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Six months since my last update on the company, the situation at Inogen (NASDAQ:INGN), a leading provider of portable oxygen concentrators (or POCs), is a little more interesting. The financials really haven’t improved and there are still valid concerns about the company’s strategic positioning, but the company has another new management team in place and has the opportunity to leverage the sudden market exit of a major competitor.
Even with the shares popping more than 50% since my last update (largely on the news of that competitive exit), expectations are minimal and the shares trade close to 0.5x forward revenue excluding the cash on the balance sheet. That’s a pretty bleak outlook for a company with what should be a viable product in a real market; if management can staunch the bleeding and recraft a more sustainable go-to-market strategy, there’s meaningful upside here.
An Opportunity To Leverage A Competitor’s Profound Troubles
It’s hard to properly express just how comprehensively Philips (PHG) appears to have screwed up their respiratory care business, but the relevant takeaway here is that the company announced back in January that it was exiting the U.S. POC business with pretty much immediate effect.
While Philips had lost some share in recent years, the company’s market share on exit was still somewhere in the 15% to 20% range, and that leaves Inogen as really the only “premium” provider left in the market – ResMed (RMD) bailed out on the POC market back in 2021 due in large part to frustrations with how the market was evolving (a slower than expected shift toward POCs versus tanks and stationary concentrators) and difficulties making ground in the direct-to-consumer market.
Given that POCs aren’t strictly necessary (portable tanks do work), it’s not as if the business Philips is abandoning will automatically flow directly to Inogen. Nevertheless, it is still a meaningful opportunity for Inogen if the company can successfully restructure its go-to-market strategy, as I believe there is still a real demand for these products.
A New Management Team Will Have A Lot On Their Plate Initially
Inogen’s board made the decision to replace its now-former CEO Nabil Shabshab in November of 2023 after a roughly two-year tenure.
Shabshab’s tenure saw a lot of issues on the manufacturing side (due in no small part to pandemic-driven component shortages), as well as very inconsistent performance in marketing. While the strategic decision to shift the company’s focus to rentals over direct-to-consumer sales did generate significant revenue growth, it has come with lower margins and higher cash consumption – though it’s admittedly hard to tease out the margin impact given the significant challenges the company had with component sourcing/pricing.
The new CEO, Kevin Smith, has a long work history in the med-tech space, serving most recently as the CEO of Australia-based Sirtex. The company also brought in a new CFO, with the hiring of Michael Bourque announced back in January.
So far the new management team has been guarded in their comments about what the new strategic direction for the company will be. What I gather from what they have said, though, is that they want to push the premium POC offering angle with the idea of being a partner of choice for home medical equipment companies (both B2B and rental), and further refine/improve (but not abandon) the direct-to-consumer model. Management has also made it clear that Physio-Assist (acquired back in mid-2023) is a priority.
At this point I don’t really have an issue with what I’ve heard. I think there is money to be made in establishing Inogen’s products as the go-to premium offering. The basic technology of POCs is pretty straightforward (they all operate on basically the same technology), but there are opportunities to differentiate yourself in the market with features like weight, battery life, noise, and customizable features. Given that POCs are in some respects a “luxury item” (many services push patients toward tanks or stationary concentrators), these are important areas where Inogen can differentiate itself and stand out from the numerous clones in the market.
I likewise think there are still credible opportunities in the B2B and rental spaces. While the pace of adoption of POCs has been frustratingly slow, I do think the market will continue to see POCs gain share and these channels should offer growth.
I have more concerns and questions about the direct-to-consumer side. This has been a tough place to operate (as I said, ResMed had their fill after three years and bailed out), and it seems to me that it is very much tied to ongoing DTC marketing efforts – TV ads drive marketing leads for the salesforce and the salesforce then tries to close the sale (and in the past, Inogen’s approach had been pretty high-pressure).
My concern, then, is that it’s tough to gain any sustainable scale – not only to you have to spend money to make money, you have to keep spending and spending and I think you eventually pluck all of the low-hanging fruit and then see sales trail off before that patient pool builds back up (which seems to have happened at times at Inogen). Relative to the B2B and rental, then, it seems like an inherently less stable and scalable sales approach.
The Outlook
Inogen did about what I expected for sales in FY’23 ($316M versus $319M), but the company saw even more pressure on gross margin than I’d expected, driving a substantially worse EBITDA and free cash flow result.
Management has been unwilling to go more than one quarter out with guidance, which I think speaks to the fact that they’re still getting their arms around the business and what needs to be changed to maximize the company’s future prospects.
I’m looking for a modest improvement in revenue this year (around 1% to 2%) and a bigger uptick in FY’25 (up about 7%). It’s plausible that they could pick up a bigger tailwind from Philips’ exit sooner than I expect, particularly as I think medical equipment companies would prefer to deal with more established partners (like Inogen) than smaller generic manufacturers. Still, with the DTC business posting 20%-plus year-over-year declines, I don’t want to get to far ahead of things.
Inogen has been profitable in the past at the sort of sales level I expect in the near future, and I do think the company should see some tailwinds from easing input costs in 2024. Still, there is a lot to resolve in the business, including pricing pressures in the B2B market, and I don’t expect positive EBITDA in FY’24 or FY’25. I do think low-to-mid teens EBITDA margins should be possible down the road, but I also note that the company may elect to invest more heavily in launching/supporting Physio-Assist.
As far as cash flow goes, a lot depends on whether the company elects to maintain/grow its commitment to the rental business. This is far and away the largest driver of capex in recent years and a big swing factor in future free cash flow margins – Inogen generated double-digit FCF margins on relatively low revenues when rentals were a small part of the business, but spent about 7% and 5% of revenue in the last two years on capex for rental units. At this point, I’m modeling as if rentals remain a major part of the business mix.
If Inogen can generate around 5% long-term revenue growth and return to mid-single-digit free cash flow margins, the fair value of the shares is over $12. Likewise, a 0.5x forward EV/revenue multiple gets me to a little over $12; unfortunately, it’s not uncommon now for low-growth small-cap med-tech to trade at less than 1x revenue, as the market just isn’t interested in these stories.
The Bottom Line
Expectations are definitely low here, but even so there are significant risks. It may well prove to be the case that further POC market penetration will be resisted by payors and/or that generic POC manufacturers will continue to dominate the market and continue to undermine pricing. Inogen has an opportunity to stand out as a provider of choice with better product features and customer satisfaction, but there is still a lot of work to do on the go-to-market strategy and the market just may not be willing to pay a fair price for what Inogen offers.
I see the speculative appeal here and I’m not betting against Inogen, but I would at least like to see/hear a more coherent plan for what this management team is going to do differently and I want to see a little more predictability in the DTC and B2B businesses before getting more bullish.