Merger And Acquisition Target Entellus, And Our Reasoning Behind It

Entellus Medical (NASDAQ:ENTL) has been on Altum’s watchlist since its IPO early in 2015. We’re writing this article because we believe it’s time for Entellus stock is to move. We will explain what will drive this move in this article.

The company’s stock hasn’t performed exceptionally well since IPO, losing 17.45% of its initial value. However, given that the company underwent it’s public offering primarily for expansion and hiring purposes, it was expected that spending would outpace revenue in the short term. Even so, the ER reports didn’t make investors happy, and the stock has seen a low of $13.72, or nearly -37% from IPO, the day before their 2016 Q1 earnings results. We believe that a large part of the decline in PPS was due to what could be considered unreasonable expectations.

We believe that Entellus has done what very few established healthcare companies which seek IPOs hope to do: Entellus has utilized it’s cash to leverage strong relationships and aggressively carve into the competition’s market. On the short term this comes at a cost to the shareholders, sure. However, shareholders have jumped ship due to myopia, and not understanding the company’s longer term vision.

2016 has presented Entellus with an opportunity which it did not expect. In their Q1 transcript Entellus outlines how it has stolen market share and capitalized on pressures faced by competitors: JJMC [Johnson & Johnson Medical Companies (NYSE:JNJ)] and Medtronic (NYSE:MED).

One item however, remains a questionable: a $100 million shelf which Entellus has prepared. In the same earnings call mentioned above, Entellus guided that this was created “for good housekeeping”.

We believe that there is more here than just good housekeeping.

Q1 earnings were positive overall, with good guidance in growth and spending, and it’s been quoted that the company has enough cash to become profitable, however the exact quarter that will happen is still far off, and we won’t model that here.

What we want to focus on is the future merger / acquisition possibility for ENTL. We believe the company has come to a ripe position to do one of the following:

• Purchase a smaller eye, nose, & throat (ENT) company (SinuSys) or surgical device company
• Merge with a larger company (Medtronic, J&J, or Intersect ENT (NASDAQ:XENT) inc)
• Acquired by Medtronic or J&J

These are in inverse order of shareholder (short-term) value.

Why do we think now is the time?

The company is at the bottom of its revenue:spending parabola. While spending may increase, or at the very least stay constant, we see revenues increasing dramatically more; the company expects to grow 25% y/y in revenue.

Finally, ENTL has shown (and projected) that “it made it”: the adoption rates of their procedure and devices are increasing, patient and provider feedback is substantially positive, and the procedures continue to deliver efficacy while minimizing tissue damage.

Thus we see ENTL as the cheapest it’s ever going to be, while finally displaying a observable decrease in the risk of market adoption delays or other issues of uncertainty.

Scenario I: ENTL to Acquire a Small Company

If ENTL were to purchase a smaller company, the justification is going to be largely blocked from shareholders until a serious evaluation is put out by the company, or analysts. How this will effect ENTL price is not easy to understand with a back of the envelope calculation, however, luckily for us, the possible targets of acquisition are low.

• SinuSys
• Otogenix
• STStent
• Acclarent

These are a bunch of private companies that likely have smaller acquisition price tags that may just sit within reach of Entellus’ cash on hand. What we’d need to see from ENTL is some type of synergy, or a complete takeover of a major competitor.

Interestingly, none of these guys are that serious of competition (the major competition we’ll look at in the mergers).

SinuSys makes what seems to be a single line of products, which would rival that of the balloon inflation devices of Entellus. However, there’s not a strong reason for Entellus to swipe this at this point, considering there’s not an incredible advantage to SinuSys’ technology, and their market share isn’t large. Unlikely.

Otogenix is, well, private. Real private. Go check out their website. We got nothing.

STStent is definitely a possibility for an acquisition as they have one product line and it’s something that Entellus lacks; a long-term stent (28 days) which allows the sinus cavity to fully heal while maintaining dilation. Although it’s a possibility, it would likely be an expensive purchase and add relatively little value – unlikely.

Acclarent seems like a growing competitor. They have a full line of sinusitis products with a line of ‘catheter’ products, which ENTL does not have. This would again, be an expensive purchase, something that likely the shelf would be required in full for. The synergies are low, but the take-over of a growing competitor would be somewhat enticing. However, Acclarent is owned by Ethicon (which is in turned owned by J&J). This makes an acquisition even more expensive, as J&J is unlikely willing to give this asset up. Unlikely.

To our knowledge, that just leaves an asset of Medtronic in the ENT sector.Unlikely for the very same reasons as Acclarent.

So for acquisitions, we can’t see it happening. But that shelf is likely for something beyond “housekeeping”. Perhaps it is meant to leverage a merger…?

Scenario II: ENTL to merge with another company.

This scenario makes the most sense to us.

We think that there is either not enough value added by an acquisition through ENTL (SinuSys), or that the sticker price is just going to be too expensive. Therefore we’d like to put the idea of a merger in place, and with who:

Intersect ENT.

There is something extremely telling the latest 10-Q put out by XENT:

Our industry is highly competitive, subject to change and significantly affected by new product introductions and other activities of industry participants. Many of the companies developing or marketing ENT products are publicly traded companies, including Medtronic, Olympus, Johnson & Johnson, Stryker, Smith & Nephew and Entellus.

Further, they say

Most of these companies enjoy several competitive advantages, including:

•

greater financial and human capital resources;

•

significantly greater name recognition;

•

established relationships with ENT physicians, referring physicians, customers and third-party payors;

•

additional lines of products, and the ability to offer rebates or bundle products to offer greater discounts or incentives to gain a competitive advantage; and

•

established sales, marketing and worldwide distribution networks.

We’ve emboldened what applies directly to Entellus. Physicians are catching up with ENTL, and the popularity has grown exponentially.

Additionally, we believe that the sales team of ENTL to be doing exceptionally well, while with XENT, the sales team has “reached critical mass”. It’s seen in the latest Q1 earnings report by XENT that sales are likely peaked, and their market has been saturated. Inversely, ENTL had done all of its R&D pre-IPO, and the IPO was nearly solely dedicated to growing sales & market expansion (and it’s been working).

Thus we see that XENT would gain exceptional value from merging with ENTL.

Additionally, XENT had this to say:

If physicians treat more patients in their offices instead of performing surgery in the operating room, our ability to sell PROPEL may be harmed

What this tells us, is that XENT realizes it has painted itself in a corner, and it needs to do something to get out. This story comes out more advantageous to XENT, if a merger were to take place.

However, with ENTL attempting to own the in-office procedure, they are generally leaving the operating room (OR) procedure naked, giving competition easy to maintain their space here. Albeit, a strong consumer desire to have procedures move into the office and out of the OR, for what it’s worth.

The major synergism that ENTL would gain from merging with XENT is that they’ll have access to the Propel product which is a steroid-releasing implant able to reduce swelling and pain post-surgery. Thus, we see a total market strengthening if the merger were to happen, the two companies would be a major force in taking over the OR and in-office procedure. This would shake the market for MEDT and JNJ substantially, and the investing market is likely to respond favorably for ENTL and XENT.

Lastly, the patents are going to begin butting heads, as can be seen here. With ENTL and XENT both grasping for steroid/pain-killer stents for the procedures, this may finally be where an intersect actually happens.

Scenario III: ENTL to be bought by or JNJ.

To put it bluntly, we think if this scenario were to happen, it would have happened already, or needs to happen within the next month.

We believe the next quarterly earnings is going to boost the PPS significantly for ENTL as they’ll show their revenue growth is stable at 25% y/y and ENTL has “made it”. A company would want to purchase before that earnings release for the discounted premium; all the signs are there that ENTL is robust and healthy.

Indeed, the only two companies we see footing the bill is Medtronic or J&J. J&J has no significant holding of ENTL, while MDT holds 5.09%, a significant investment. This makes MDT the more likely candidate.

JNJ has provided diminished guidance for their medical devices segment Ethicon (which owns Acclarent).

Inversely, Medtronic seems to be doing better as indicated from their latest 10Q, with new adoption of a sinus balloon.

So there is pressure for JNJ to strengthen their ENT, while MDT may start to see ENTL/XENT as a serious threat to market share.

We’re not going to model this, but we believe a fair acquisition price for ENTL to be 30-50% of their current share price. The market cap is relatively high, at $343MM, and while they still aren’t profitable, it’s a significant investment here.

Summary

We believe that while XENT has hit critical mass on the sales force, ENTL has hit critical mass in spending and R&D. We believe that XENT needs to try desperately to gain continued growth, while ENTL is finally on the upward slope of profitability.

Here is a prime position for a merger to take place (or for JNJ/MDT to swoop in) and disrupt the market.