Monday, December 4, 2017

A current AIM International Fund Holding: CryoLife, Inc. (CRY) by Tim Donovan. "Can CryoLife Buy Its Way Into Europe"

CryoLife, Inc. (CRY, $19.05): “Can CryoLife Buy Its Way Into Europe?”

By: Tim Donovan, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and expresses my own opinions. I am not receiving compensation for it and I have no business relationships with any company whose stock is mentioned in this article.

  • CryoLife, Inc. (NYSE: CRY) is a medical devices company involved in the processing and distribution of implantable tissues used in cardiac and vascular surgeries.
  • CryoLife generated $180.4MM in revenue throughout 2016 from the sales of its extensive portfolio including products such as BioGlue, BioFoam, On-X, PerClot, and several more in the area of cardiac and vascular tissue preservation.
  •  On October 10, 2017 CryoLife entered into an agreement to purchase Germany-based JOTECH AG for a total of $225MM (75% cash, 25% stock). The acquisition is set to close by the end of 2017.
  •  JOTECH is focused on the development of endovascular stent grafts as well as cardiac and vascular grafts with a focus on aortic repairs. Over the past 5 years JOTECH has seen a CAGR of 17%.
  • The acquisition provides CryoLife access to a $2B global market for endovascular stint grafts. The market it projected to grow to $2.5B by 2021.

Key Points:

CryoLife has an impressive portfolio of products from both development and acquisition. Since its inception it has grown a list of 11 products, including some duplicate versions for international sales. Having expanded into Canada, Europe, and parts of Asia, they still derive 76% of overall revenues from the United States. With increased competition inside of the United States, international expansion is becoming a viable option to sustain overall growth for the company.

With its current focus on sealants and tissue regeneration, the company has looked for other markets to break into. With international expansion and product line growth in mind the company announced the acquisition of Germany-based biotechnology company JOTECH. This privately held company focuses on the manufacturing of endovascular stent grafts for aortic repair. This segment of medical devices has a potential addressable market of $2B. This inorganic introduction into this industry will give CryoLife an opportunity to not only partake in the aortic repair business, but also expand its footprint in Europe. A main driver that pushed the business into Europe were the costs of selling through international distributors. By having a wholly owned subsidiary in Germany, CryoLife will have an easier opportunity to try out a direct sales method to people throughout continental Europe. In the last quarter the company announced that it is now selling directly to customers in Canada, Belgium, Luxemburg, and the Netherlands, with the hopes of one day having a direct market in the rest of the continent.

While this acquisition provides an opportunity to move further into the European market, it comes at a cost. $225MM was the settled purchase price for JOTECH. Of this 75% will be cash, and the remaining 25% will be stock. The stock portion of the acquisition represents $56.75MM, or 2,682,403 shares of common stock. The company expects this recent acquisition to provide a CryoLife an EPS CAGR of above 20% over the next 5 years.

Despite significant opportunity in the European countries, CryoLife could face some difficulties in this expansion. With limited experience in European markets CryoLife will be taking a large stake in a part of the world they are not accustomed to. If they are unable to successfully transition into the European market the overall profitability of this acquisition will be strained or even eliminated.

What has this stock done lately?

2017 has not fared as well on CryoLife as expected. Posting 9 month revenues of $136.9MM fell short of expectations, representing a 1.13% change YoY. Despite slower top line growth management was able to improve efficiencies, raising their gross margin to 67.4% up from 64.7% in 2016.

Despite significant movement throughout the year CryoLife is trading up 0.26% since the beginning of January. Throughout this time it has seen troughs as low as $14.60 in April, and peaks as high as $23.85 in October.

On Monday October 30th Cryolife announced Q3 EPS of $0.08, falling $0.01 short of the targeted $0.09. On top of this their revenues came in at a modest $44MM, representing a -2.8% change YoY. This resulted in a missing of revenue projections by $1.65MM. Having significant exposure in the Florida and Texas markets, recent hurricanes in September and October have resulted in around $1MM in lost revenue during this period. On top of this they had a delay in the receipt of Ascending Aortic Prosthesis, resulting in a $1.1MM repurchase of inventory from third-party distributors.

YTD Price - Source: FactSet

Price Relative to Russell 2000 - Source: FactSet

Key Takeaways:

CryoLife has seen some headwinds in their domestic operations. Increased competition and lagging revenue growth numbers have pushed the company to make alternative moves. With the acquisition of JOTECH, CryoLife has an opportunity to drive sales abroad in both their existing market segment, as well as their recently acquired aortic repair segment.

Going forward I believe that a direct selling method in Europe along with an introduction into a new market segment will help stimulate further top line growth for CryoLife. Despite this opportunity, they need to still remain focused on domestic sales to maintain market share within the United States. This teamed with the risk of international expansion still pose some threats to CryoLife. Due to a balance of risk and reward, I recommend that CryoLife, Inc. remain held in the AIM Small Cap Portfolio while their international expansion plays out.