One of the worst performing IPOs of 2019 was undoubtably SmileDirectClub Inc. ($SDC). Shares hit their all-time high on their first trading day, 9/12/2019, at one point reaching $21.10 a share. Since then the shares have slid substantially, by the end of 2019 shares were down 58.6% from their all-time high. While I was uninterested in this IPO at the offering price range given, the newly marked down valuation is much more appealing and news of late intrigued me enough to take another gander.
SmileDirectClub (SDC) is a vertically integrated teledentistry firm with the core belief “everyone deserves a smile they love.”1 In simplest terms, the core business of the company is to sell clear aligner braces.
SDC has the following intellectual property around their processes, manufacturing and software.1:
On January 7th 2020, SDC announced it will be expanding its addressable market by offering an exclusive new line of oral care products at over 3800 Walmart locations.2 This announcement solidified SDC’s entrance into the market for: electronic toothbrushes, teeth whitening kits, toothpastes, water flossers, & smile spas (a unique dental product cleaner). Simultaneously, SDC introduced two additional items available on their website, a “club edition electric toothbrush” and a replacement toothbrush head subscription.2 This announcement was positive news for multiple reasons, the first is brand awareness. With entrance into a multitude of Walmart stores, SDC will help their name be recognized more readily which in turn should boost sales. Secondly, the new product lines (I.E. electronic toothbrushes) gives SDC a more traditional funnel approach to their business. For instance, SDC can build a reputation of quality products and acquire emails and contact information that can be used to upsell customers to the core product (their teeth aligners). Lastly, and most obviously, the announcement diversifies SDC’s product line.
Prior to their IPO the firm had already helped over 700,000 members and claimed a very high satisfaction rating (More than 95% of members surveyed would recommend the SmileShop experience to a friend).1 SDC is differentiating itself in the market through convenience, price and access. In 2019 SDC secured 5-year non-exclusive agreements with both CVS and Walgreens to open SmileShops inside their stores around the country (Up to 1,500 in CVS stores and an unlimited number in Walgreens stores). As of the company’s website on 1/9/2020, there were 317 SmileShops in the U.S. (not including temporary pop-up locations).3 However, the company’s website claims to have now helped over 750,000 customers, grown to 5,400 employees and counts 366 SmileShop locations (likely including pop-up locations and international SmileShops).6
The orthodontic addressable market is very large, but that should be taken with a bit of salt because while 85% of people worldwide have malocclusion (abnormal alignment of upper and lower teeth) less than a percent are treated annually.
Given the market size, it shouldn’t come as a surprise that the orthodontic competitive environment is vast. The other mentioned DTC invisible aligner companies were all priced uniquely but totaled a very tight band of pricing similar to SmileDirectClub’s own offering.
SDC’s offering starts with teeth impressions (the first step) which is free to do at a SmileShop or $49 to receive a remote impression kit, then the core product is priced at $1,895 upfront, and lastly they charge $99 for retainers (Total price with remote kit of $2,043 before tax).
“SmileLove” has a $79 Impression Kit and has a deal for $1,495 if paid upfront for treatment with free retainers and whitening. However, they do not mention any type of teeth professionals on their website except when they stated “Straighten your teeth with all the orthodontic expertise, right from home.” Regardless, they are the lowest cost mentioned competitor (Total price $1,574 before tax).
“Candid Co.” has a $95 Candid Starter Kit currently marked down to $33.25, their treatment offering costs $1,900 if paid upfront and does state they have a licensed orthodontist assigned to each case (Total price of $1,995 before tax). There was no mention of retainers. This company seems to be the only competitor mentioned that has physical locations (similar to SDC) however there are not that many locations as of yet (22 locations according to their website) and a quick search in Google Maps solidifies this fact; furthermore, the Google search shows a large difference in the amount of reviews between Candid Co. and SDC, although both firms have high overall review scores.
“SnapCorrect” sells an impression kit for $49, an aligner treatment for $1,749 and includes a free retainer set (Total price of $1,798 before tax). They cite having dental technicians create customer’s custom treatment plan.
As I went through the competitor’s websites the only firm with a similar offering I saw was Candid Co. SmileDirectClub does a good job of explaining the product/process while both assuring potential customers of the value and trust worthiness of the firm. By second 43 of the intro video or sentence three of the “How it Works” tab, SmileDirectClub mentions their licensed dentist or orthodontist assigned to each person’s case. SmileDirectClub also has the most professional website in my view, and boasts a very high review count and very high review score (5,000 5 star reviews). But beyond that, I think the brand name recognition and their physical store count presence has truly been the company’s advantage over the DTC competition.
As is typical with IPO’s, the best aspect of SDC’s financial story is their top line growth. From 2017 to 2018 total revenues grew 184%. This growth slowed but remained respectably strong in 2019, in the first nine months of the year revenues were up 88%. Gross profit margins are also impressive and have been improving; in 2017 SDC’s gross profit margin was at 56%, it increased to 68% in 2018 and as of the first nine months of 2019 reached 77%. However operating costs are increasing substantially as SDC increases its reach across the country. During the first nine months of 2019 marketing and selling expenses rose 137% and general and administrative expenses ballooned 527% YoY. It is important to factor in the G&A spend was heavily impacted by the stock-based compensation associated with the company’s IPO, this is a one-time expense that will likely never be repeated at this magnitude again. The ramp up in spend is expected given the goals of the company to expand not only in the U.S. but internationally. In fact, on January 7th, 2020 the firm announced it would be expanding into Asia by bringing their clear aligner therapy to Hong Kong.4
Moving on to SDC’s balance sheet, the firm appears viable for the time being. Their current ratio is above 2.5X (showing they have more than enough short term assets on hand to meet short term liabilities) and their debt to assets as of 9/30/2019 was 22% (there isn’t a sizable amount of debt in respect to their total assets).
The gross cash burn of the firm was $115M in 2018, and that has increased to $192M for the first nine months of 2019. I wouldn’t be surprised to see up to $280M gross cash burn for the full year given the product lineup and SmileShop expansions mentioned earlier. Even at that high rate of cash burn, given their cash at the end of the period, I expect SDC could continue to continue their expansion and operations through 2021 without raising additional capital. According to analyst average estimates on Koyfin, SDC is expected to become EBTIDA positive in fiscal year 2020 and have positive net income by fiscal year 2021.5
To a lesser extent”1 as management put it, there is a clear public competitor in the market to compare SDC to as well, and its brand name awareness is respectable. Align Technology, Inc., the parent company of the Invisalign products, was founded back in 1997 has now reached an enterprise value of about $22B. Align (ALGN) is by far a more developed firm than SDC, but the latter is growing fast. Given these two firms have competing products in the orthodontist market, I took a brief look at ALGN’s financial history.
It may be surprising to read that Align Technology’s revenue is not too far ahead of SDC’s, even though ALGN has had a 17 year head start. In 2018, ALGN had $2B in revenue, compared to SDC’s projected 2019 revenue of $750M. It is important to note ALGN has been operating globally for years, in fact international sales accounted for 35% of total 2018 sales. Furthermore, ALGN is profitable; while their gross margin is a bit below SDC’s at 74% for 2018, their profit margin has ranged comfortably between 16-20% since 2014. ALGN’s cash flow from operations has been positive and growing for years, in 2018 it grew 26.5% to $555M.
It should be clear to see that Align Technologies Inc. is a healthy and profitable firm, this information can be looked at from multiple viewpoints; personally, I am seeing more of the market potential for SDC as a competitor than I am seeing the danger of going against ALGN. This is because, although the products of SDC and ALGN are quite similar, the operations of the two firms are very differentiated. SDC is a teledentrisy business with SmileShops that aid with the experience, marketing and sales efforts. ALGN however has a more indirect path to the final customer because they sell their clear aligner and scanner products mainly to orthodontists and general practitioner dentists. This difference may separate the sub-markets that these two firms are targeting and in turn allow for continued growth for both firms.
As of the close 1/10/2020 $SDC shares traded at $9.22. This implies a market cap of about $3.5B and in turn a price to sales ratio for 2019 (using a 2019Q4 sales forecast to arrive at 2019FY sales of $753.6M) of 4.7X. At the current share price the Price/Sales ratio comes down to 3.1X by the end of 2020 and 2.2X by the end of 2021 (using average analyst sales forecasts from Koyfin which imply 53% growth in 2020 and 38% growth in 2021).5 There has been a recent pick up in share price and trading volume given the buzz around the Walmart anouncement, but since that news has matured, shares are only up 7.8% this year and are still at a 55% discount to their opening day high. SDC is very much a growth story and should be looked at as a high-risk high-reward investment. SmileDirectClub is the first DTC clear aligner company and I believe their recent deal with Walmart, along with partnerships with CVS and Walgreens, should help the brand grow substantially in the years to come even with the very competitive market.
Lastly, there are two trends that I feel SmileDirectClub will naturally benefit from, that of the increased pursuit of looking good all the time and the ever-lowering patience/attention span of people. With the rise of social media came an increased focus on physical appearance; having straight and healthy teeth is certainly a factor in the pursuit to look as good as possible. However, the time and effort to find and go to an orthodontist in order to correct malocclusion can be a dealbreaker for many potential customers. SmileDirectClub helps mitigate that cost through their DTC process; furthermore, their numerous SmileShops and additional product offerings (both online in in store) create a more recognized and trusted brand name.
*Of note, SDC and ALGN were in a supply agreement from 2016 through the end of 2019 to manufacture a portion of SDC’s non-Invisalign clear aligners. In March of 2019, SDC won an arbitration case against ALGN regarding the non-compete and confidentiality provisions of their agreement. “The arbitrator ruled that Align had breached both the non-competition and confidentiality provisions of the Operating Agreement and that, as a result, Align was required to close its Invisalign Stores, return all of the Company’s Confidential Information and to sell its membership units to the non-Series A unitholders of SDC Financial for an amount equal to the balance in Align’s capital account as of November 2018.”1 This case highlights the legal liabilities in this type of business which should be understood as a potential threat to players in the industry.1
On the positive side, the ending operating agreement with ALGN does not seem to have impacted SDC’s business negatively. From 2018Q3 to 2019Q3 SDC increased their gross margin by 7%. During the 2019Q3 earnings call, SDC management stated the continued gross margin improvement was primarily “driven by manufacturing 100% of aligners in house.”7