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Align Technology
Write-ups on healthcare companies always take the most time for me. The previous issues have been on Illumina (genomic sequencing), Veeva Systems (healthcare SaaS), Chemed (hospice), and STERIS (sterilization). Maybe it’s getting up to speed on the nuances of industries that I have very little background in or maybe it’s needing to familiarize myself with an potential regulatory impacts to the businesses. There’s also the issue of not being able to effectively drill down on unit economics to better estimate incremental returns. Having said all that, hope you enjoy reading this one.
Align is the leading provider of clear aligners and digital impression technology for the treatment of malocclusion (misalignment of teeth) cases globally. Through its Invisalign brand, the company has pioneered the adoption of clear aligners by partnering with orthodontists and general practitioners. Since Align’s founding in 1997, clear aligners have taken share from traditional metal braces but still only represent 20% of the annual case starts. Cumulatively, Align has treated over 12M patients and facilitated over 45M orthodontic and 9M restorative scans through the company’s digital impression machines.
When a patient elects an Invisalign treatment plan, an impression is taken of his or her teeth using PVS (putty like substance) or an intraoral scanner. If the impression is taken on one of Align’s iTero scanners, the patient can see a 3D image of their teeth. The impression is sent to an Invisalign plant and a customized treatment plan is created through ClinCheck based on the impression. The treatment plan is then sent to the doctor for approval. Once the treatment plan has been approved, the customized set of clear aligners are created using 3D printing technology and shipped to the doctor’s office.
Initially, Align was only able to treat a fraction of malocclusion cases with the Invisalign system (50% until 2016). Through years of research and development into new treatment types, the company increased that number to 75% in 2018 after approval of Mandibular Advancement treatment. Expansion into other geographies in recent years has increased the addressable percentage to 90% since 2020.
There are now many Invisalign treatments for the differing levels of severity of the patient’s malocclusion (dependent on how much crowding there is + extractions and other dental work are needed). The mild cases can be treated with as few as 5 stages, while moderate plans range between 10-20 stages. These types of cases can be treated by a general practitioner. The more complex cases can require up to 50 stages and are usually treated by an orthodontist.
Since Align was essentially creating the market for the use of a new medical device, the company worked hard to bring awareness of the benefits of clear aligners to both consumers and doctors. It wasn’t enough for consumers to ask their orthodontist for this new type of teeth straightening technology or for orthodontists to recommend clear aligners to patients. Both parties needed to be convinced of the benefits of clear aligners in terms of efficacy and efficiency.
When a person wants to get his or her teeth straightened there are two main choices, traditional metal braces or clear aligners. From the patient’s perspective, clear aligners have many advantages to metal braces. (1) The aligners are removable, making it easier to eat and clean teeth, (2) they are less invasive and less noticed by others, and (3) they require fewer trips to the orthodontists for adjustments. Align increased consumer awareness of the Invisalign product through annual advertising campaigns of up to $100M (even more so as of late) via TV, digital and social media, PR, and event marketing.
Align also worked to show doctors the advantages of treating their patients with clear aligners. The cost per case for clear aligners is 3x-5x higher ($300-$400 for metal braces vs. $1k-$1.5k for clear aligners). Even though the Orthodontists mark them up to around $6k-$7k to the patient, clear aligners still have lower profits on a per case basis.
At first glance, it seems like it wouldn’t make sense economically for orthodontists to switch from metal braces to Invisalign. These doctors would also have to learn a new system and explain the treatment plans to their patients. Align successfully made the case that clear aligner treatments require fewer trips to the doctor throughout the life of the treatment, thereby requiring less chair time. So, even though gross profits per case are lower, with less chair time per case orthodontists using Invisalign can treat more patients.
The company estimates that 60%-75% of the global population is affected by some level of malocclusion. There were 21M case starts in 2021 and 90% of cases were able to be treated by the Invisalign system. Even with the share gains that Align and other clear aligner companies have made throughout the years, metal braces still make up 80% of the case starts. Teens make up 75% of the market but only represent 25% of cases for Align, but that number should move higher as Invisalign has received approval for treating Mandibular Advancement cases. The orthodontic market is growing 3%-4% annually and Align is growing much faster from share gains and addressable market expansion through advancements in treatable cases.
Align had little competition in its early years and used litigation to protect their competitive position throughout its history. The company lobbied for the enforcement of key patents (these eventually expired in 2017), which kept many competitors at bay for some time. This helped Align keep high market share and mind share with doctors. Competitors in the doctor-directed channel include ClearCorrect, SureSmile (owned by Dentsply Sorona), SLX Clear Aligners (owned by Henry Schein), and Clarity Clear (owned by 3M) to name a few. In the Direct-to-Consumer channel, Smile Direct, Candid, and Byte are some of the well known players. In China, AngelAlign (recent IPO in 2021) is the largest competitor.
It's interesting that even with the increased competition, there hasn’t been much price compression in the industry (at least in the doctor-directed channel). That’s partly due to the fact that individual orthodontist have little negotiating power and price isn’t the largest factor in determining which clear aligner system to go with since orthodontists are marking up clear aligners by 4x-6x. In the DTC channel, prices to the consumer are lower since there are fewer interactions with a doctor but these companies have to run costly marketing campaigns to acquire to patients resulting in lower operating margins.
Align has long-term financial targets of 20%-30% revenue growth (will not be achieved in 2022 coming off of a 60% y/y growth in 2021), gross margins between 73%-78% (this will be under some pressure as the % of revenues from systems and services increases over time), and operating margins between 25%-30%.
Why is it a good business?
During its early years, Align benefited from counter positioning. Clear aligners presented patients and doctors with many advantages over traditional metal braces (discussed in the previous section), but the incumbent suppliers of braces were slow to adopt to the new technology. This was partly due to the profits they were already generating and to the risks of adopting the use of a new medical device.
Align did well to partner with the doctor-directed channel to push the growth of the Invisalign platform. Doctor-directed cases make up most of the case volume for clear aligners in any given year. Patients generally want their orthodontist or dentist to recommend the best treatment for their teeth regardless of how much consumer marketing they’ve been exposed to.
As Align has grown and as more orthodontists have shifted their malocclusion treatments to Invisalign, the company has benefited from increasing switching costs. The knowledge base and habits formed by the doctors and technicians that use the iTero scanner and Clincheck software reinforce the importance of Invisalign platform. As these doctors offices get more comfortable using the Invisalign system, they are more likely to order additional iTero scanners and prescribe more Invisalign treatments to their patients. The average number of annual cases submitted by a North American orthodontist using the Invisalign program has increased from 24 in 2012 to over 98 in 2021.
Using the iTero scanner for impressions also leads to more Invisalign cases. More than half of the doctors in the Invisalign program use the iTero scanner. Because the doctors that do submit impressions using the iTero scanner drive more than 4.5x case volume, iTero scanners account for over 85% of Invisalign case submissions.
Even though Align has the highest market share within the clear aligner segment, the benefits from scale are minimal and largely indirect. Production of clear aligners at the company’s processing plants are more efficient as volume increases, but there’s only so much efficiency that is achieved. Having plants closer to any doctor’s office doesn’t make much of a difference (within each major geography) because shipping is usually quick enough and the aligners themselves are small in packaging. And we can see this in the gross margins of the clear aligner segment, which has ranged between 73% and 79% over the past decade.
Align does benefit indirectly in a couple of ways as the largest clear aligner company. First, the company is able to better negotiate with DSOs (Dental Service Organizations), which are organizations that own groups of dental practices. DSOs help their practices become more efficient, negotiating large purchase orders and contracts, and handling the back-end technology and nonclinical administrative tasks. And because many of the top DSOs are large in size (own 500 to 700 practices), it helps that Align is the leader in the industry.
The company has stated that servicing DSOs results in lower gross margins, but Align makes out better on operating margins due to the efficiency related to doctor training and marketing. DSOs are typically quicker to adopt new technologies (if they make sense economically) and clear aligners meet that requirement. Some of the large DSOs that Align has relationships with are Heartland and Aspen Dental.
Second, the company is able to leverage its database of malocclusion cases to develop better treatment plans in the future. Align has treated over 12M patients with the Invisalign system, which is up materially from 2013 when that number was close to 3M. The company can also leverage the data to develop better iterations of ClinCheck and Exocad in the future.
Returns on incremental capital?
Over the past 10 years, Align has spent 46% of its capital on capex, 38% on R&D and 16% on acquisitions. Capex is mainly used for building out the company’s manufacturing capacity. While there isn’t that much of an advantage to building production closer to the end user, it does make sense to build out new capacity within each major region that Invisalign expands into. Capex as a % of revenues increased in 2016, which coincides with the company’s push to expand internationally.
Align did once have a retail store concept where prospective customers could browse the different Invisalign treatments and get complementary iTero 3D scans of their mouth. A pilot store was started at the end of 2017 and the company had planned to build out 12 by the end of 2018. Things were going well (55k prospective customers visiting the stores and 10k receiving a scan) but the company had to the shut the stores down to an arbitration case with Smile Direct Club (more on that towards the end).
R&D has been much more steady as a percentage of revenues and is mainly spent on expanding Align’s clinical treatments (which has increased the company’s ability to handle most malocclusion cases) and developing the company’s scanning, modeling and manufacturing capabilities.
Acquisitions have been lumpy, with only a handful of meaningful targets over the past decade. Align acquired Cadent (maker of the iTero scanner) in 2011 for $120M, implying a revenue multiple of 3x and a multiple of gross profits of 13x. The iTero scanner has been a huge success for Align on many metrics. Align’s Systems and Services segment has grown at a CAGR of +36% since 2012. Just that type of growth alone would make the acquisition a financial success. But we also have to consider that the iTero scanner also drives incremental Invisalign cases (which also command higher margins).
Assuming that most of the revenues within the Systems and Services segment come from iTero scanners and related CAD/CAM software, 2021 revenues of $706M would imply a 17.5x increase since the acquisition. Align has also disclosed that the company has sold 68k iTero scanners to date (2021). The segment has generated cumulative revenues of $2.2B and gross profits of $1.3B over the past decade, which implies an ASP of $32.4k and average gross profits of $19.4k. We also note that the segment has increased its gross margins from the mid 20s% in 2012 to 65% in 2021, making the growth in earnings much faster than revenues.
The other large acquisition was Exocad in 2020, which Align purchased for $430M. Exocad complements Align’s software/digital strategy, since Exocad has the largest installed base of CAD software with labs. With the Exocad acquisition, Align now owns the leading hardware and the software technology for digital dentistry. Exocad has over 200 global partners and 35k installed software licenses.
We estimate that Align has generated returns on incremental capital between 40%-60% over the past 5 years. The stepped up investment into international expansion, the acquisition of Exocad, and the temporary impact from the Covid related lockdowns skewed the returns lower in 2020. This reversed in 2021, as growth came back due to pent up demand and consumers being flushed with savings. We are starting to see signs of that reverting back in 2022.
We also point out that Align has maintained a very conservative balance sheet over the past decade, not taking on any debt throughout the period. Due to the company’s high margins and plentiful cash generation, without any obvious large acquisitions the company has steadily increased the cash held on its balance sheet.
Reinvestment potential?
Align estimates that there are 500M potential customers who would benefit from treating malocclusion. Assuming that the simple ASP of $1K would imply that the market size is $500B for clear aligners. Of the 500M potential cases, there are roughly 21M case starts per year, of which 75% are teen and 25% are adult. So far Align has much higher exposure to the adult category because the company only recently got approval for mandibular advancement (MAF) treatment, which are common with teen cases. In addition, teens are less likely to be compliant with the Invisalign treatment plan vs. adults, since they are removable.
International expansion is a big focal point for the company’s growth strategy going forward. Asia has the most potential with China being the 2nd largest market after the U.S. and the region with one of the highest ASPs. Within China, the company is expanding to tier 2, 3 and 4 cities and building manufacturing capacity in many of the key regions. Align has already formed partnerships with both public and private hospitals and have Invisalign programs for each type. The company is also partnering with some of the key universities in China like Wuxi University, which have a lot of authority in the orthodontic arena within China.
Align is also excited about the opportunity to expand in Latin America and in particular Brazil. There are over 1M orthodontic case starts per year in Brazil and the country has a large number of orthodontists (almost 3x that of the U.S.) and dentists.
The company sees an opportunity to sell to more general practitioners (GP). Typically, GPs don’t have the specialized training to take on many of the complex cases that an orthodontist may treat, but some of the less complex treatments can be done by a GP. Align launched Invisalign Go in 2017 to help GPs treat cases which require 20 or fewer treatment stages. The iTero scanner has advanced that it can help the GP determine if the patient can be treated with an Invisalign Go plan.
One of the reasons that Align is excited about the GP opportunity is that there are almost 20x more dentists than orthodontists in the U.S. Globally, it’s estimated that there are 2M dentists and the company wants to get an iTero scanner within each practice to drive the number of Invisalign cases. The utilization metrics for GPs are much lower than orthodontists, but has been increasing nicely over the past three years. That number is even higher outside of the U.S.
The company also sees retainers as an opportunity for market expansion. Align estimates that less than 10% of the completed Invisalign cases use a Align branded retainer for maintenance. Many orthodontists recommend other branded retainers to their patients after an Invisalign treatment is completed. In the past there was little incentive for the orthodontists to push the Invisalign retainer brand, Vivera. But with the Doctor Subscription Program, the company has increased that incentive. Align sees the retainer market as a $1B opportunity over the next few years (from the 2021 Analyst Day).
With a reinvestment rate between 30%-38% and a return on capital between 40%-60%, we estimate that Align has increased its intrinsic value between 15%-19% annually over the past 5 years. The reinvestment rate has been very consistent for Align, given the steady pace of R&D and capex expansion.
What else is important?
How much pull forward in demand from Covid?
Because of the various lockdown measures and subsequent reopenings around the world, coupled with different levels of fiscal stimulus, it’s difficult to parse out pull forward demand vs. regular growth for Align. Looking at the y/y growth rates, there was a bigger dip in the Americas region in 2Q 2020 (vs. International), followed by a higher rebound in 2Q 2021. On a 2 year basis, the growth rates are a bit smoother, even up to the most recent quarter, but next quarter is where we lap the 2Q 2020 quarter.
We do know that the outlook is murky this year. The company has not given guidance for the year since there are uncertainties around the China lockdowns, weaker consumer confidence, inflationary pressures as well as the war in Ukraine. Even with the presumed slowdown in growth this year, it’s difficult to know how much of the growth in the back-half of 2020 and most of 2021 was pulled forward. It does make sense that fewer social interactions and excess cash probably led to higher demand for orthodontic procedures for most people. How the growth rates trend for the remainder of 2022 should make this a bit more clear.
Smile Direct Club (SDC)
Align has a complicated history with its competitors, especially with the amount of litigation that has been thrown around. Smile Direct Club was one of the more successful clear aligners companies using a direct-to-consumer model. The company raised over $400M in VC funding and successful completed its IPO in 2019 raising another $1.3B.
It was interesting at some point in the past, because there was the possibility that this new DTC model could disrupt Align’s model of doctor-directed treatment. The cost to the consumer was lower (around 1/4th of the cost) because there was no 4x-6x mark up from the orthodontist. However, this model required more effort on the part of the consumer (taking impressions, doing research on the right treatments, etc.). And because SDC was directly responsible for the cost of the locations, consumer marketing, and still had to have a doctor approve the treatment plans, the model was more challenging from a margin perspective.
Align sued SDC in 2015 for patent infringement. Remember that most of Align’s key patents expired in 2017. Ultimately it was settled outside of court with Align taking a 17% ownership interest in SDC for $46.7 million (and an additional 2% in 2017 for $12.8M) and providing SDC a $15M line of credit for working capital needs.
A supply agreement was also signed which resulted in Align manufacturing the clear aligners for SDC while SDC would only focus on DTC marketing and increasing awareness for clear aligners. In that agreement, there was also a referral program in which SDC would refer cases that were too complex to Invisalign doctors (about 30% of the cases).
However in 2017, Align started to experiment with opening their own retail based locations, and SDC filed arbitration against Align on the basis of a violation of the non-compete provisions in their original settlement.
The proceedings went back and forth but ultimately the two companies went their separate ways. In 2019, Align gave up ownership in SDC and was ordered to shut down their physical locations. In 2021, Align received payment of $43.4M for the ownership stake.
Optionality
With the growth opportunity in taking share from traditional metal braces, international expansion, and increasing share potential with general practitioners, the reinvestment opportunity still remains very large for Align. Where they can see upside optionality is in continuing to invest in researching new methods so that 100% of malocclusion cases can be treated with Invisalign. There is also the opportunity to advance in 3D printing technology so that aligners can be printed directly from the intraoral scan at the doctors office, reducing the turn around time necessary to start treatment.
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AGB 2022.6 - Align Technology (ALGN)
This was very helpful. How are you monitoring the share gains/losses in the doctor direct market?
Thanks for the write-up!
Just a quick question: Do you know whether the Exocad licenses are either Perpetuals or Subscriptions?