From Groundbreaking OCS To Sky-High Ambitions: Mini Deep Dive On TransMedics (NASDAQ:TMDX)

I covered TransMedics Group, Inc. (NASDAQ:TMDX) in my newsletter for the first time back in February 2021, when the stock was at $26 per share, and TransMedics had not yet launched its National OCS Program (NOP), which has been a game changer for the company, completely transforming it ever since.

Several months ago (September 2023), after almost 2.5 years, I published a second deep-dive on TransMedics (7,000+ words) in my investment group, Fundamental Growth Investor, covering everything from the company’s story and near-term/long-term catalysts to the recent acquisition of Summit Aviation and the 3-5 year price targets based on my investment model.

Today, TransMedics is one of my top 5 positions, and in this mini-writeup, I will supply an update after the recent quarter (Q3 2023) and explain why I am still bullish on the company.

Thesis

My investment thesis for TransMedics is centered around its innovative Organ Care System (OCS), a technology that has the potential to truly revolutionize organ transplantation. OCS technology represents a significant advancement over traditional static cold storage methods used for organ transplantation and a much superior alternative to other warm perfusion storage solutions, such as XVIVO and OrganOx.

This positions TransMedics as a leader in the field of organ transplants, with a significant first-mover advantage, particularly as they hold FDA approvals for heart, lung, and liver transplantation – the only FDA-approved device for multiple organs.

The critical demand for organ transplants, a space where supply and utilization are highly mismatched, highlights the need for such technology. OCS is well positioned to bridge this gap, providing TransMedics with years of continuous growth.

The company is projected to reach substantial revenue growth, expecting to exceed $1 billion by 2030 from an estimated $228.9 million in 2023. I foresee TransMedics to reach $1 billion in revenue earlier, maybe two years earlier, due to its increasing involvement in the growing number of transplants. In fact, TransMedics, with its OCS technology, is a primary enabler of increased donor utilization. The company, essentially, creates the market for itself.

Right now, TransMedics is unprofitable, but at this rate of growth, it should become adjusted EBITDA positive in 2024 before turning profitable on a net income basis in early 2025. I believe TransMedics could be profitable in 2025; however, it will depend on hiring costs, R&D, S&M, and additional expenses related to building out their aviation and logistics business.

The company’s strategic proceed into aviation, building its own fleet of small airplanes to transport donor organs, should only accelerate the growth in the coming years.

My thesis also acknowledges some potential risks, including the complexities involved in integrating an aviation division, the company’s indebtedness, shareholder dilution, operational readiness in meeting increasing demand, and a few others I cover extensively in my TransMedics deep dive.

However, a combination of TransMedics’ technological innovation, market leadership, growth potential, and competitive advantages make my thesis strong enough to defend a position in the top 5 in my investment portfolio.

I also put faith in Waleed Hassanein, TransMedics’ founder and CEO, who not only has skin in the game but is also one of the most respected people in the field. He anticipates 10,000 transplants annually in five years’ time, a significant enhance from the 2,000 transplants scheduled for 2023. With a track record of beating and raising its projections, I am confident that TransMedics will successfully accomplish that target.

Quarterly Update

Speaking about beating and raising, TransMedics delivered yet another outstanding and, to some extent, surprising quarter. EPS in Q3 2023 came at $0.07, beating estimates by $0.20, while revenue was $66.43 million, a whopping 158.65% year-over-year enhance, surpassing expectations by $17.25 million.

The best part of this earnings is that TransMedics has significantly raised its 2023 outlook. Annual revenue guidance for 2023 increased to between $222 million and $230 million, representing 138% to 146% growth over 2022, from a prior range of $180 million and $190 million.

It is the main reason why the stock bounced back from its October lows when it reached its 52-week low at $36.42 per share, primarily due to investors’ skepticism around the company’s acquisition of Summit Aviation and its ability to successfully supervise and function an aviation fleet – something that is entirely out of TransMedics’ scope and something that will significantly pressure gross margins from now on.

In the third quarter, TransMedics completed the acquisition of eight planes and outlined plans to enlarge its fleet to 15-20 by the second half of 2024. This quarter, the company initiated a limited launch of the transplant logistics service, resulting in $2.1 million from the new, transplant-related aviation and logistics offerings.

The NOP (National Organ Preservation) program continued to significantly contribute to revenue growth, and the company is on track to complete over 2000 NOP transplants in 2023.

On the not-so-bright side, the company has seen a considerable decrease in gross margin, from 70% in Q2 2023 to 61% in Q3 2023. This decrease is attributed to several factors, primarily due to transient inefficiencies – the old charter business is phasing out, while the new transplant business is just starting, with neither operating at full scale during the quarter. Once logistics is fully operational, the gross margin is expected to better, though not to the previous level.

The acquisition-related costs and the purchase of eight jets influenced the enhance in total operating expenses, dragged down net loss to $25.4 million from the $7.4 million loss in the same quarter of the previous year and $1 million in the prior quarter of 2023, and resulted in a significant decrease in free cash flow, from negative $7 million in Q2 2023 to negative $114 million in Q3 2023.

TransMedics still maintains a strong cash position, finishing the third quarter with $427.1 million. The company’s significant investments in acquisitions and logistics infrastructure display a strategic effort to enlarge its service capabilities and infrastructure, which will eventually start to pay off.

Growth Drivers

TransMedics has a number of near and long-term growth drivers that will profoundly impact its revenue growth and profitability.

A key focus for the company is the expansion of its National OCS Program (NOP), which is essential for increasing the adoption and use of its Organ Care System technology by transplant centers. Only a small percentage of U.S. transplant centers currently utilize this technology on a constant basis, providing significant room for growth. Expanding the NOP is particularly important because it is expected to be a major source of volume and revenue for the company in the coming years.

To ease the National OCS Program encourage, the company is continuously improving its OCS technology. TransMedics is already working on next-generation OCS technology, which will bring innovations admire cloud connectivity, automation, and remote control. This new technology, which includes new perfusion systems for hearts and lungs, is expected to enter clinical trials by 2025.

Another major catalyst for TransMedics is the development of its aviation operations. The company is now establishing its own air transportation fleet, which marks a strategic shift from relying on private jet brokers. The aim here is to control the entire logistics process from donor to recipient to directly supervise all NOP transplant volume in the U.S. by the second half of 2024.

This integration will help TransMedics supervise transplant volumes more efficiently and overcome previous logistical challenges. Most importantly, it will encourage cement TransMedics’ competitive advantage, making the competition at this stage almost obsolete.

Finally, TransMedics is looking to enlarge globally, particularly in Europe and Asia-Pacific markets. Despite being present in Europe for over a decade, the company has had a limited success rate there so far due to the way reimbursements work in these regions. I believe there is significant untapped potential, especially if reimbursement policies admire those in the U.S. are eventually adopted. TransMedics is currently developing materials and conducting clinical trials to ease this expansion. If successful, this will supply an additional boost to revenue, which is not projected in the current estimates.

Valuation

Now that TransMedics is on the brink of profitability (it would have been profitable in Q3 2023 if it wasn’t investing in the aviation and logistics business), the stock will trade at a premium multiple because EPS growth should be in the triple digits for the next 3-4 years as net income margins better from negative 5% in 2023 to positive 8% in 2026 to 14% in 2028 and perhaps even 20% by the end of the decade. If you look at other more mature MedTech companies, most have net income margins north of 20% by the time revenue growth has slowed into the teens, and I expect TransMedics will be no different.

TransMedics is very much a hypergrowth stock that is still investing in the business and building its moat, much different than Medtronic (MDT) or Intuitive Surgical (ISRG), which makes it a little harder to come up with a fair market valuation for TransMedics since the next 5-6 years is less predictable. Below is my investment model going out to CY2030 with my revenues and net income margin estimates, which gets us to some rough price targets. Based on my investment model and estimates, I do believe TransMedics has 100% or more upside over the next 2-3 years and 200% upside over the next 4-5 years.

Conclusion

TransMedics is one of the largest positions in my investment portfolio because it has all the attributes of a long-term winner, assuming continued revenue growth (5x over the next six years) and expanding margins, which leads to substantial EPS growth, which is the most important ingredient when trying to find the best stock outperformers.

TransMedics has increased revenues almost 10x over the past few years, but that’s just the tip of the iceberg now that heart, lungs, and liver are all approved. We should see OCS Kidney approved in the next couple of years, which will be another catalyst for the stock.

Just a couple of months ago, investors were giving up on TransMedics because of the company’s decision to push into aviation and logistics. Still, after an incredible Q3 earnings report, those same investors are flocking back to the stock because they grasp that strategic decisions might cause some near-term margin compression, but over the long term, it gives TransMedics a dominant position and allows it to uphold its aggressive growth goals.

Suppose the CEO is correct and TransMedics can go from ~2,000 OCS procedures in 2023 to ~10,000 OCS procedures. In that case, the only way that happens is with its own aviation fleet, not to refer at some point, we might see TransMedics surgeons doing the actual procedures, which just increases the total addressable market, or TAM, even encourage.

Once I acknowledge a potential multi-bagger and build out a large position, I rarely want to see that company get acquired because it puts a ceiling on the upside. However, I will refer it here because I think there’s a 30-40% probability that TransMedics will be acquired in the next 18-24 months. If it does happen, I’m hoping it’s not until 2025, and the price is north of $150+ per share, which still leaves a 100% upside from the current price.