and 16.0% in 2017 as Alcon invested heavily to get the basics for building a successful med device company right. The decision to become a standalone company is to further leverage prior investments and a strong product portfolio while remaining agile to take advantage of strong end market tailwinds. Alcon was publicly listed again in April 2019 and the stock has been flat since then.
Can Alcon be another medical device success story?
Margin re-base and reinvestments have allowed Alcon to build a strong pipeline of products in the surgical business as well as vision care business. Alcon is well positioned to take advantage of favorable industry tailwinds (an aging population, cataract procedure growth ~5%, shift from reusable contact lenses to dailies modality etc.). Additionally, I expect the margin compression to reverse as elevated investment levels normalize and business starts to grow at a rate similar or higher than the end market growth rate. Overall, I expect Alcon to grow EBIT at 11% CAGR and EPS at 14% CAGR over the next five years.
A single post would have been too long to discuss all the growth levers and the appropriate multiple for the stock. Therefore, I have decided to break it in two parts, please refer to Part 2 of the post.