Believes InMode’s Cash Balance of Roughly 55% of its Market Cap is Grossly Inefficient
Asserts the Current Valuation Offers an Unprecedented Opportunity to Create Shareholder Return
MIAMI, July 25, 2024 /PRNewswire/ — DOMA Perpetual Capital Management LLC today sent a letter to the Board of Directors of InMode (NYSE: INMD) urging the Board to execute a 40% tender offer of the stock.
The letter can be downloaded here.
The full text of the letter follows:
July 25, 2024
To the Board Members of InMode:
DOMA Perpetual Capital Management is an asset manager focused on generating long-term value for its investors. DOMA is one of the largest shareholders of InMode (the “Company”).
Over the last few months, we have communicated privately with the Board of Directors of the Company (the “Board”) about our concerns regarding the Company’s capital allocation strategy and to urge the Company to prioritize finding new ways to make the equipment acquisition process more efficient for its clients. During this period, InMode’s stock price has continued to decline, as market participants are losing faith in the capacity of the Board and the Company’s management to generate returns for shareholders and allocate capital in an efficient way. We believe this Board needs a strong independent voice that will advocate for the interests of the Company’s shareholders.
Early this year, we brought to the Board’s attention the misguided and financially-uninformed comments of InMode’s CEO and former Chairman, Moshe Mizrahyi. These comments, made on multiple occasions, evinced a lack of understanding of the basic tenets of share buybacks and capital allocation. Shortly thereafter, the Board announced a new Chairman, Dr. Michael Anghel. Dr. Anghelii possesses a background in finance and seemed to understand that issuing a dividend at the lowest valuation in the history of a company is a significant capital allocation mistake and sends the wrong message to investors. The Board also announced a share buyback, reversing course on Mr. Mizrahy’s prior statementsiii. However, the announced buyback falls short as it amounts to less than the Company’s free cash flow in a normalized year.
InMode’s stock price is plummeting, along with its valuation. InMode holds nearly $800 million in cash and marketable securities, which is approximately 55% of the Company’s current market capitalizationiv. In addition, the business possesses a large and healthy free cash flow, no debt, approximately 80% gross marginv, as well as a moat around its intellectual property, preventing new market entrants. We believe InMode completely dominates its sector.
The Board has spent significant time looking for companies to acquire, yet we believe it has failed to consummate any attractive acquisitions due to valuationsvi. In the current market, where valuations are stretched, the task of finding a quality company with valuable intellectual property at a reasonable purchase price is exceedingly challenging. By contrast, InMode, a company with margins and return of equity superior to those of any potential acquisition, has experienced a significant valuation contraction. We challenge the Board to find an acquisition target in the minimally invasive or non-invasive cosmetic procedure market with better financial returns, margins, and intellectual property assets than InMode, which has an irrationally depressed valuation. We believe that it does not exist.
In order to create proper and material shareholder return, InMode’s Board should immediately approve a tender offer of 40% of the Company’s stock, to be followed by the already announced buyback.
The Company’s shareholders have been made to endure subpar performance for too long. We believe the Board is destroying value with an inefficient and ineffective capital allocation strategy. There is ample, unused flexibility to generate shareholder return. Keeping roughly $800 million dollars on the balance sheet of a Company with 80% margin and no debt, with the hope that an attractive acquisition will magically appear, is wishful thinking and is detrimental to shareholders. While the Board is buying back stock in “eye dropper” amounts, the opportunity to buy back 40% of the Company at its current, irrationally depressed valuation could quickly vanish. The tender must be approved immediately. We believe that a decision not to proceed with the tender will prove the Board is either unable to understand the massive return opportunity in front of it or that the Board is unwilling to uphold its fiduciary responsibility to shareholders. Doing nothing at this critical moment will demonstrate that the board lacks independence and the Company needs shareholder-led change on the board, with focused, aligned directors who are accountable to its owners.
The tender offer we are suggesting will only use about $600 million dollars. InMode would still have close to $200 million in cash as well as all its debt capacity. Assuming 3x of next year’s debt and EBITDA, we estimate that the Company would have another approximately $500 million of debt capacity that could be used for a potential future acquisition. If the Company needed to execute a large acquisition that required use of its debt capacity, it could stop the regular buyback after the tender and de-leverage quickly, due to its large and healthy free cash flow. Again, InMode possesses net income margins of roughly 40%. The Board is fundamentally mismanaging the balance sheet by ignoring shareholder returns.
It is clear that a potential acquisition in neuromodulators or fillers is the right long-term move for the Company to diversify its intellectual property, but there are many years ahead before InMode’s patents expire. Private markets do not deviate much from public valuations and generous valuations in the sector – shown by publicly traded companies like Galderma or Evolus – mean that acquisitions cannot be made in the current market without overpaying. This is not a buyers’ market and maintaining so much cash on the balance sheet with the hope of finding an acquisition is hurting shareholders. Compared to InMode’s business, the barriers of entry in neuromodulators or fillers are lower and the margin profile of these companies is inferior. We believe InMode’s moat is superior to any potential acquisition that the Company could execute. There are many years ahead to diversify the Company’s intellectual property. An M&A deal does not have to be done now, next year, or ever, as InMode continues to have an incredible R&D department capable of pushing the boundaries and developing new intellectual property internally.
The current slowdown in equipment leasing is due to macro factors and it will likely dissipate in coming quarters, as central banks around the globe continue to lower rates. In the US, the market is predicting multiple rate cuts this yearvii. As such, the opportunity to buy back 40% of the Company could disappear. In our view, InMode’s free cash flow will continue to grow as the Company expands internationally and its customers begin a cycle of capital equipment replacement in the US, all while the pricing power of the Company remains untapped. We believe InMode’s best years are ahead; its cash flow will continue to grow, creating more opportunities for hoarding large cash at hand for future M&A execution.
The strategies laid out below represent a sensible and thoughtful capital allocation program for InMode:
Continue to invest organically in R&D. To avoid the same fates experienced by medical laser companies when their patents expired, InMode should focus on constant innovation and developing new intellectual property internally. The belief that intellectual property diversification can be acquired from M&A opportunities could prove wrong. To control its own destiny, InMode should expand its R&D and focus on innovation, pushing more boundaries. At this moment, we view InMode’s R&D productivity as unparalleled and believe that the Company must continue investing in the development of internal intellectual property. We believe this should be the tentpole of the capital allocation strategy, especially when there are no great companies at rational prices to acquire.
Buy or invest in new and promising developing technologies in the sector. This is a venture capital-like strategy of capital allocation, in which the Company invests small sums into promising start-ups in their early stages. This is a smaller but crucial component of capital allocation strategy.
Approach large M&A deals with even more patience. In future M&A, InMode must take its time. We sense the Company is rushing to find something at a moment when valuations are very high and there are no clear candidates with margins comparable to InMode’s or large contributors to earnings growth. InMode should take a multi-year approach to this process and, when ready, should use its debt capacity for future acquisitions.
In recent remarks, Mr. Mizrahy and InMode’s CFO, Yair Malca, stated they have yet to find any businesses with margins similar to InMode’s and are looking at an acquisition target that should be accretive to EPS after twelve monthsviii. Setting the bar this low is a huge mistake. Every company produces the same thing: cash. From Mr. Malca’s statements, it sounds like the InMode’s management and the Board are proposing spending hundreds of millions of dollars to buy a business that would need to cut executives and salespeople to be able to even approach breakeven EPS after a yearix. What is the return of invested capital of this deal? What is the cash production and the predictability that competitors will not enter the market or choose to outspend you in marketing? In neuromodulators and fillers, there are several players with new products coming to market; the business is not a monopoly. Compare the results on EPS and ROE of executing this M&A deal versus the execution of a 40% tender offer for InMode’s stock.
M&A should be part of the Company’s capital allocation strategy, but always in competition with other alternatives at hand. We believe that the opportunity cost of such an M&A transaction would be way too high, especially when compared to using capital for a large tender offer when InMode’s valuation at an all-time lowx.
Choosing to spend hundreds of millions of dollars to close what sounds to us like an unfavorable, unprofitable M&A deal instead of executing a large, opportunistic tender would make it obvious to shareholders that board-level change is needed.
Rethink dividends. Companies with low returns on equity – including those with no competitive advantage, selling an undifferentiated product and suffering from the competitive dynamics of capitalism – should return all free cash flow to shareholders in the form of dividends. Reinvesting in a business with low or no returns does not serve the interest of shareholders. In contrast, companies with high returns of equity and the potential to enjoy high returns of capital invested should show a low dividend or no dividend at all. When a dividend is issued, the company imposes tax on its shareholders. If the nature of the shareholder is short term and they are looking for cash from their investment, they can always sell their shares and cash out.
InMode’s returns of capital and equity are so high and its patents are so far from expiring that there is no reason for the Company to pay dividends at the present time, nor in the coming years. The business is growing, and we understand that InMode has a strong potential to develop new intellectual property and the opportunity to acquire great complementary businesses in the future. We believe that paying a dividend, a strategy the Company appears to prefer over issuing large buybacksxi, is a huge mistake. Certainly, if patents were near expiration, and if the Company has failed to diversify its intellectual property, then there may arise a moment when a large dividend could be appropriate use of capital. This is not that time. If Board members are interested in obtaining cash, they are free to sell some of their own stock at the tender offer. Of course, one could argue it does not make a lot of sense to sell stock when InMode’s valuation is so low.
Strategically execute tender offers and buybacks. We believe that any tender offer or buybacks should only be executed at a value-accretive price. This occurs when the price paid for the stock is low enough that the value generated, when compared with using that same cash for M&A or internal growth, is still a superior return. At this moment in time, we would challenge the Board to find an M&A opportunity with higher returns of capital, equity and assets, higher margins with less competition, better intellectual property and superior free cash flow growth characteristics than InMode possesses – and do so at a lower valuation than InMode. Outstanding businesses at attractive prices are very scarce. There are many years before InMode’s patents expire but the opportunity to buy 40% of the Company with a tender offer of stock at this depressed valuation might not last. We believe that InMode will still have plenty of cash in the future for M&A activities and about half a billion in current untapped debt capacity for an opportunistic M&A deal.
It appears the Board thinks it has done enough by issuing a small buyback in relationship to the cash at hand, debt capacity and free cash flow of the firm. We believe the Board is mistaken. It is our view that InMode could be at significant risk of a hostile takeover from leverage buyout players due to its depressed valuation, high margins, superior intellectual property and the fact that the Company is full of cash and possesses no debt. This Board needs to act quickly. It must return cash to its shareholders with a large tender offer, thus taking advantage of InMode’s valuation opportunity in public markets. The Board has legal and fiduciary responsibility to its shareholders and the path to honoring that responsibility is clear.
Sincerely,
Pedro Escudero
CEO & CIO
DOMA Perpetual Capital Management LLC
i InMode Q1 2024 Earnings Call
ii InMode Q1 2024 Earnings Call
iii InMode Q3 2023 Earnings Call
iv InMode Q1 2024 Earnings Release, DOMA Perpetual Internal Calculations
v InMode Q1 2024 Earnings Release & Call
vi InMode 23rd Annual Needham Virtual Healthcare Conference Presentation 04.09.2024, InMode Jefferies Global Healthcare Conference 2024 Presentation 06.05.2024
vii Melloy, J. (2024, July 16). Traders see the odds of a fed rate cut by September at 100%. CNBC. https://www.cnbc.com/2024/07/16/traders-see-the-odds-of-a-fed-rate-cut-by-september-at-100percent.html
viii InMode 23rd Annual Needham Virtual Healthcare Conference Presentation 04.09.2024, InMode BNPP Exane 2nd Annual Aesthetics Day 05.21.2024
ix InMode BNPP Exane 2nd Annual Aesthetics Day 05.21.2024, InMode 23rd Annual Needham Virtual Healthcare Conference Presentation 04.09.2024
x DOMA Internal Calculations, Bloomberg Database
xi InMode 23rd Annual Needham Virtual Healthcare Conference Presentation 04.09.2024
SOURCE DOMA Perpetual
