Masimo Stock: Sound Deal Might Not Be Sound (NASDAQ: MASI)

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Doctor reviewing patient medical record on digital tablet

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On the first day of February, I thought that Masimo (MASI) was getting a bit healthier after a very fierce sell-off. Shares hit fresh 52-week lows, albeit that it was not alone is appearing on this list at the time. Fast-forwarding a couple of weeks in time, shares have moved another leg lower on the back of a questionable deal, which might look a bit thin on the strategic front, but the deal multiples look fair as the current share price reaction feels like a gross overreaction to me.

Non-invasive Medtech Play

Masimo is a medical technology player which focuses on the development, manufacturing and marketing of non-invasive monitoring technologies. Founded in 1989, Masimo is a big player in this niche market, recognized for quality and innovative solutions.

The core line-up includes measurement through motion and low perfusion arterial blood oxygen saturation and pulse rate monitoring. Measuring these levels typically is not hard, yet when patients are in motion, it is Masimo which provides much more reliable results.

Since its IPO back in 2007 at $ 17 per share, the company and shares have generally seen good times. By 2017, shares hit the $ 100 mark, to even hit the $ 250 mark weeks after the pandemic. After some volatility surrounding the pandemic, shares actually hit the $ 300 mark late in 2021 as the company was doing just fine.

After all, the company already announced preliminary full year results for 2021 in January of this year. This guidance called for sales of around $ 1.24 billion, as both GAAP and non-GAAP earnings were seen at $ 3.88 per share. Net cash of $ 652 million worked down to $ 11 per share and with share trading at $ 215 in early February, operating assets were valued at around $ 200 per share, or about 50 times earnings. The company guided for 2022 sales growth around 10% with sales seen around $ 1.35 billion, as adjusted earnings were guided to rise to $ 4.30 per share, still working down to 46 times earnings multiple.

Despite the dramatic share price underperformance of the shares over the past two years, I felt that the valuation was still high at 46 times earnings, leaving the company very susceptible to higher interest rates, despite the quality and operating momentum of the operations of the company .

What A Difference A Month Makes

In fact, it has been just six weeks since I last looked at the shares, and fast-forwarding this period of time, shares are down to $ 135 per share, with shares down 35% despite a solid net cash position.

By mid-February, the company posted its results which were in line with expectations, as sales came in at $ 1.24 billion, with non-GAAP earnings posted at $ 3.99 per share, and GAAP earnings a penny lower, as the company maintained the 2022 guidance provided a few weeks earlier. So far, no surprises.

The big news event was that Masimo has reached a $ 1.025 billion deal to acquire Viper Holdings, the owner of Sound United which is a consumer technology company. The company is known for brands like Bowers & Wilkins, Denon, Polk Audio and Marantz.

Financing the deal should not be a major issue as the company ended the year with three-quarters of a billion in net cash, resulting in a very modest net debt load on a pro forma basis. Remember that the 57.8 million shares still valued the company at just over $ 12 billion at $ 211 per share early in February, or $ 11.4 billion if we factor in net cash. This is equivalent to roughly 9 times reported sales.

The issue is that the deal is completely outside the core competency of Masimo. After all, Sound is a consumer technology name found with many retailers. The rationale is supported by the observation that audio expertise results in consumer products which over time can be coupled with Masimo’s remote health monitoring businesses.

Deal multiples actually look quite reasonable as Sound is set to add nearly a billion in sales and some $ 125 million in adjusted EBITDA, resulting in very reasonable multiples. This is certainly the case as shares lost more than $ 80 upon the deal announcement, shedding over $ 4.5 billion in value on the back of a billion-dollar deal!

And Now?

The 58 million shares outstanding have fallen further to $ 135 per share, reducing the equity valuation to $ 7.8 billion, or its enterprise value to some $ 8.1 billion after we factor in the deal. The $ 125 million in EBITDA contribution from Sound should probably easily boost earnings by a dollar, making a $ 5-6 earnings per share number on a pro forma basis attainable, while leverage is no issue at all, while multiples fell to 23-27 times earnings .

Truth is that this market reaction simply feels like an overreaction as the strategic rationale (other than becoming a telehealth consumer player) is a big soft. On the bright side, it simply feels like an overreaction, as more news should be given at the Investor Day, and given the good track record, perhaps some benefit of the doubt should be given to the management here.

Hence, a still richly valued company early in February has been reset to normal valuation, quite appealing based on the core business. While the rationale behind the deal is perhaps little, and perhaps management is making a big leap forward, the extent of the value destruction in the share price in relation to the deal tag has been unprecedented, which made that I have initiated a position here.

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