Key Takeaways
- Align Technology (ALGN) has one of the most ubiquitous and recognizable brands in orthodontics, yet it has barely penetrated markets for customers who seem to have a great alignment with the product.
- The company is experiencing growth across multiple dimensions. The share of teens as a share of total users is growing rapidly. The company also has the worlds largest 3d printing business.
- The company also has very credible plans to expand internationally. The initial efforts in APAC and other markets have been very promising and are another cylinder in this company’s admirable growth engine.
- The nature of the product, Invisalign, is converging with flush consumers and other trends that we believe are causing consensus to underestimate the earnings and growth potential of the company.
- The company is in the sweet spot of healthcare because it has a product that converges with customer satisfaction, has increasing efficacy, declining costs (as sales of ancillary services increase) and an industry-leading digital platform that’s operational in 60 countries.
It’s what you wear from ear-to-ear, not from head-to-toe that matters as they sang in Annie. The performance of Align over the last years seems to support this notion as well. If there is one company that can capitalize on this timeless sagacity, it is probably Align Technologies. It is becoming a lot more than just its flagship Invisalign product. It is becoming a platform and a network. The systems and services segments is growing to be a nice complement to the well-known clear-aligners.
This is a proven name that has already made a lot of strides and has handily outperformed the S&P over its life; however, we think growth more in line with some of its successful peers is quite possibly on the horizon if everything aligns correctly. Given the price appreciation over the last years, you may think it is too late to get into this name and that you’ve missed the boat.
We would say that is decidedly wrong from our analysis. This company has a lot of runway left and in a bullish scenario, we believe this company will make mincemeat of consensus expectations. We think there is a distinct possibility that the market for clear aligners could eventually be winner-takes-all. The recent piling in of leading hedge funds into the name, recently reaching an all-time high, supports this notion. Some of these guys have major positions in this name comprising large portions of their portfolio, which is a vote of confidence in the narrative being told and delivered on by a capable management team.
Sometimes growth isn’t as complicated as it is made out to be. You don’t always have to be an expert in Moore’s Law, rocket science or life sciences to understand how a company can achieve higher than market growth. The power of network effects pre-dated technology. Everybody has seen the value of being talked about, discussed, and the recipient of tailwinds from being trendy.
Sometimes, there is just a superior product that is so much better than the alternative that growth occurs because of the magnetic pull that happens between a consumer and a company who has taken the time and done the homework to really consider and respond to their needs. As Steve Jobs famously said, it isn’t the consumer’s job to tell you what they want, it is the company’s job to figure it out and then delight that consumer. When this process aligns organically as Mr. Jobs showed, the results can be quite harmonious from a shareholders perspective indeed.
Align Technology Is Aligned With Its Consumers And Distributors Harmoniously
We’d say that transparent braces and smartphones are very different, but we don’t think we’re overstating the consumer-friendly design of this product particularly when measured against the alternative. No one liked being called metal-mouth or brace-face as a kid. Would you rather have cumbersome metal braces or the Invisalign?
And judging by how much adults prefer this product to the alternative, it’s not a fear that vanishes with age. The fact is, we live in an age that has been marked by increasing importance of aesthetics in many ways. Recent coverage of social media and its powerful and sometimes toxic effects have raised awareness as to the power and social downside of a more connected and aesthetically focused world.
It also raises the possibility that a generation, for better or for worse, that is hyper focused on their appearance may take the product up in even greater numbers than adults. This alone gives the stock capacity to surprise, but there are multiple other avenues of growth too.
It’s almost always better to a have a few paths to above-market growth than just one. There is huge runway and potential for growth at this company that has already demonstrated a firm ability to execute it and rewarded investors handsomely in the process. We think it likely has much more to bestow upon discerning and patient shareholders. We believe the adoption in teens has the potential to surprise to the upside and to occur rapidly. Clusters of purchasing behavior are pervasive in this demographic.
So, the secular rise in human beings more focused on their appearance isn’t always positive in its outcome, but it is a real trend that this product capitalizes on. We would, however, put Invisalign firmly in the positive side of some of the more problematic trends. There is also evidence that markets where malocclusion hasn’t been as extensively treated are having awareness of the issue and corresponding treatment grow at high rates.
Self-improvement is not a bad thing in the case of malocclusion we think. If you can correct your teeth as effectively without the added self-consciousness, then why not do it? This is a positive product that helps people be more willing to optimize their orthodontic health. Importantly, it is also something that people are often very willing to pay for. Our bet is many people who have not even heard of this product would be very willing to pay for it as well.
This is a trend being exacerbated by social media and the company clearly knows how to utilize new realities in advertising campaigns. As you can also see, this company is not only capitalizing on its own network effects as we’ll discuss below but building its brand value by riding the coattails of some of the world’s most successful networks as well. Smart strategy if you can pull it off!
Medical devices and the Health Care sector in general is a difficult business environment for many reasons. The intense regulation associated with approval through the US Food and Drug Administration (FDA) is but one complicated dynamic that can relegate even the best ideas to uncertainty. Biotech and medical device companies can often be jokingly referred to as lottery tickets, because many fail and returns are driven by a few winners. This is one of those winners. This company really sticks out amongst its’ sector.
The maturity of this company’s product, now in use for a few generations, insulates it from the risk that earlier medical device companies face. This is not a lottery ticket company, this is a company with a solid track record with a future that suggests the growth premium in the multiple is well worth it. At near $60 billion in market-cap, the upside seems to outweigh the downside in this name, particularly for this sector.
Stock prices are often subject to large jumps as acquisition has become a more and more crucial part to the growth of the larger Pharma players. Returns on research for pharmaceuticals at the big guys has been negative, and the rapid proliferation of smaller companies who are able to take asset-light models has changed the face of the industry.
Align is intellectual property heavy and has gone a great length toward boosting operating leverage and reducing costs to help catch the convergence of pro-growth winds in its sails. This company also is somewhat insulated from this in that a lot of orthodontic procedures are elective, while still enjoying the legacy and brand that will be covered by what insurance exists in the largest geographic segment, the American market.
Wall Street Worships At The Altar Of The Golden Metcalfe
It is a well-known fact that network effects are one of the primary reasons for the levels of exponential growth possible in the Communications Services and Technology sector. Think of the almighty FAANG and what differentiates them from other companies and many things may come to mind; great technology, top talent, top universities and all the rest that we think of when we imagine the impressive aura these companies seem to have. In fact, most of their value, about 70% is driven by network effects.
Metcalfe’s Law is an important and well-known insight that states the value of a network is proportional to the square of the number of nodes in the network. A more recent insight in the field that is referred to as Reed’s Law suggests that the networks can increase in value at an even faster rate if they are subject to a high clustering coefficient, meaning that particularly dense connections between nodes can form that increase the level of exponential growth.
Now, we want to be clear that we realize this isn’t the same direct network effects that happen in a purely digital business, but that the indirect network effects can be still powerful given the particulars of the market. Align Technology has put a recent special focus on international expansion and, like many beneficiaries of network effects it is the early-mover and main player in the clear-alignment market.
However, the focus getting Orthodontists and Doctors to be the primary distributors, supported by the seamless ITERO Scanner (which creates a 3D map of the customer’s mouth) is where the clusters could really start emerging and CAPEX could really pay off. Efforts are already proving fruitful in Japan, and efforts in China have been impressive as well. However, let’s talk about the type of market penetration the company has already.
The type of personal network effects that are occurring when users share their positive experience and communicate that to other folks through word of mouth, who then potentially do the same, is growing the value of the network by making the solution Align Technology sells more ubiquitous and sought after. The company is capitalizing by direct relationships with influencers and a heavy marketing campaign. It has a leading app, recognized for great customer experience, with a million downloads.
You can see the value of the network growing and growth coming from multiple dimensions as revenue expands and awareness rises of the product in the market. We’d also say the competitive moat, which is primarily intellectual property and scale, has proven hard to assail. Research suggests Align’s product is superior to the competition in outcomes.
Many competitors have tried to supplant Align’s advantage and the results have so far been lackluster, particularly since Align upgraded technology to enable it to treat a more comprehensive market segment. The ancillary services Align provides are growing with revenue, including provision of the ITERO scanner to Doctors. The more Doctors that have that scanner, the more new revenue will come in. The more revenue that comes in, the more Doctors get scanners. All this was made possible by a strategic acquisition in 2011 that the company has continually built upon. This management team have proven themselves good stewards of capital.
Why We Like This Stock In A Nutshell
The global malocclusion market is subject to growth which we believe could be above-consensus as the result of several trends both in place before and because of the pandemic. The catch-up in this somewhat cosmetic product will likely also be augmented by a very flush US consumer, another area where consensus could be potentially be behind the mark. Hedge funds love the stock. Earnings beats have been far closer to the rule than the exception and growth and market penetration are likely in early stages.
The company has multiple paths to expansion including in international markets. We also believe it is possible that estimates for growth in this area could be low. The social media phenomenon is a global one, and we believe a focus on aesthetics has the potential to drive increased levels of adoption (far beyond previous generations) in many markets across the world.
We described how growth can quickly turn exponential when critical mass is reached, and don’t know when that day will come particularly given the complex indirect network effects associated with this company, but we do know you will want to own the stock when they do start to make themselves more evident. The recent pullback in the stock from recent highs seems like opportunity.
Risks And Where We Could Be Wrong
There is a risk that a competitor comes up with a superior technology that supplants the current advantages enjoyed by Align Technology. This is always a threat, and given the estimates for high CAGR in this market in the next 5-8 years, the incentive to establish a foothold in it is considerable. We do think the company has done quite a lot to insulate itself from such an outcome. Given the considerable role of intellectual property in the competitive moat, there is an outside risk that efforts in APAC markets, specifically China, may not yield the expected result. However, the ITERO acquisition helps mitigate this as well.
However, the direct-to-consumer business model that has been adopted by several competitors could eventually be a threat if quality becomes competitive with the Invisalign. This, so far, does not appear to be the case, but trying after repeated failure sometimes yields miraculous results.
There are certain elements of this market that are counter-cyclical, particularly in the American market where wealth is greater and spending on appearance a well-established cultural rite. There is also a somewhat cyclical element to the international growth. As emerging markets adopt more and more technologies that connect them with the world, and as their wealth grows, they tend to demand products like clear aligners that provide clear consumer benefits from multiple vantage points.
So, in the event of a global economic downturn, it is possible that emerging market adoption and demand for this product will have been overestimated. There is even this possibility in the event that economic progress continues at a high rate in the developed world, relative to the emerging markets where vaccination campaigns are still far behind levels in Western economies. The continued divergence could result in slower rising awareness of malocclusion an treatment solutions than company management estimates.