TELA Bio: Turning More Constructive

Investment Summary

Following the hold thesis on TELA Bio, Inc (NASDAQ:TELA) in December, based on market and macro-generated data, there has been no change to the company's equity stock. This is despite several developments in the company's growth narrative.

Following the company's Q1 FY'23 numbers last month, there are numerous factors for consideration in the TELA investment debate. As such, a revision to the critical facts is needed. Looking forward, I am turning more constructive on TELA. This is based on fundamental catalysts gleaned from rigorous analysis of its business economics. However, given internal investment criteria, I rate TELA a hold, looking forward to its additional updates in FY'23.

Figure 1.

TELA fundamental drivers

The latest data throws off key findings in terms of the company's financials and business economics. Both domains are telling on the company's future outlook.

1. Financial results

The firm booked another strong quarter in Q1 with revenue pulling to $11.9mm, up 45% YoY. Growth was predominantly fuelled by the 42% YoY increase in OviTex revenue and an impressive 52% YoY growth in OviTex PRS sales. Notably, management also said the hernia, abdominal wall and PRS divisions experienced significant gains, despite elective procedure volumes still lagging behind the pre-pandemic range. Nonetheless, there are positive indications of procedures trending in the right direction based on this.

Regarding expenditures, TELA put another $9.4mm in sales and marketing, amounting to $13.5mm in Q1. Whereas it invested another $2.1mm to R&D during the quarter, a small uptick on the $2mm last year.

There a multiple bullish features regarding TELA's financials:

• TELA has persistently expanded the business each year with sales growing at a considerable pace from 2017–date. Taking 2-year periods over this period, using rolling TTM figures, the company has grown revenues substantially as shown.

Table 1. TELA growth record (TTM figures)

• It looks to be investing heavily into growing sales through volumes over pricing. TELA has set its sights on ending this year with 75–80 reps in the headcount. This isn't a huge amount on the 72 reps currently on board but builds upon a base of 61 as of December last year. Q1 revenue per rep was $165,277/rep, down from $190,163/rep in Q4 last year. Each rep would need to average $812,000–$866,700 in turnover this year to hit the company's guidance of $65mm at the upper end of range.
• Furthermore, the company successfully raised over $46mm in net proceeds through an equity placement during the period. Management plans to put these funds to work and will allocate the bolus to expanding the sales force.
• Given the momentum, the firm expects $60mm–$65mm in turnover this year, calling for 45%–60% at the top in FY'23.

2. Business economics

Margins and asset utilization are a standout for TELA in these early stages of the growth curve. It provides a clear breakdown of the unit economics underpinning its top-line growth, marked as an equation of sales force, their productivity, what products are being sold, GPO access, and clinical data that will drive sales.

Figure 2.

As demonstrated in Table 1, the firm has done quite well on this front on a percentage basis, and not too bad on an absolute basis. The question is, how has it done from there?

Looking back to 2020, sales growth has been tremendously strong on a sequential basis. More importantly to the investor, the gross margin on this has been equally as expansive. The firm has clipped another c.6 percentage points in gross since Q3 FY'20 and brought in 68.3% from the top in Q1 (TTM figures). As seen in Figure 3, there has been linearity in the growth route of the company to date.

Figure 3.

At the same time, gross profitability – that gross profit scaled by total operating assets – has tracked up from 15% to ~50% in Q1 (TTM figures). This, as the company increased its capital base from Q1 FY'22 lows. Hence, the firm is recycling back $0.50 on the dollar from its operating assets, with the trend increasing. Looking ahead, there is reason to see this continuing, based on the factors discussed here, and the overall profitability of the firm. Plus, as it begins to expand, it will benefit from economies of scale in its costs, further helping gross margin and gross capital profitability.

Figure 4.

3. Underlying market economics

In addition to the factors above, the company's end markets present as potential long-term compounders with interesting economics tied into the mix.

Hernia repair

Looking to its hernia repair opportunity in the U.S., management projects a total addressable market ("TAM") of $1.5Bn, with various exposure along the hernia surgical spectrum [Figure 5]. The global hernia repair market, in which I've included the U.S. market here, is projected to compound at an annual growth rate of 6.1% into 2030, reaching ~$7Bn.

Figure 5.

As a reminder, a hernia is the protrusion of an internal organ (usually the intestines) or other tissue through a weakened area (usually a tear or hole) in the anterior or lateral abdominal wall.

The most common type of hernia occurs in the abdominal region, with a small portion of the intestine or fat pushing through this weak spot in the muscular wall. There are different types of hernias, including inguinal hernias, femoral hernias, umbilical hernias, incisional hernias, and hiatal hernias.

Each has various symptoms, including a visible bulge, pain or discomfort in various locations, weakness or pressure in the affected area, and gastrointestinal symptoms like heartburn or difficulty swallowing in the case of hiatal hernias. However, not all hernias require surgical intervention. Hence, the $1.5Bn and $7Bn market size represents the surgical treatment populous of the hernia repair market.

Plastic and reconstructive surgery

Not to be confused with cosmetic surgery, the plastic surgery and reconstructive market has experienced significant growth over the years. Key drivers include evolving beauty standards, major technological and surgical advancements, and a growing aging population.

According to industry reports, the global plastic surgery market is expected to grow at CAGR 6–7.8% by 2025 to reach a value of $67Bn. TELA has its eyes on a $700mm market opportunity in the U.S., made up of $600mm in plastics and ~$100mm market in cosmetic surgeries.

In fact, the company's differentiated offerings in this segment (OviTex) could bridge the gap in human acellular and cellular matrices in soft tissue healing in my view. I am constructive on TELA in this regard, and the rapid uptake of its products (evidenced in sales growth) is something to consider moving forward.

Figure 6.

Discussion

The latest developments in TELA's growth journey are appealing and certainly cause the investor to sit up straight in his or her chair. So far the data has led us to strong cumulative revenue growth, high gross capital productivity and a fairly broad market opportunity. However, given my own investment criteria, there would still need to be additional factors to get me over the "buy line".

For one– operating profitability. The market is receptive to companies that can appreciate capital at rates above the market return on capital. This requires growth in post-tax earnings from additional growth investments. The same doesn't apply to post-tax losses, which is the case for TELA now. Second, a change in sentiment. Options positioning is low, as with price action, whilst there's been a lack of upward revisions in turnover.

However, this is a name I have to watch from a close distance. Its revenue upsides are notable and there is any chance these could pull in operating earnings into the near future. Consensus is heavily bullish on the growth outlook [Figure 7] and looks for $81mm in turnover next year. In that vein, with fundamental data turning more constructive, I would be looking for an event-based catalyst to see a near-term change in price.

Net-net, the culmination of these findings is supportive of a hold in my view.

Figure 7.