InfuSystem (INFU) shocked investors in two respects on Thursday, February 10. First, they surprised by releasing 4Q21 and FY21 preliminary results with an accompanying conference call; and second, by showing disappointing results from their 4Q21. The company cited the Omicron variant as the primary reason for a disappointing Q4. But perhaps more disappointing to investors was the revelation that the company had not yet fully executed the contract with their global biomedical services partner they announced in the 3Q21 earnings release.
In reaction to these results that were below both management and analyst expectations, shares dropped by more than 25% on February 10. In this article, I will analyze the situation and argue that the recent stumble provides an attractive risk/reward opportunity for investors. Specifically, I see 25% downside to current prices as the worst-case scenario, with 300% upside possible over the next few years.
All in all, the temporary disruption of business related to Omicron, and the longer-than-expected execution of the biomedical services contract, has nearly zero impact on INFU’s long-term fundamentals and outlook. Based on the fact that a Director recently purchased shares on the open market and the company repurchased $560,000 of its own shares in 4Q21 (at higher than current prices), investors can be assured that the Board of Directors and Management also believe the company is currently undervalued. I will discuss my own view in more depth below, making the case that INFU can still attain a $40+ share price over the next three to five years.
From a medium-to-long-term perspective (i.e. 18-60 months), absolutely nothing has changed at INFU since my last article where I highlighted INFU’s potential, and why I think they could eventually be valued around $1B. As a refresher, I will highlight several key aspects of that vision here.
INFU’s services are provided under a two-platform model. Integrated Therapy Services (ITS) provides the last-mile solution for clinic-to-home healthcare where the continuing treatment involves complex Durable Medical Equipment and services. Their second platform, Durable Medical Equipment Services (DME), supports the ITS platform and leverages strong service orientation to win incremental business from direct payer clients.
As the healthcare industry moves towards home-based care and a service-oriented model, INFU has benefited significantly, and several opportunities have presented themselves to the company. In 2021, INFU made a slight pivot in its business plan. I like to sum up this pivot by saying that INFU went from being a cash cow to a business aggressively investing cash back into its operations in order to become a much bigger cash cow over the next 3-5 years. It is important to note, however, that INFU has never veered from its core competencies or from this two-platform model. Rather, it is simply leveraging this model for a much larger long-term benefit.
To wit, the company specifically mentioned on the 3Q21 call that they expected to “double revenue” over the next few years (which CEO Rich DiIorio reiterated on the 4Q21 preliminary results call), with continued growth expected after that. In doing so, the company will be diversifying its customer and payer base, expanding into additional therapies beyond their highly successful oncology ITS business. However, as noted, all of these additional therapies will make use of the ITS platform that INFU has honed over the past few years in oncology.
In the “Valuation” section below, I will provide a little more detail on each of these areas of business where INFU expects to grow. Here, I will simply list the various types of business: oncology, pain management, wound care, lymphedema, and biomedical services.
INFU’s 4Q21 Results
As noted in the intro, INFU’s 4Q21 results were disappointing. Revenue came in about $5M below the level necessary to meet management’s previous guidance for the full year. In hindsight, this revenue miss should not have surprised anyone given the fact that the Omicron variant ripped through the US during 4Q21, disrupting almost all healthcare companies in one form or another. Many patients with non-life-threatening illnesses or health issues delayed or bypassed medical care in hopes of avoiding Covid. This inevitably impacted INFU.
In speaking with several other investors, I believe part of the shock of INFU’s earnings miss was due to the bullishness of INFU CEO DiIorio. In presenting at conferences and speaking with investors privately, DiIorio has maintained a very optimistic tone on the company. And justifiably so! As the CEO, DiIorio is managing the business for the next 3-5 years and beyond—not to make a rather artificial quarterly target. Still, investors do not like negative surprises, and so many of them were also understandably frustrated in feeling blindsided by the quarterly miss and the contract execution delay.
Putting aside the emotions an investor might have from this scenario, we should step back and see that INFU’s performance in 2022 and beyond is not impacted by this temporary disruption caused by Omicron. The only issue that might impact their 2022 numbers is the delay of the final authorization on their new biomedical services contract.
Status of Biomedical Services Contract
INFU first mentioned a large new biomedical services contract on their 3Q21 conference call. At that time, November 15, 2021, DiIorio expected the contract to be fully-executed by EOY ’21 and for revenue to begin kicking in by early 2022. Given INFU’s revenue in 2021 was roughly $102M and this contract is expected to bring in an additional $15M of revenue annually, this new partnership is highly material for INFU. As of the February 10, 2022, preliminary earnings release, the contract had still not been executed. This is likely the biggest reason INFU was punished so severely on their 4Q21 preliminary results, so it is worth assessing the situation to discern if the 25% stock price drop represents an attractive buying opportunity.
In listening to the 4Q21 preliminary conference call and in speaking with people familiar with INFU, I have little doubt that INFU’s yet-to-be-named partner will execute the contract. CEO DiIorio summed up the situation best on the call when he noted that while the contract is highly material to INFU, it is rather immaterial for a multi-billion-dollar global organization like the one with whom they are partnering. As a healthcare organization, INFU’s partner was also disrupted by Omicron, which certainly did not help. Furthermore, in my experience dealing with small-cap companies, their management team almost always underestimates how long it takes large organizations to move, even for seemingly simple tasks.
And to be sure, the only thing left for the contract to be executed is a rather simple task. According to my sources, INFU is simply waiting for their partner’s legal department to review and sign off on the contract. There has been zero discussion about changing the terms of the deal, of dissatisfaction with INFU, or any other issue with this partnership progressing. In fact, INFU is already at this point of having agreed to terms because their partner selected them through a rigorous process. To everyone’s best knowledge, the only delay is that a multi-billion-dollar global organization dealing with Covid (and the normal holiday season lull) had more pressing issues than executing a $15M/year contract.
According to “Occam’s razor,” the simplest explanation is usually the best. With respect to INFU and this contract, the simplest explanation is that small-cap companies almost always underestimate how long it takes large organizations to move, and INFU therefore overestimated how quickly the contract would be signed, even after the full agreement on contract terms. The only other explanations would involve much more complexity and improbability.
From a fundamental business perspective, the biggest near-term risk for INFU is that Occam’s razor is incorrect as it relates to their current biomedical services contract status. That is to say, the biggest risk is that the contract is never fully executed and INFU does not pick up this material $15M/year revenue bump. While that is not impossible, it is also not probable for the reasons noted previously. Furthermore, as CEO DiIorio noted on the 4Q21 preliminary call, in this worst-case scenario, INFU has other opportunities to earn that revenue with other possible partners if this one falls through. Clearly, no one at INFU desires or expects for that to happen, but investors should be assured that this contract succeeding or failing is not a zero-sum proposition.
From a stock price perspective, the biggest near-term risk is how investors respond over the next couple of quarters after some of them were unpleasantly surprised by the 4Q21 earnings miss. It remains to be seen how quickly investors begin to trust INFU’s management team again. Investors do not like negative surprises, but my educated guess is that INFU’s management team will be reporting positive results and news in upcoming quarters. Consequently, my expectation is that DiIorio and team earn back investment community trust and INFU’s share price recovers to better represent the company’s value.
The final risk worth noting is that INFU is entering several new businesses even though all of them simply involve the company leveraging its current two-platform model. Still, as they enter these new indications and work with much larger organizations, it is possible the company will see some temporary delays or bumps in the road similar to what is happening now with the biomedical services contract. INFU investors should be aware that the company is not a quarter-to-quarter story as much as it is a year-over-year story.
My valuation of INFU has not changed materially from my previous two articles. The reason is that the Omicron disruption and the delay in fully executing the biomedical services contract do not change the business from a three-to-five-year perspective, which is my investment timeline with INFU. Therefore, the only thing that has changed is my expected return on current shares, which I believe could now quadruple over that timeframe.
Below, I break out by indication my expectations over the next 3-5 years.
- Oncology ITS and DME legacy businesses continue to grow at a 3-5% annual clip.
- Pain management should reach $15M run-rate revenue by EOY 2022, if not sooner. I consider there to be some further upside in pain, but to be conservative will model pain revenue to grow 3-5% annually after ’22, like oncology.
- Biomedical services should be at a $15M revenue run-rate within one year or less after the contract discussed in this article is finalized. I continue to model $40M in annual revenue for that division in three years given the fact the company has previously indicated ongoing discussions with other possible partners.
- Wound care revenue should start being material in 2022. I will maintain my estimate of $40M in revenue from wound care in three years.
- Lymphedema has the largest TAM of all indications, but the company has consistently guided it will be the slowest among those mentioned here to ramp. In fact, no material revenue from this indication is expected until 2023. With a TAM of $1.5B, and INFU’s expectation of obtaining about 10% of that market share, in 5-7 years this therapy could dwarf their current total business.
- AEBITDA margins should be around 30% within 3-5 years, with the company unlikely to slip below 25% margins in the interim. This year was an exception because the company invested in human resources and DME that will not produce revenue until 2022.
Based on these assumptions, I expect INFU revenue to be at a $265M run-rate, with AEBITDA run-rate of roughly $80M by EOY ‘24. Considering that INFU will likely still be in a growth phase for the next five years, minimum, I would use a 12x EV/EBITDA multiple, which gets me to an enterprise value of $945M, or $42/share, nearly quadruple current prices.
On the possible downside, we should consider that INFU already produced $24M in AEBITDA for FY21. This number could have been significantly higher had INFU not invested in human resources and DME whose revenue potential will only be recognized in 2022 and beyond. In any case, based on this metric, INFU trades at roughly 10.5x trailing AEBITDA. Even if the company were to fail in adapting to these new therapies expected to come on-line for them, they can still make money from their legacy business, and thus it would seem the downside risk is around $8.00/share, or around 8x trailing EBITDA.
All in all, it appears INFU is a stock with downside of roughly 25% and upside of up to 300% over 3-5 years. To me, this is an extremely attractive risk/reward scenario, which is why I am once again overweight on INFU at this sub-$11/share level.
INFU surprised investors by pre-releasing disappointing, Omicron-impacted, FY21 results. Combined with a delay in contract execution of a new biomedical services contract, these results led to the stock being severely punished, to the tune of a 25% one-day drop. I believe that despite these hiccups, INFU’s medium-to-long-term prospects remain unchanged. The company’s Board of Directors and Management seem to believe so as well, given the recent Director open market purchase and the share repurchases the company made in 4Q21 (at higher than current prices). Investors who are patient and who believe management can execute could be rewarded with massive returns over the next 3-5 years. Despite seemingly limited downside risk, INFU shares could possibly quadruple from current sub-$11/share prices, offering an attractive risk/reward scenario.