March 10, 2015 - 3:07am EST by
2015 2016
Price: 19.05 EPS -0.36 0.69
Shares Out. (in M): 32 P/E n/a 27.6
Market Cap (in $M): 613 P/FCF 0 0
Net Debt (in $M): -4 EBIT 0 0
TEV (in $M): 609 TEV/EBIT 0 0
Borrow Cost: General Collateral

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  • FDA
  • Manufacturer
  • medical equipment
  • Medicare
  • Healthcare


Invacare (IVC) Idea Memo

$613mm market cap
$609mm EV
Sales: $1,280mm
52-week range: $11.65 - $20.81, current price $19.05
Short Interest: 5.7%
Short IVC
Picking only one healthcare stock to write about as a short was as tough as deciding which ice cream flavor to get at Baskin Robbins. Since I am boring and often favor plain old vanilla there, I correspondingly chose one of the more mundane companies in the space. Invacare (IVC). Also chose this because Invacare can be an anagram for [I needed to] “Earn a VIC” credit. This is part of a broader med device/biotech basket of shorts.
Invacare is a manufacturer and distributor of medical equipment used in the home medical equipment market and long-term care settings. Home medical equipment products include “non-disposable products used for the recovery and long-term care of patients.” Such products include beds, powered wheelchairs, manual wheelchairs, walkers, and respiratory therapy products. They are best known for their broad wheelchair product line-up. Here is a list of IVC’s US products to get a sense of what they manufacture and sell:
Invacare’s stock has recently elevated back to a relative high on what investors are pointing to as signs of stabilization in its core business and hope for putting the prohibitive FDA consent decree behind them soon as the company marches towards high single digits operating margins over the next few years. My variant view on the situation is that IVC is a less than mediocre business (as measured by ROIC) at 29x forward earnings estimates that has structurally changed for the worse and will struggle to re-attain lost market share, as well as its previous operating margin levels and as a result the company will disappoint relative to the consensus estimates for material improvement in profitability that are baked in. Even in the “good years” IVC had peak ROIC of 9-10% and within the last decade hit peak Operating Margins of 5.6% in 2009. Management had previously targeted an 8% operating margin target by 2016 this will be very tough to achieve so they’ve stopped providing forward guidance. The company’s customers are the home medical equipment providers/retailers/rental companies. Being young and having zero experience with these retailers it is quite a shock that are there are over 5,200 of them in the US (greater than the number of Taco Bells). For the ones I visited, the retail experience and format is more akin to a pawn shop than anything else.
We all know that in theory over the long run a company must achieve a ROIC over and above its cost of capital to produce economic value. And ROIC must exceed WACC for growth to contribute positively to the value of the business, while growing a business that earns a ROIC below its WACC actually destroys shareholder value. Average ROIC for IVC since 2000 is 0.31%. Average ROIC since 1995 excluding all negative periods is 5.9%, with a peak of 10.9% in 1995, with ~9% in 2002 and 2003, but then has never exceeded 4.3% from 2005 onwards.
The company has lost market share in the higher margin motorized wheelchairs and is increasingly shifting its product base to more commoditized, lower-end manual wheelchairs while it awaits the resolution of the consent decree when it can fully ramp up the power wheelchair production again. This ongoing product mix shift makes it even less likely that they expand gross margins from here. Average Operating Margins in a “normal” operating environment from Q1 2005 – Q2 2012 (before FDA Consent Decree) averaged 5.3%.
This is a negotiated agreement between the FDA and IVC in which IVC had to suspend manufacturing and design activities at their Taylor Street and corporate facilities in Elria, Ohio. While this was not due to any particular recall issue, the CD was mainly due to the company’s manufacturing processes and how it handled customer returns and complaints.The FDA sent a warning letter in 2011 related to an inspection of Invacare's bed manufacturing facility in Sanford, Florida. The warning letter took issue with Invacare's compliance with the FDA's Quality System Regulation, specifically related to Invacare's ability to establish and maintain adequate procedures to analyze processes and operations and to document the actions taken on product complaints and how those were handled. IVC then warned on the Q3 2011 conference call that they had a company-wide issue. The FDA requested and eventually got a consent decree for the manufacturing facility at Elyria. IVC then hired a “Quality, Assurance, Regulatory Affairs” VP, Doug Uelmen who had previously led GE Healthcare and Abbott Labs out of similar predicaments. This consent decree did not cause a full shut-down as IVC was still able to fill backlog orders and make replacement parts at the Taylor Street facility. As part of this agreement IVC was required to pass a 3-part independent third-party audit, before a final FDA audit. In 2013 they completed two of the three required third-party expert certification audits around Design Control Systems the FDA’s Quality System Regulations. Passing these audits allowed IVC to resume design activities of new products. After a final FDA audit, the FDA should provide written notification that they are permitted to resume full operations. They failed the third leg of the audit tri-fecta, needing more work done in their complaint handling procedures and risk review processes.
Resolution of the Consent Decree: How much of a positive growth catalyst?
Revenue at IVC’s Taylor Street facility was $43.2 million in 2014, $55.5 million in 2013, $147 million in 2012 and $172 million in 2011. What does this tell us? The Consent Decree was not until December 2012, so revenue on products made at this facility was already declining rapidly in 2012. If we assume an immediate ramp in Taylor Street capacity to get to revenue to previous 2012 revenue levels that is an incremental ~$104 million in revenue on the current base of $1.27 billion. Also, the company has still been selling power wheelchairs to customers under the consent decree when there is a “a verification of medical necessity filled out with either a replacement chair or a new chair.” (q4 conf call), though I am not sure exactly how much of the $43.2 million this consist of.
Key Divestitures Possibly Prevent Return to the ‘Glory Days’:
When the company was bumping into covenant issues they were forced to “burn furniture to heat the house,” so to speak, and in the process really sold some of the more profitable and growing divisions making a return to previous margin profile less likely.
  • Sold its Invacare Supply Group (ISG) to AssuraMed for $150.8 million in January, 2013.
    • ISG was their domestic medical supplies business.
    • ~$341 million in sales and ~4.75% EBIT margins (using 2012 numbers)
  • IVC sold Champion, its segment that made medical recliners for dialysis clinics in August 2013 for $45 million.
    • Annualized sales in 2013 through the sale date were $23.79 million for ~4.5% year-over-year growth.
    • 19.9% EBIT margins at time of sale.
    • Champion was embedded within the IPG segment.
  • August 2014: IVC sold Altimate Medical, its manufacturer of stationary standing assistive devices used for rehab for $23 million. Altimate was in the North America/HME segment.
    • Annualized sales in 2014 through the sale date were ~$17.67 million, for a Y-o-y growth rate of ~-1%.
    • 23.7% EBIT margins at time of sale.
  • These three divestitures add-up to $341.5 million of sales that are permanently gone.
  • These divestitures also comprised a disproportionate amount of operating profits (almost all of them), likely in the $25 million range compared to the 2012 total of just $26 million, so while they were just ~26% of total consolidated revenue, they were conceivably 90%+ of consolidated EBIT.
  • Of course, there may be a lot of associated corporate SG&A with these divested assets that the company left out of the data, but it is pretty clear each of the divested businesses had a superior margin profile than the continuing operations that are left over.
  • If we go all the way back to 2012 and exclude these divested divisions we can get a rough estimate of what the continuing ops did for EBIT margins:
    • 2012 Total revenue $1.455 billion – Divested Revenue of ~$380 million = $1.075B
    • 2012 total EBIT of $26.1 million – Divested EBIT of ~$25 = $1 million
    • Continuing Ops EBIT margins were essentially breakeven.
Four Segments | Operating Performance in 2014:
  • Consolidated Organic Sales of continuing operations declined 5.0% y-o-y in constant currency.
  • European segment sales increased 3.6% organically (+4.4% in 2013, so second derivative of growth worsened).
    • +7.2% in Q4 Yoy
    • There was weakness in respiratory products and strength in lifestyle, mobility, and seating products.
    • Segment SG&A +4.0%
    • Segment gross margins +1.0%
    • Excluding VAT benefit from Q4 2013 European segment Q4 GM was actually -0.4% Yoy
  • North America/HME segment sales decreased 13.3% in constant currency, organic terms (-12.6% in 2013, so decline actually accelerated/worsened).
    • There were declines across all product categories.
    • Respiratory products had a particularly large decline y-o-y decline due to a significant one-time shipment of product in 2013.
    • SG&A -7.8% yoy
    • Segment gross margin -2.5%
  • Institutional Products Group: -8.2% revenue growth y-o-y (-11.2% in 2013). declines across all product categories, except therapeutic support surfaces and patient transport products.
    • Segment SG&A -6.5% yoy
    • Segment gross margin +0.9%
  • Asia/Pacific segment: sales -0.4% organically y-o-y (-25.6% in 2013).
    • Segment gross margin +2.4% yoy (exited microprocessor contract manufacturing business)
    • Segment SG&A expenses -3.2% yoy
Key observations: For two years in a row the company’s organic sales growth has been negative 5% or worse, led by declines in North America/HME, cushioned by relative strength in Europe.
Revenue began declining rapidly across all product categories outside of Europe even before the consent decree, and since then in categories unaffected. Europe has truly been the bright spot.
Medicare DME Competitive Bidding Program:
As many of you are probably familiar from various other investments, CMS introduced and is phasing in a broad competitive bidding program in an attempt to lower Medicare reimbursement levels on various durable medical equipment and services by having suppliers submit bids which Medicare would then base its maximum reimbursement rate on. This began in nine states as of 2011 (expanded in 2013 and started due to legislation all the way back to 2003). This is important because about half of DME/HME industry revenue (IVC’s customers) comes from Medicare payments. CMS will implement the cuts to an even broader geographical base starting in January 2016 to 100% of the Medicare population.
This pressures the prices DME retailers get for equipment sales and rentals, cutting into margins industry wide. An IBIS report from February 2015 states that operating profits for DME retailers is expected to fall to 9.0% in 2015 from 15.0% before the introduction of the competitive bidding program. This will not likely recover to the previous boom times of the 2000s…this is for the equipment retailers and rental companies, which in turn will negotiate harder with the equipment suppliers and/or be forced to consolidate and could gain bargaining/volume purchasing power (in theory). The number of HME retail operators still exceeds 5,200 but is shrinking by about 2-3% a year. To give you a sense of the magnitude and immediate impact the competitive bidding program has had, it induced cuts up to 42% for the rental price of respiratory therapy equipment, which account for the bulk of revenue in the space. “Round 2” of the reimbursement cuts kicked in in July 2013 in 91 MSAs and this coincided with the rapid revenue declines we’ve seen for IVC. This reimbursement pressure could also expand to Medicaid from just Medicare which has just been proposed in Obama’s latest budget plan. The new plan proposes to have Medicaid reimbursement rates mirror those of Medicare rates. The private payors could also ultimately join the fray as they index off of Medicare rates. This should keep the revenue growth rate negative for IVC’s end markets until at least 2016 at which point the program will have been completely phased in across the country.
Medicaid competitive bidding processes seem to be building support at the state level lately, as well. Here is a link to an audit report from the Dept. of Health and Human Services Office
of Inspector General for NY, citing how much NY Medicaid could save on various DME categories, of course focused on IVC’s bread and butter:
  • Oxygen supplies and equipment could have been reduced by 28% on average.
  • Standard power chairs, scooters and related accessories by 14%.
  • Hospital beds and related supplies by 18%.
  • Walkers and related accessories by 32%.
The cuts cited in a Medi-Cal (Medicaid for CA) audit were even steeper, e.g. 42% in standard power wheelchairs:
Minnesota? 29% cuts for walkers and canes, etc., etc. all across the country.
There is a counter-reform bill called the Medicare Competitive Bidding Improvement Act, introduced that is garnering some co-sponsors in Congress. This will be worth keeping an eye on. 
Payor segmentation for the industry looks something like this (source: IBIS World report: Home Medical Equipment Rentals Industry – February 2015): 50.0% Medicare Insured Individuals, 26.2% Private Insurance, 16.8% Medicaid, 7.0% Out-of-pocket Individuals. In general, I think investors may be continuing to downplay the competitive bidding risk or ignoring it all together.
Regardless of what happens with future squeezes from Medicaid and private payors, HMEs are in survival mode now (see article on The Price of Keeping the Doors Open from December 2014) and this will either continue to hurt profitability industry wide, potentially raise IVC’s A/R write-offs, or help to consolidate the industry potentially leading to more purchase bargaining power against IVC. It’s possible there is a bit of a secular tailwind for the demand side of the equation due to the US/European demographic trends. The population of senior citizens (baby Boomers) is certainly growing faster than the overall population for a short to contend with, as well as increased healthcare coverage due to ACA and falling unemployment. While the precise data is very hard to come by on the number of Americans insured pre and post-ACA, it is generally thought that prior to ACA ~49 million Americans were uncovered and newly insured since then is ~11 million, with over ½ of this is from Medicaid expansion and upwards of ~4 million of the newly covered being young adults who have gotten health insurance for the first time. Given it is mostly old people and/or obese people with chronic health issues that require the respiratory therapy equipment and walkers/wheel-chairs, etc., I view Obamacare as only a small incremental positive.
Sentiment/sell-side activity:
Keybanc just raised their price target to $22 on March 1st based on the potential release of a new custom power wheelchair that they think has some differentiated features and that will not be manufactured at the Taylor Street facility. They did not change any estimates, but think this new product can mitigate near-term earnings risk and this raised their P/E multiple to 15x on normalized earnings that will come “potentially in the 2018 timeframe.” To give you some sense of how far they have been off out of the gate in early 2014 and thought IVC would earn $(0.43) in 2014 and it came in at $(1.59). Admittedly, I do not have conviction enough in my own detailed estimates to share a precise number, but am obviously betting on the under.
Additional Reason Cash Flow is at Risk in 1H 2015:
There is a combined $24.7 million severance payment due to four retired senior executives by the end of Q3 in 2015, disclosed for the first time in the latest 10-K that just came out in late February. Previously this liability was lumped under Other Long-Term Obligations and is now booked as the line-item Supplemental Executive Retirement Plan (SERP) under Current Liabilities on the balance sheet. While this may be viewed as non-recurring in nature and investors may “look through it,” it is nonetheless a material amount of cash for IVC to pay out. To frame the scale--it is equal to 130% of IVC’s cash flow from operations…for the last two years combined. It is also equivalent to 94% of current 2015 EBITDA estimates. I cannot find any mention of this payment in the conference calls, and subsequently any acknowledgement of it in any sell-side report or sell-side earnings model, thus near term free cash flow expectations are too high and they are likely to be especially surprised by weak cash flow in 1H 2015.
Currency Risk due to European Exposure:
The Keybanc sell-sider was extremely quick to jump on seemingly improving sequential trends (citing seasonal dip from Q3 to Q4 in past years). If you remember the anecdote of the study cited in Fooled By Randomness, if you show two groups of people a blurry image and increase the resolution in various increments the one seeing more frequent frame changes receives too much data, over-guesses and mistakes noise for new trends and is less timely/accurate in identifying the picture as a fire hydrant. The CEO on the latest call downplayed any sequential trends or strengthening and instead reminded the analyst that organic revenue in N. America/HME was still down a whopping -10.7%. Keybanc was equally quick to increase price target just a week ago on the back of potential of a new custom motorized wheelchair launch in 2H15 due to its effect of possibly lowering near term earnings risk. Private competitors are launching new products all the time, so I don’t worry about one new product. For example, see Sunrise Medical’s new “Quickies” and "Zippies." 
The European segment accounts for 48.8% of total revenue (and growing as a % of total as other segments collapse) and > 100% of consolidated EBIT (e.g. only profitable segment), and at least 60% of the currency exposure in this segment is the Euro. The Euro has fallen 9.9% YTD already as of 3/9, and is down 4.4% just since the day of the last earnings call. If the Euro is ~60% of exposure within European segment, YTD this could already swing Q1’s consolidated revenue negatively by 2.0% or more overall and consolidated EBIT by a much wider percentage due to Europe being the only EBIT positive segment. So while the sell-side thinks the risk for near term earnings misses has been lowered, I argue it has risen substantially in the last three months with the collapse of the Euro. The Euro/USD averaged 1.34 in 2014 versus the current exchange rate of 1.08, so the currency impact will be significant, at least in the near term.
Op-Ex: Overall they’ve managed op-ex decently in the face of steep revenue declines. They’ve substantially cut sales people over the years out of necessity to preserve cash flows, and I point to this as potentially one more reason sales won’t snap back to pre-consent decree levels in the various segments---especially not in a way that will show meaningful positive operating leverage as they’ll likely have to ramp hiring back up.
Stock Ownership Dynamics
Heartland Advisors is the largest owner at 14% of the shares out. I believe this to just be a 1.6% position for Heartland and as of Q4 2014 they were at least trimming their position. Heartland does have a history of activism with 7 different 13-D’s filed, so one risk could be Heartland noticing this laggard in their portfolio and writing a public letter to the board to sell themselves, or some other such move to increase share price.
18.4% of IVC is owned by index funds. 7.4% is owned by ETFs specifically. The biggest category of buyers recently has by far been passive index funds, followed by those Factset identifies as “Yield investors” (dividend yield is a paltry 0.3%). 53.1% is owned by funds identified as GARP-styled. Again as with yield investors, why, I am not sure as obviously the revenue and cash flow growth has been negative for three years in a row, and is expected to be negative again this year. Insiders own a combined 10.3% in economic value, but control 31.0% the vote via B-class share structure (B-shares get 10 votes). After the consent decree became an issue, there was a shift in bonus metrics so that management would receive a bonus simply for rectifying this situation—must be nice to get paid a bonus just to get things to normal from your own previous mistakes (they ended up not getting it). Also it appears the bar is continuously set low for bonus payout triggers, such as 100% bonus payout for a measly $1 million threshold in FCF (for a billion+ revenue company) in years past. I don’t like that the management’s chosen peer comp group all seem like larger companies and they target executive pay in the 75th percentile. The average annual “run-rate” of equity awards to executives has been 2.5% of the shares outstanding a year. Equity option awards outstanding have accrued for an additional 14.2% to the current shares outstanding, along with another 13.9% potential shares in potential future awards—so a staggering 28% increase in shares (this ain’t a high flying tech stock issuing equity to all employees). Since the stock price has stumbled they just began issuing more options to
make up for it. In the sell-side assumptions there is no share count creep embedded, but since I think cash flow will meaningfully disappoint they won’t be buying back stock anytime soon and there could be a negative surprise on the share count dilution.
In market environment that is often reminiscent of the Twilight Zone, often what we think is universally expected and therefore accurately priced into a stock and absolutely not a catalyst (e.g. see VIC discussion around the time of the close of Z/TRLA merger) is somehow a major catalyst for share price liftoff. In this market one may need to dumb things down more than usual in order to try and better time an entry point. While the resolution of the FDA consent decree should be widely expected by now (and has been for at least 18 months), I fear the actual news of it will cause a price spike. A few days/weeks after this non-news has worked its way through the momentum chasers, that may be a more ideal time to enter a short. I just wanted to get this on people’s radars ahead of these events. I think the stock is an uncrowded “safe, grind-down/value-trap” type of short, versus a potentially binary biotech stock that can rip your face off and become entirely untethered from reality based on intangible 2025 peak sales forecasts, of which we are getting burned by many.
Q1 2015 sales growth is expected to be 9.6% lower YoY. The give you a quick sense of the estimate trend, 2015 sales were expected to be $1.474 billion at the end of Q3 2013 and now the estimate sits at $1.186 billion and the stock is higher than it was then. 2016 sales estimates are down by a slightly larger magnitude over that time frame (-22% versus -19.5%). EPS estimates are worse—previously expected to earn $1.32 in FY 2015 and now -$0.36.
EV/Sales is a good way to measure sentiment/valuation of IVC over the course of its profitable periods 2010-2012 and unprofitable periods since. EV/Sales has averaged 0.49x over the last 5-years and sits at 0.48x currently. EV/NTM Sales are also exactly in-line with the 5-year average at 0.50x. One risk is that there is a wide EV/Sales and operating margin disparity between IVC and some of its perceived trading comps, which could tempt people or a larger company (Hill-rom?) into thinking IVC will make for an accretive acquisition target with a lot of corporate fat to cut out.
Actual tangible book value is ~$140 million versus the market cap of $611mm, so the P/TBV is well over 4x.
I think IVC will to continue to experience an ongoing shift to lower margin, lower ASP, more commoditized products like the low-end manual wheelchairs. While this is tough to quantify, it makes a quick snapback to previous margin profile highly unlikely and thus I am betting against the company achieving consensus estimates, with a continued downward slide the estimates due to a more permanent impairment than is widely perceived. IVC is a negative revenue growth company that trades at 29x consensus 2016 earnings estimates and 9.2x EV/2016 EBITDA estimates (average trailing EBITDA multiple from 2005-2011 was 9.6x).
What multiple should we assign a low margin, negative growth manufacturing company? Maybe a FY1 P/E in-line with the S&P 500 around 17x to be conservative? This gives IVC 40% downside. At 7x 2016 EBITDA estimates and a $455 million EV, IVC has 24% downside. In case the stock doesn’t price off of the earnings and EBITDA that won’t materialize, for a sanity check this downside would also put the EV/FY 1 Sales (using 2015 sales estimates) multiple right in line with its recent low at ~0.40x and puts the stock still higher than where it was just as recently as October.
Biotech bubble bubbles ever higher and medical device companies follow suit
The new CEO finds meaningful SG&A to cut more quickly than the market expects and starts to generate meaningful FCF even in the face of revenue declines.
Medicaid competitive bidding process does not gain traction/implementation.
Products shift back rapidly to higher margin power wheelchairs due to consent decree resolution for Taylor Street facility.
Euro strengthens.
The company beats earnings/revenue estimates and sentiment and support remain elevated.
There has been extreme operating leverage to the downside, so if I am wrong on revenue directionally or in absolute terms I may be drastically underestimating EBIT and the market may continue to price the stock based on 2018 potential.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Missing earnings estimates, continued revenue declines. 

Cash flow disappointment due to $24.7 million Severance Payout in 1H 2015.

January 1, 2016 nationwide implementation of Medicare reimbursement cuts.

Legislative progress for Medicaid competitive bidding process implementation.

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