Inmode: Betting on Vanity

Inmode (INMD:US) is a medical technology company that combines a very reasonable valuation with solid growth, a long runway and a rock solid balance sheet. I believe at its current valuation it offers a low risk, above market return and has been unfairly caught up in the significant selloff amongst growth stocks. As we continue to move into the social media age, the demand for cosmetic products will continue to experience strong tailwinds as we increasingly find social value in our appearances. Inmode offers a variety of non-invasive alternatives to traditional cosmetic surgery procedures that have been endorsed by figures such as Kim Kardashian, Chrissy Teigan and Britney Spears. These processes in many cases offer surgery like results with significantly less discomfort, inconvenience and risk with significantly shorter hospital stays and recovery times. The value proposition for physicians here is clear, as Inmode procedures are faster, simpler with significantly broader appeal amongst the general population. This value proposition is presented by Inmode’s army of salespeople, who drive sales of their devices to medical practices all over the world, but with a clear focus on the US which accounts for 2/3rds of equipment sales. Inmode estimates that there are over 100000 physicians in the US that would benefit from their products. Furthermore, once set up these physicians provide a recurring revenue stream of services revenue which currently accounts for around 13% of total revenues.

The Financials

The first thing that springs out are the company’s incredible growth rates. Revenue has grown by above 30% each year while net income has compounded at 108% yearly. This is combined with incredibly high margins with around 84% gross margins and 42% net income margins. Throughout this time the company has been incredibly efficient with its capital with an impressive 40% ROIC. Furthermore, Inmode’s fixed capital expenditure is basically non-existent with free cash flow almost identical to net income historically. This means that they don’t have to worry about funding for growth and their capital can be used to reinvest in the business, look for acquisitions or even  buy back stock. A byproduct of that is a rock solid balance sheet with $443m of cash and cash equivalents with no debt. These metrics all obviously look very attractive, but what about the valuation I hear you ask. Multiples on quality growth companies are still generally pretty high and a company like this must command a solid premium.

Inmode trade at a cash adjusted P/E of approximately 13, remarkably cheap for a company with these metrics. Revenue growth is expected to slow to mid teens as it increases off a larger base, however income growth has slowed to 7% (from the last quarterly) and is expected to be single digits at least for the next year. This slowed income growth is mainly attributed to inflationary pressures in raw materials and wages as gross margins have fallen by 2% and net income margins have fallen by 5%. While this is concerning, it’s hard to see the same level of inflationary pressures continuing in the long term and with a long runway and high returns on invested capital it's not difficult to see high single digit to low teens growth going forward. A DCF for the company with a 10% hurdle rate and what I believe are very conservative growth estimates offers us 70% upside. Even reducing our growth estimates to just 5% out for 15 years presents us with 27% upside and an increase in our discount rate to 12% with our original numbers still gives us 34% upside. There is a significant margin of safety in the valuation, with significant upside if they do overperform on numbers.

With 15% of the companies market cap in cash and equivalents and a huge amount of free cash flow capital allocation is certainly the biggest risk to the intrinsic value of the company. In the most recent earnings call management indicated that they were ideally looking into some sort of acquisition, however were happy building cash until the right opportunity comes up. Firstly, while some may not be happy at the lack of capital initiatives and high cash balance, it’s comforting to know the company isn’t going to just burn capital on a poor acquisition as so many companies do. Additionally, the benefit of their sales model is that the acquisition of new products is highly synergistic as Inmode can leverage their current sales network with the new product. A good acquisition would allow Inmode to not just increase sales, but also expand their offerings and reduce sales costs in the acquired company. Furthermore, Inmode is founder led with their CEO and Chief Technology Officer still controlling a combined $180m in stock. Management are very much aligned with shareholders and listening to them on call, speak passionately about the business and the industry. This should bring shareholders a bit of comfort regarding capital allocation and shareholder value creation.

I believe that the best stock ideas are often the simplest. With Inmode you’ve got a simple company with a squeaky clean record and balance sheet along with really solid management. We have a significant margin of safety in our conservative valuation, long term tailwinds in the cosmetic industry and have the capacity to outperform significantly based on historical numbers. It is hard to see a significant loss of capital at the current valuation, and I believe the stock offers very attractive both risk adjusted and absolute returns for investors.