Hypes and manias are part of the game of stock markets. Whenever a new trend emerges, more and more people hear of it and start to invest. Commonly, it’s first the professionals and depending on the underlying theme also ultra-contrarian investors. If a story has legs, then the retail crowd jumps in which often leads to exaggerations and bubbles. One of the current hypes is clearly weight loss drugs. But thinking around the corner, is there an overlooked, more conservatively valued stock to benefit?

Summary and key takeaways from today’s Weekly
– Weight loss drugs are currently a big hype – what about a company that offers skin tightening?
– The fundamentals make for a great first impression. But having spent a few hours on this, there are too many risks and potential pitfalls for me.
– Nonetheless, it served as a great case study to show you how I think and look for new ideas.

As a believer and (to the best I can with minor exceptions) practitioner of a healthy diet myself, I have a rather skeptical view on these new pretend wonder drugs Wegovy and Zepbound from diabetes specialists Novo Nordisk (ISIN: DK0062498333, Ticker: NOVOB) and Eli Lilly (ISIN: US5324571083, Ticker: LLY).

Here’s a page that explains some differences between the diabetes drugs and their weight loss counterparts which are using the same base ingredient, though under different dosing and administration methods (German: here, English via Google Translate: here).

Besides that we don’t know for sure about potential long-term side effects by interfering into the metabolism, respectively natural processes of our bodies, this is clearly another way for an industry to benefit from one’s misfortune, but also in many cases self-caused unhealthy conditions that are often preventable, and if there, also reversible with some knowledge and discipline, to put it mildly.

I am talking about the miraculous injections which propelled those stocks higher.

They cost several thousands of dollars per year to help reduce weight. This topic is well known and the stocks have already priced in a huge success (free cash flow multiples of 40x for Novo and even 80x for Lilly) as especially the wealthier western part of the world has a known overweight problem among its population.

The numbers reach from every third to even every second American being obese, thus offering a huge potential customer base. As many people are not willing to bring about a change by themselves – I see it in my everyday life – this will likely be a treasure trove for the aforementioned companies.

However, I don’t like chasing trains that left the station.

What happens to companies with inflated expectations and valuations is well known. Sooner or later, the stocks dramatically underperform. Some don’t reach their former highs for years or even more than a decade, even though the underlying business continues to grow! Keep this always in mind, even if Nvidia (ISIN: US67066G1040, Ticker: NVDA) or the mentioned Lilly are currently still pressing higher.

While I think that, as it stands now and ceteris paribus, Novo and Lilly will be able to generate massive extra sales and income from this “side-kick” (not their actual, traditional business), the valuations of the respective stocks are already beyond a reasonable range for a fundamentally driven investor.

So I asked myself the question whether there’d be a stock outside the spotlight to benefit from this new theme?

When someone loses pretty much weight and fat, it is obvious that the formerly overstretched skin remains. While the person might be healthier and therefore have less risks for cardio-vascular issues, the result is leaving an optical picture almost as unfortunate as before for the affected person.

Who wants to walk around with excess tissue hanging down at the waistband?

Although it is not a weight loss company, there is one publicly traded business that offers among others minor fat loss procedures and more important skin tightening treatments for people who either want to or already have lost some fat, say 10–20% (but not those extreme cases).

Will this be a direct beneficiary of the weight loss hype?

The chances for such procedures to gain more attention and demand is quite high. Especially, as the company I will discuss today offers its services under conditions that are both, financially and also medically advantageous, compared to traditional optical corrections.

Also, the company is rather small and not hidden inside a blue chip company where it barely moves the needle.

Let’s think a bit around the corner today.

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After weight loss comes skin tightening

Today’s stock pick for a check up is InMode (ISIN: IL0011595993, Ticker: INMD), an Israeli-based company specialized in developing and selling radio-frequency (RF) devices for cosmetic treatments.

Or as they describe it themselves in their annual report:

“We are a leading global provider of innovative, energy-based, minimally invasive surgical medical treatment solutions”.

InMode annual report 2022, p. 27 (see here)

The company exists since 2008 and the stock is traded on the NASDAQ since 2019. With a market cap of 1.8 bn. USD it’s no heavyweight, but liquid enough.

While there are many competitors, big and small, public and private, like for example AbbVie’s (ISIN: US00287Y1091, Ticker: ABBV) division Allergan with offerings like Botox, hyaluron face fillers or CoolSculpting (a non-invasive method using cooling to get rid of smaller parts of body fat), InMode seems to be a more innovative company.

At least, they set themselves apart by offering minimally and even some non-invasive procedures that make it possible to tighten and rejuvenate one’s skin without the issues of classic surgical interventions which produce scars, while also eliminating longer downtimes for recreation from surgery and the need for being under anesthesia.

The key difference is that they use a form of radio-frequency with two pulses, showing strong results and reducing the amount of therapeutic sessions needed. Using radio frequency is not a novelty per se.

This approach in beauty and cosmetics is rather new and quickly expanding.

Celebrities like Eva Longoria help to raise consumer awareness by submitting testimonials and talking about their minor complaints.

Also in the presentation, InMode shows pictures of their machines, but also some customers with before and after looks, which I pasted here, instead of trying to describe it all as a non-medician.

See for yourselves what InMode promises.

If you’d like to see more, feel free to flip through the slides yourself (see here).

^{source: all InMode – latest November 2023 investor presentation (see here)}

While this looks like minor cosmetics, during the last conference call in November, management was explicitly asked whether they could be a beneficiary of the weight-loss hype.

The answer was: yes!

Having a brief look at some cornerstones (at least for me), this makes for a strong first impression and promising idea:

• the balance sheet is debt free, high net cash position
• a highly profitable business, no start-up
• double digit margins
• highly free cash flow generative
• founder-led
• dramatic growth in the past, likely more to come in the future, assuming the weight loss hype continues
• an enterprise to free cash flow multiple of only 7x (no typo!)

Reading such an intro, one would expect to have found a no-brainer for a home run.

But as is often the case, this one here has also a few blemishes. The stock tells you that something’s likely not running as smooth as it should:

While the stock returned 108% since its IPO – this is respectable – you can see that the shares first were a multi-bagger by roughly tripling, only to fall by more than 70% more or less back to where it came from initially.

There are several things that in combination have led to the rather brutal correction of an otherwise what it looks like sound business.

Starting with its location, being based in Israel is seen as risk factor. The company has its headquarters in the northern part of the country. Even though its most important market is the USA, followed by a growing international business outside of the Middle East, InMode’s suppliers are also Israel-based.

Though management could not deny that they are in a risky and uncomfortable situation, they also explained that they have enough supply for the next six to nine months. This is at least the explanation for a part of the recent drop, as many investors seemingly turned more cautious.

However, you will see that the stock lost the majority of its price from late-2021 until 2022 already, when there was no war.

Ironically, during the periods of lockdowns, the business was thriving and many people underwent treatments. Management explained it this way: as people could not travel and in some parts also had excess savings left over, they set up for personal improvements.

You can see that the sales growth rate dropped massively, from once over 120% to “just” around 25% in 2022. As the valuation multiple was also somewhat high, it fell from 70x to just the low- to mid-teens, in tandem with slowing sales growth.

Remember too high expectations and stocks falling despite growth in the business?

But that’s not all.

The year 2023 proved to be more challenging than thought, not even having to do anything with the situation in the Middle East.

As the US economy, but also Europe and parts of Asia, have slowed down, people started to become more restrictive with their discretionary spending. This is entirely pay-for-yourself, no insurance or even publicly subsidized service. While one cannot escape or postpone housing and eating, such cosmetic treatments clearly can be.

In Q3 2023, sales growth was only 2% compared to the same quarter a year ago.

During the last call, management also said that there was a seasonal part to it, as people don’t like to undergo such treatments during the summer holidays when on vacation which frankly makes sense to some degree.

At the latest in early December it was clear that it’s the economical situation that made the difference. The prior guidance was too optimistic. Management had to reduce their guidance for this year, sending the stock lower by c. 10%.

Having grown strongly in the double digits, it is questionable and even unlikely that InMode will continue to grow at all, at least in the short term!

Last Tuesday (see here), management again published an update to up the priorly revised guidance a bit. Now, they are expecting to come in somewhere between the old guidance and the revised one from December.

All in all, this is still a slowdown in business.

While they will likely beat the 454 mn. USD in sales from 2022, even with the reduced guidance, I have some doubt that from there on there’ll be that much growth, if any. At least for the foreseeable future.

Besides issues on the consumer side, also InMode’s customers are facing challenges. With higher interest rates, also leasing costs increased dramatically. While one could think that 5% interest rates is not much – management said during the call that doctors and surgeons who typically lease such equipment, have to pay 13–15% in interest. This is a completely different calculation for them to turn a profit.

The question will be whether this is already baked into the price of only 7x EV / FCF or if there are other risks and potential pitfalls.

Personally, not having enough in-depth knowledge about this industry regarding competitive advantages, I feel somewhat insecure with this case. In other words, I cannot express proudly that this could be one of my best ideas, as the unknowns and risk components are too high and too many.

Reading InMode’s annual report, I stumbled upon a few pieces that confirmed my hesitating stance.

The competitive landscape as well as the topic around patents and legal disputes is better not to be underestimated.

Though InMode has a few patents and more applications filed, there are often legal disputes in the courts.

And InMode even already lost one itself, having had to pay not only a penalty to close the case, but it also had to pay a license fee to a competitor – ironically, a company the CEO founded and led himself before starting InMode – as it could not circumvent the issue. The potential to be caught on the wrong foot is quite dramatic.

The other way around, InMode filed a complaint itself against a competitor recently, though in a different therapeutic area (see here). Unfortunately, this is reality and part of the business.

Should for any reason a big fish like Abbvie / Allergan drag InMode to the courts, it is likely that their biggest expenditure suddenly becomes legal fees, not research and development.

This by the way was also a comparable case with two ideas of mine for my members: a former one and a current one where I changed horses after the underdog won a year-long legal battle.

The switch was a great decision as the new pick is up by 25% since my report was published. On the other side, the first pick which was closed at a minor neglectable loss, fell slightly further.

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The final two points: I simply don’t know whether this form of treatment will still be there in ten years or so. Maybe someone comes up with a novelty, crushing the novelties of today?

This is hard to tell.

Maybe if there’d be just one of those risks, I could live with it. But taking them all into consideration makes me step aside. I think I will put this name on my watchlist and have a look into it from time to time. It is also possible that I will understand this case better only with time.

But overall, no thank you and not now.

As a malus to end this weekly: InMode has around a third of its market cap in net cash, the majority available. Management, however, does not buy back stock at a 7x multiple – it did in the past at several times this number. Being asked during the call, they said they prefer to look for takeover targets and that a competitor recently bought back stock and that the stock dropped nonetheless.

Hmm…

Conclusion

Weight loss drugs are currently a big hype – what about a company that offers skin tightening?

The fundamentals make for a great first impression. But having spent a few hours on this, there are too many risks and potential pitfalls for me.

Nonetheless, it served as a great case study to show you how I think and look for new ideas.

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