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Morningstar | LivaNova's Preliminary First-Quarter Results Fall Short of Expectations; Lowering FVE

Narrow-moat LivaNova pre-announced first-quarter sales performance that fell well below our and consensus expectations. While reported quarterly revenue is expected to come in flat versus the prior year, sizable currency headwinds depressed otherwise acceptable performance that clocked in at 4% in constant currency. The press release indicated management is assessing its full-year outlook, and we'll have a better understanding of some of the underlying dynamics when more comprehensive results are reported on May 1. We intend to lower our fair value estimate modestly to $90 per share from $92, as we incorporate the growth and margin implications of lower neuromodulation sales.

At face value these results aren’t good, but also don't warrant the stock trading down roughly 25%, either. Two aspects of the release caught our attention. First, the company was nearly two thirds of the way through its first quarter when management provided full-year guidance in late February that we expect will now be revised lower. Second, management cites "competitive dynamics and salesforce turnover" as the primary drivers of weakness in the U.S. neuromodulation segment. During 2018, this business grew 10.3% and 10.1% for the quarter and year, respectively. Today's release shows this business declining 1.7% in the first quarter. We think each of these factors is likely explained by Medtronic's full U.S. commercial launch of its deep brain stimulation device to treat drug-resistant epilepsy that commenced in late February.

While volatility associated with Medtronic's product introduction will likely persist over the short run, the breadth of LivaNova's trial and real-world data supporting the efficacy of its VNS therapy will continue to support its narrow economic moat over the coming years. We expect this segment to return to growth over the course of the year following Medtronic's initial sales push, but we'd emphasize our high uncertainty rating on the name.

With similar outcomes on mean reduction in seizure frequency over time, a significantly less invasive implant procedure, and better battery life, we see no reason why LivaNova shouldn't continue to win in this niche market. However, while Medtronic's product competitiveness is an important factor, we're most concerned about the commentary regarding salesforce attrition at the company, as the physician/rep relationship is an important piece of the sales process in neuromodulation.