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It has been all the way back to 2016 when I covered Zimmer Biomet (NYSE:ZBH) when I hoped that the cash flow yield should start to provide some support.
The company was struggling at the time, due to supply issues which resulted in weaker growth, as I was a bit cautious to blindly use the non-GAAP earnings number which look decent, deeming realistic earnings to be quite a bit lower.
A Recap
Zimmer Biomet was created when Zimmer and Biomet tied up in 2014, causing shares to rise to the $100 mark, and even a high to $130 in 2016, as investors were pricing in the anticipated benefits from the deal.
In reality, this was an acquisition by Zimmer to acquire Biomet in a $13.3 billion deal, in order to create a $45 billion giant in the so-called musculoskeletal industry. Greater scale and cross-synergies between knee and hip implants, as well as spine, thoracic, dental and SETs categories were anticipated. The transaction was set to create a $7.8 billion business in terms of sales based on the 2013 results, as the deal did close in 2015.
These anticipated benefits did not translate into reality, causing shares to fall to the $100 mark in 2016, due to some softer quarterly numbers. Early 2016 was an interesting date, as the company outlined a guidance for the upcoming years, the first full year after the deal had closed. The company guided for earnings to come in around $7.80-$7.95 per share, based on revenues of around $7.7 billion.
The near $8 earnings per share power in relation to a $100 share price looked too good to pass, yet the issue was that GAAP earnings only came in around $1.50 per share, marking a huge discrepancy between both metrics. Much of the difference came from costs associated with the Biomet deal, including substantial amortization charges. Adjusted for some items, I pegged realistic earnings closer to $6 per share, which translated into 17 times multiple as the company furthermore torched along $11 billion in net debt. This worked down to a 3.1 times leverage ratio based on EBITDA of $3.5 billion.
If the company could return to 20-25% operating margins, we might see $2 billion in operating earnings on an $8 billion revenue base. After interest costs and taxes, that should reveal some update, yet it would require some execution.
Going Nowhere
Since 2016, shares of Zimmer Biomet on a net basis have not moved at all. Ahead of the pandemic, shares traded around the $150 mark as they peaked in the $170s in the spring of 2021. Ever since it has been all downhill with shares approaching the $100 mark this past summer, now trading at $125 per share.
Fast forwarding to early 2022, we see that Zimmer Biomet posted its 2021 results. While revenues rose by 11% in 2021, they only came in at $7.8 billion, coming in exactly flat compared to 2016. The lack of any revenue growth over the past five years marks a significant underperformance, taking into account the growth of the industry and the impact of inflation over the time window. Moreover, the company has not been as buyer of its own shares, in fact, the share count has risen by about 5% over the same period of time. On the bright side, net debt has come down to $6.6 billion in the process, making some deleveraging from 2016.
On the earnings front, the situation remained utterly complex. The company posted adjusted earnings of $7.37 per share, yet GAAP earnings only came in at $1.91 per share. No progress on the earnings front was seen while numerous adjustments were made to arrive at the adjusted earnings numbers. No less than 13 adjustments were made to bridge the gap between both metrics.
The 2022 guidance was anything but inspiring. The company guided for sales to come in flat at best, but to potentially fall up to 4%. Adjusted earnings were initially seen between $6.40 and $6.80 per share. In all fairness, this is partially due to the spin-off of ZimVie (ZIMW), the dental and spine operations of the business. This business has seen a detrimental share price performance since the business was spun off in spring of 2022 under the ticker ZimVie.
Despite some intensifying currency headwinds, the company actually raised the full year outlook in a modest way following the first quarter earnings release, with earnings now seen at a midpoint of $6.75 per share. The guidance was hiked to $6.80 per share upon the second quarter earnings release as net debt fell to $5.6 billion following the spinoff of ZimVie.
The guidance was hiked to $6.85 per share following the release of the third quarter results with the new Zimmer Biomet currently positing sales at around $6.8 billion per annum, with net debt now down further to $5.2 billion, as debt looks reasonable in relation to the earnings power.
With 210 million shares now trading at $125, the company commands an equity valuation just north of $26 billion, for a more than $31 billion enterprise valuation. With sales trending at $6.8 billion, the resulting 4.5 times sales multiple and about 18 times adjusted earnings multiple seems more than full, given that still some leverage is apparent here.
And Now?
Early in 2023, Zimmer Biomet announced a bolt-on deal, announcing a $155 million deal to acquire privately-held medical device company Embody, as earn-outs have the potential to increase the deal tag by another $120 million. With the deal, Zimmer will obtain ownership of, among others, the TAPESTRY implant line of brands for challenging orthopedic soft tissues injuries.
Unfortunately, no financial details have been released regarding the revenue contribution, or profit or loss contribution, other than that slight dilution was anticipated following the deal.
The reality is that the deal for Embody is just a tiny deal, of course, not having any substantial impact on the business. The issue is that Zimmer Biomet continues to trade at a full valuation, despite the ZimVie deal, marking a period of nearly a decade now of stagnation in the business and hence shareholder value creation, pretty much having started since the tie-up between Zimmer and Biomet.