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Is There Growth Left in the TransMedics Tank?

Disruptive growth investing is a simple endeavor. You’re looking for companies that use technology to disrupt existing business models or create entirely new markets (called blue oceans). The size of the opportunity is referred to as the total addressable market (TAM). If you’re planning to hold a company for a decade, the TAM needs to be sufficiently large so they can grow for long periods of time. Ideally there are some recurring revenues (i.e. software-as-a-service) or, in the case of hardware companies, consumables.

Revenue growth is a proxy for market share captured so that’s our main focus. Healthy gross margins ensure that profitability can be achieved at an appropriate time (when raising capital is no longer economically viable).

Click for TransMedics company website

One company that ticks the revenue growth boxes and then some is TransMedics (TMDX). The green bars in the below chart show the strong growth TransMedics has realized since our last piece on the topic – TransMedics Stock Comes Alive with Organ Transplant Tech.

Bar chart showing TransMedics quarterly revenues
Strong growth continues while valuation declines – Credit: Nanalyze

An Evolving Business Model

The TransMedics core product offering is the OrganĀ CareĀ System (OCS), an organ preservation platform that keeps organs alive longer than flopping them onto a bag of ice.

The Organ Care System (OCS) from TransMedics - Credit: TransMedics
The Organ Care System (OCS) from TransMedics – Credit: TransMedics

For each organ the machine assists in transplanting, there’s an associated consumable referred to as a “cassette.” This razor-blade model is compelling, but TransMedics moved in a different direction last summer when they acquired a charter flight operator called Summit. Months later, they acquired 11 fixed-wing aircraft as well with plans to acquire even more. They’re now seemingly situated to move more towards services than products.

With the acquisition of Summit, the purchase of fixed-wing transplant aircraft and the addition of a logistics team, we anticipate increased service revenue from our aviation transportation service offering.

Credit: TransMedics

Vertical integration is often used to create cost efficiencies by cutting out the middleman, but now TransMedics has moved beyond developing life sciences equipment to managing an expanding fleet of aircraft. We’re told this is because it’s impossible to capture the opportunity without the transportation network which begs the question. Just how big is the opportunity?

The TransMedics Opportunity

Our previous piece raised concerns around the “limited” total addressable market (TAM) of $3.5 billion domestically and about $9 billion globally. It’s a market that’s not currently being served, so much of the opportunity is blue ocean. The company’s technology is directly responsible for a 12% increase in liver and heart transplantation in the US in 2023 where they conducted 2,300 total OCS-enabled transplants compared to 1,000 transplants in 2022. With a stated goal of hitting 10,000 transplants by 2028, revenue would eclipse $1 billion (assuming $100,000 in revenue per transplant) reflecting one-third of the U.S. opportunity captured.

Bar chart showing TransMedics path to 10K transplants
Credit: Nanalyze

At a global level, TransMedics has only captured 2.7% of the opportunity with revenues of $241 million. Guidance for 2024 in the range of $360 million to $370 million represents 49% to 53% growth compared to the company’s prior year revenue. Nothing to sneeze at. At least today, the company provides very specific progress numbers to gauge the percentage of U.S. transplants their platform is capturing.

We ended 2023 with the OCS case volume representing approximately 17% share of the national liver transplant volume, approximately 16% share of the heart national transplant volume and approximately 4% share of the lung national transplant volume in the U.S.

Credit: TransMedics

While growth continues, the share price languishes. That’s great because you can now purchase a quality company for cheaper than before. Much cheaper. Just a year ago, TMDX shares were richly valued at a simple valuation ratio (SVR) over 20. Today, that number sits at around nine (compared to our catalog average of 6.5). More importantly, the business model has changed dramatically as the company embarks upon operating their own aircraft – for good or for bad. These recent changes have attracted attention from Congressman Paul Gosar who accuses TransMedics of utilizing their strong competitive position to prioritize dollars over lives.

The Letter and Response

The Congressman’s letter says TransMedics is more driven by “revenue generation and continuous forced bundling of services” than it is by the opportunity to decrease the patient transplant waitlist. Prices of the consumable cartridges are said to have increased following FDA approval (seems about right) and TransMedics is accused of strongarming customers into using air transportation methods provided by TransMedics in a bundled offering. The extra costs are said to be “borne by Medicare” which reimburses the organ transplantation centers, not TransMedics. Customers aren’t required to use TransMedics’ new transportation network, but it’s anticipated that up to 80% will.

The response from TransMedics goes on the attack and accuses the Congressman of being largely misinformed. Mentions of “reputational damage” imply that the company’s attorneys have decided to behave in a more hostile manner while the response contains some interesting tidbits. The disposable OCS perfusion modules (cassettes) that represent consumables were priced at $45,000 during the trials while a price change to $60,000 after FDA approval was “fully expected” as is typical practice.

Regarding the need to purchase a fleet of new jets, TransMedics says this was an obvious move. In 2022 and early 2023 they lost 20-30% of donor opportunities not having jets on call 24/7 that could be used at the drop of a hat. The fragmented offering of charter flights were often old planes that lacked the speed and distance needed to efficiently conduct missions while plenty of middlemen took their cut as well. If TransMedics is correct, then their customers should actually see costs decline rather than the gouging implied by the Congressman. It remains to be seen what comes out of this spat which TransMedics can only hope withers on the vine.

The Bigger Picture

A lack of organs for transplant is an avoidable problem. In an era of flying cars, can we not manage to get organs from dead people to those who need them? Transporting organs more efficiently isn’t the final answer through. Xenotransplanation – or growing organs in animals and transplanting them to humans – is one solution that could reduce the need for TransMedics services and products. It may become a necessity as the emergence of autonomous automobiles means less organs available for transplant.

Deaths from motor vehicle crashes and fatal injuries are the biggest source of organs for transplant, accounting for 33% of donations, according to the United Network for Organ Sharing.

Credit: NPR

Our previous coverage of TransMedics noted a rich valuation and a business that needed to show some sustained success. Now, it’s the changing business model that’s the biggest concern. Seems like this will either work really well or will create all kinds of unforeseen problems. Operating an efficient aircraft transportation company is an entirely different skillset from developing life sciences hardware.

As for survivability, the $395 million in cash on hand is offset by $506 million in debt on the books. Last year they saw negative operating cash flows of just $13 million so we’ll assume that keeps moving in the right direction with 64% gross margins giving them plenty of leeway. Just pay attention to the breakdown between product gross margin (77%) and services gross margin (29%) as the latter is expected to be where much of the growth comes from with all the aircraft purchases.

TransMedics financials
Credit: TransMedics

Since our last piece in March 2023, shares of the company have risen +12% compared to the Nasdaq at +36%. Over that same time, quarterly revenues grew over 160%. Why the disconnect between price appreciation and growth? Perhaps it’s because the market has repriced the lower-margin services business model and finds it less compelling. Still, growth seems likely to continue because there are no good substitutes and revenue growth means lives saved. That means TransMedics has lots of leverage and responsibility, precisely the concerns raised by the Congressman.

The company believes that the opportunity can’t be captured at scale without vertically integrating the transportation elements of their business model. After a year of operating this new model, we ought to have a clearer picture of what to expect. We’ll check back a year from now to see how they’re progressing.

Conclusion

TransMedics is now more fairly priced though the appeal has changed. We’d much prefer a high-margin razor-blade model than a lower-margin services model of the type they appear to be ramping up. The pivot into managing an aircraft fleet seems like it will either work really well or will create all kinds of unforeseen problems. Operating an efficient aircraft transportation company is an entirely different skillset from developing life sciences hardware. In the meantime, there’s every reason to think the strong historical revenue growth will continue provided those regulatory problems don’t escalate.