Pinned valuation:
October 23
Given Polynovo was a popular topic of conversation yesterday at the Brisbane meetup, I thought I might share my valuation methodology for some feedback after updating for FY23 numbers.
My valuation is based the following assumptions:
- Cost per employee and other expenses as a percentage of revenue are relatively stable.
- Gross margin of 85%. Is this correct/conservative?
- I am conservatively (or maybe not??) assuming the growth isn't going to continue or accelerate from current position.
- R+D of $5-6mil a year.
- Assuming a PE40 in FY28 with 15% discount rate (required return). In all cases this gives a PEG of less than 2.
- Additional 70 employees a year to create the growth.
The two major factors contributing to the profitability of Polynovo and hence my valuation after the above assumptions are:
- The increase in revenue over time
- The extra cost of the additional employees which enables the revenue growth.
I'll start with where I get my numbers from. The table below extracts the % in comparison to revenues from previous years to be able to make the assumptions going forward:
My base, stretch and bear cases are below, orange cells are inputs with the highlighted yellow being the discounted back valuation. My final valuation is the average of the three at $2.19.
Would be extremely interested in any feedback and thoughts on the above! Models are never correct and my model above is somewhat simplistic. When I do the numbers in the way I have Polynovo looks like a potential cash printer but I don't know if my numbers further down the line are a bit too optimistic!
Have you considered the investment required through the balance sheet? Working capital runs at 15%-20% of revenue. You've scaled the D&A expense as the company grows, but remember D&A only starts after you have acquired (paid for) the assets. It looks as though implicit in your D&A expense assumption is an ongoing growth capex requirement that looks similar to the setup at the moment where PP&E is ~18% of revenue. Taken together these are two fairly significant items – ie growth is not free even for cap light businesses. And that's before competition, inertia etc enter the value picture. Obviously if your estimates play out then this is all academic and the business won't need cash or will have no problem raising debt or equity cheaply.
But, following on from that, I'm a cheapskate, so your bear case looks like my stretch case. I'm not sure a bear case that doesn't include any further need to raise capital, has revenue growth of 600% over the next 7 years with high single digit EBIT margins rising to 20%+ and an ending PE of 40x is...bearish. That to me would be what an absolute killer company looks like.
I haven't done as much work on PNV as you have. I have put it in the too expensive basket a while back and haven't really followed it too closely so all of this is just rubbery thoughts.
Cheers
Hi @Dominator Its interesting that your average valuation is $2.19. Compares with $2.00 for my latest (range of $1.63 - $3.30 across a range of scenarios).
If I take one of my central scenarios, which is closest to you average, I have $2.16 and I'll respond to your assumptions referring to that case, for simplicity.
Cost per employee:
I break these out into Sales and Marketing and non-Sales and Marketing.
In Sales and Marketing there is a big dependency on where the sales is coming from. For example, USA, EU and ANY sales reps are typically $160k/FTE(fully-loaded), whereas in developing markets like India its much lower, so I've assumed $40k/FTE, but developing markets are likely to inflate more rapidly.
Non-Sales and Marketing Staff are skewed by high management costs and I have a starting point here of $269k/FTE.
I've triangulated the total wage bill off recent headcount and wages reports in the Annual Reports.
Although R&D will (and should grow) rapidly, overhead costs should scale more slowly than sales, so this is one source of operating leverage.
I can't tell you precisely how $/FTE scales in my model, because my approach is to scale G&A and R&D as absolute costs over time.
Gross Margin
Historically, Gross Margins have been mid 90%. Its an incredibly capital-light product - almost unique in medical devices.
I have the starting point for %GM at 95%, falling to 91% when the new facilities come onstream.
I end up with %GM in 2030 at 92.5%, as by that time the new facilities are almost full. However, this is a weakness in my methodology. I do not explicitly allow for the impact of lower prices in emerging markets to feed into %GM. (To be corrected in my next update in March)
However, I am OK with this "error" because in my model, emerging market revenues only account for $47m of reveue vs $333m in developed markets.
So, your model assumes a significantly lower %GM than I think they can achieve. This is why we get similar valuations, even through your revenue growth is much stronger than mine (see below).
Revenue Growth
I agree with you. Growth will not accelerate from here. It I though it would, I would mortgage my house and go all in!
You are more agressive on revenue growth than I am.
Your Base annual revenue progression to FY24 and beyond is, with mine shown in the next line:
60%, 50%, 40%, 35%, 30%, 25%, 25% landing at $613m in 2030
54%, 31%, 27%, 25%, 23%, 21%, 20% landing at $380m in 2030
R&D
We have differnent approaches. I think they will spend a lot more to expand applications.
So I have then starting at $9.3m in FY24 and growing to $36m in FY30, although as a % of revenue I am going from 14% down to 9.5%.
Employee Growth
My total FTE in 2030 is 665, so I've been adding just under your number. I expect I am adding more earlier on and fewer later, as headoffice and R&D reach scale.
On P/E ratios
Our approaches are different, as mine is a DCF. But when I backsolve my model, I get a P/E in 2030 of 24.
Hope that helps. Of course we can all get whatever numbers we like, but the great thing about modelling is that it builds understanding of what's important and risk-reward.
@Dominator I'm no expert on PNV, and i think this is where qualitative and quantitative aspects become important. If PNV 10X rev and moves from ebit losses to enormous profits, it will be another PME, maybe better. that is amongst the best-performing shares on the exchange- ever. of course, it depends on the likelihood that their product dominates (excuse the pun) the competition. is their product 10X better than the competition? thats the question i would ask.as i said im no expert
I missed the note on the Brisbane catchup - I'm based here and be keen to catchup with Strawfolk next time...