The French company Audika Groupe (EPA:ADI, company website) sells hearing aids in France and in Italy. The Italian operations were started-up in 2007 and Audika’s presence is still fairly limited with 54 hearing centers. Audika’s main market is clearly it’s home market, France, where the company has established over 440 hearing centers. The company sells its products to it’s (mostly elderly) customers. Audika does not manufacture the hearing aids. It buys the hearing aids (and accessories) from hearing aid manufacturers and resells them to the customers.
There are two things that jumped out at me when first looking at Audika:
- A history of strong growth in sales, net income and operating cash flow
- A collapsing share price
It is rare that I spend time looking at a stock like Audika. The company has clearly been very succesful in growing sales and profits. In 2001 sales were €35.0 million and net income was €2.9m. In 2008 sales had grown to €101.8m and net income was €10.2m. The result was predictable: optimistic investors and a high earnings multiple for the stock. Take a look at Audika’s graph:
In 2008 Audika traded above €30 per share and even in 2010 Audika traded around €25, or about three times its current share price of €8.05. I usually quickly dismiss fast growers trading at high multiples, because I’m not able to make accurate projections about future earnings. Paying ~20x earnings in 2010 requires you to do just that in my view.
Today, the situation has changed however, the company is now trading at ~9 times 2011 earnings and the market cap is €76 million. A much lower earnings multiple that does not require as much accuracy about future developments.
So, let’s look at how results have developed for Audika over the past five years:
|Revenue € Mln:||€110.7||€105.7||€106.5||€101.8||€92.7|
|Cash from operating activities:||€15.5m||€11.7||€13.6||€12.9||€16.2|
Where is the growth?
I talked about the growth Audika had shown, but looking at the table above you would be right to ask where the growth is. Since the financial crisis started sales growth has almost stalled and operating income and net income have both dropped since 2009, even though the company has kept opening new hearing centers in these years. What is going on?
From what I have read in the annual reports and quarterly updates (all available in English (!) on the IR section of Audika’s website) since then, two things have happened that explain the slowdown in sales and drop in net income:
1. The company has stated in the 2011 annual report that some of the prospective customers have adopted a “wait-and-see attitude”. This situation seems to be aggravating in 2012, looking at the quarterly updates the company has provided. In H1 2012 net income had dropped to €2.88m from €4.81m in H1 2011, a 40% drop. Europe is going through tough times and the near future does not look promising either. Hearing aids are a big ticket expense, coming in at €900-€2000. From what I have been able to find online, insurance in France will cover only €129,81 (65% of a max. amount of €199,71, source) of this purchase price. It is possible a more extensive insurance policy will provide better coverage though. Unsure times for consumers may well lead them to postpone the purchase of expensive items like hearing aids.
2. Hearing centers currently still require physical locations. People need a recipe from a specialist to get a hearing aid. A customer needs a hearing test and an audiologist then determines the best solution for that individual. The hearing aid sometimes needs to be adjusted, a customer needs service for the hearing aid (e.g. new batteries), etc. In short: hearing aids have not been impacted very much by internet shopping at this point in time and physical stores are still necessary. This is probably good news for hearing aid sellers like Audika, because e-commerce usually greatly reduces margins and increases competition.
A disadvantage of the physical locations is that the company has €10.4m in off balance sheet liabilities consisting of operating leases. Also, when sales slow down, personnel is used less efficiently, directly impacting the bottom line. I do think that a hearing center is less risky then a more traditional retailer though. If you take a look at the Audika balance sheet you will see the company shows inventory of just €6-7m. That is because hearing aids are made to order. This business does not require large inventories and does seem very asset light in general. Return on Equity historically has been in the 20%-25% range, before slipping to the mid-teens in 2010.
So, careful spending by potential customers and less efficiency, because of the fixed nature of Audika’s expenses seem to be responsible for the deteriorating results. However, there is also a positive trend working in favor of Audika.
Favorable demographic trend: aging baby boomers
The demand for hearing aids is expected to grow in the coming years. Demographic trends (baby boomers aging) and age related hearing loss (presbycusis) will increase the demand for the only helpful “solution” for presbycusis: a hearing aid.
This is what the company has to say about this future demand:
“The main growth driver in the hearing correction market is the aging of the population. People are living longer and the elderly are enjoying better health. Between 2009 and 2030 the population of people aged 65 and older will grow by 52.3% (40 million).
Purposely positioned on the market for hearing correction solutions aimed at senior citizens and specifically targeting the 65 to 85 age group, Audika and the market as a whole are expected to benefit from the gradual arrival of the “oldies boom” generation into their core market.
This demographic trend is in its initial phase, with the peak expected to begin from 2012 to 2015, as suggested by the population pyramid (very similar to that of Italy).”
Audika has continued to open aditional hearing centers to provide coverage for 91 regional departments in France. The company currently has a market share of 14% and has the largest share of a very fragmented market. France has around 3,840 hearing correction centers, 2,756 of which are independent (1,609 independents and 1,147 operating under a cooperative brand). Audika has grown by acquiring these smaller independent centers and by starting up new centers where suitable acquisitions were not available.
Here is an overview of the number of centers acquired and started up in France over the past five years:
- 2011: 24 new centers: 7 acquisitions, 17 new set-ups
- 2010: 30 new centers: 15 acquisitions, 15 new set-ups
- 2009: 24 new centers: 17 acquisitions, 7 new set-ups
- 2008: 41 new centers: 25 acquisitions, 16 new set-ups
- 2007: 35 new centers: 28 acquisitions, 7 new set-ups
Currently Audika has 440 hearing centers and management has a medium term goal of reaching 700 centers in France.
As mentioned before, Audika has started operations in Italy in 2007 and has expanded steadily there as well, reaching 54 centers in 2011. The Italian market has similar demographics as the French market and there are less established hearing centers. This is the reason Audika views Italy as an attractive market. I should also mention that only around 20% of the people that could benefit from a hearing aid actually use one in France. In Italy this number is even a little lower. In some Scandinavian countries and in my country, The Netherlands, this percentage is substantially higher. Gradually increasing acceptance of hearing aids among elderly people could lead to an acceleration of the favorable growth trend.
Free cash flow and capital expenditures
When looking at the free cash flow Audika generates, we have to take the significant growth into account. One problem I have with fast expanding companies is that I find it very difficult to determine how much of the capital expenditures should be considered maintenance capex and how much should be viewed as growth capex. It is likely that a significant portion of the capital expenditures have gone to establishing and furnishing new centers and remodeling acquired centers. I have not been able to come up with a good estimate of the free cash flow Audika currently generates. Without more info from management I don’t see how I can answer this question. What is clear when looking at the table above is that Audika has generated substantial cash flows.
The cash that is not reinvested or spent on acquisitions is paid out as a dividend each year.
Barriers to entry & Industry dynamics
The hearing aid business does seem to have some barriers to entry. This is what Audika mentions in it’s 2011 Annual Report about these barriers:
“New entrants regularly come into this market in search of a share of its spectacular growth potential. Nevertheless, given the foothold already established by the historical players and the constraints imposed on this market (legal and regulatory requirements, complex client needs), few entrants have been successful in recent years, and most have found they are unable to meet their initial targets.
One of the main constraints is the necessity of recruiting hearing aid specialists in a particularly tight labor market on which less than 150 hearing aid practitioners are trained each year.“
“A hearing aid can only be fitted by a hearing aid professional. The spectacular growth in this market and the increased number of centers have led to a tight labor market, with a shortage of trained specialists relative to the needs of the market. Audika is particularly adept in the area of recruiting, attracting and retaining talented professionals by offering excellent working conditions, continuous training opportunities and loyalty incentives.”
This is interesting. I think that for a hearing aid practitioner who has just finished his/her training (this takes 3 years in France) a large established chain of hearing centers is a very attractive choice. You can service multiple centers and I think you would be able to make the most money working for a large player in this market, thereby favoring a larger established company like Audika.
Another advantage for large chains is that they have a better bargaining position with hearing aid manufacturers.
History and management ownership
Like so many French small caps, Audika is a family controlled company. Brothers Alain and Jean-Claude Tonnard established a network of hearing centers in 1976 and the Audika brand was created in 1990. The IPO on the Paris Stock Exchange followed in 1998.
A holding company called Holton controls 54% of the Audika shares. The ownership of this holding company Holton looks like this:
- Alain and Jean-Claude Tonnard: 55%
- Philippe Langzam (director): 6%
- European Capital (outside investor): 39%
So effectively Alain (CEO & Chairman) and Jean-Claude Tonnard (Vice-President) own 29.7% of the company (0.55 * 0.54). The control of Holton over Audika is even greater than this, because shares owned for 4+ years carry double voting rights. This means Holton currently has 70% of the total Audika voting rights.
Compensation looks generous with Alain Tonnard taking home €433k in 2011 and Jean-Claude Tonnard €451k. Both made more money in 2011 than in 2010, which seems inappropriate since net income decreased, even though sales showed a very small gain. There are no options outstanding.
More info about the investment from European Capital in 2007 can be found here: European Capital invests in recapitalization of Audika Group. European Capital also has a representative on Audika’s Board of Directors.
A closer look at competitor Amplifon
The main competing network of hearing centers in France is the Italian company Amplifon (website). Fortunately Amplifon is publicly listed in Italy, so we can take a look at their annual report. Amplifon is a much larger company with a €750m market cap and it is active on multiple continents (including North America and Oceania). It also carries a substantial debt load.
Amplifon has 291 hearing centers in France (page 71 of the 2011 AR) and 63 ‘contact points’. The company reported revenues of €96.9m in 2011, an increase of 4.7% against 2010. Excluding acquisitions, the increase was 3.5%. The increase was attributed to a succesful new marketing strategy. Amplifon says the following about its position in the market:
“Amplifon’s product mix continues to position itself in the mid-to-upper bracket, emphasising advanced products in terms of both performance and practicality.”
Amplifon comes pretty close to Audika’s sales numbers and needs fewer stores to do it. This looks very positive for Amplifon, but could just be a result of them targeting a specific section of the market and selling more expensive products. It is not necessarily a positive factor, I’ll explain this below when we look at Amplifon’s activities in The Netherlands.
What worries me a little is that Amplifon managed to grow sales organically faster than Audika in 2011 (3.5% vs 1.3%). In H1 2012 Amplifon’s organic growth turned slightly negative, but Audika’s was much worse at -5.0%. Audika has provided two explanations for this (mentioned above), but Amplifon seems more succesful in this negative environment. What is the explantion? I don’t know at this point. We should take into consideration that Amplifon is simply outcompeting Audika or that Audika’s rapid growth has led them to open too many centers.
I found another warning sign in Amplifon’s H1 2012 report (page 23). Amplifon is active in The Netherlands with their brand “Beter Horen”. Revenue dropped 25.6% compared to the first six months of 2011. The company cited as causes intense competition and: “the significant pressure exerted by the media on the hearing aid sector”. I looked into this further and found out they are talking about a program on Dutch television called “Radar” that warned people about the sales practices of the two large players on the Dutch market: Beter Horen and Schoonenberg. Dutch readers can watch the show here: Tros Radar: Gehoorapparaten.
In short: the main point the show made was that the big players in the market in some reported cases tried to sell the most expensive hearing aid to customers where a cheaper option was available and preferable. The most advanced (and most expensive) hearing aids require less service by the hearing centers, but the equipment is also far more expensive than a basic hearing aid. All this also increases the costs for insurers. The show also quoted a source that said some companies had used their market position to force a hearing aid manufacturer to accept their selling terms. It was mentioned a complaint had been filed with the NMA (Netherlands Competition Authority) about this.
All of this is of course not directly applicable to Audika. It is a competitor and this even happened in a different country. I do believe it shows the dynamics of the hearing aid market though. Audiologists are legally required in many countries, including France. Hearing aid chains can gain a dominant position in the market and this might be happening in the French market as well. I have read some French articles complaining about the high prices for hearing aids and that this prevents many elderly from acquiring a much needed device. This could lead to negative media attention and it might require hearing aid chains like Audika to lower prices thereby compressing margins.
I worry that the reduced margins of today might not be short term, but could become a long term problem because of consumer resentment and a less favorable treatment of hearing aids by insurers.
As an aside: I noticed the “Radar”-episode mentioned above still scores top 10 positions for the Dutch search terms “gehoorapparaten” (hearing aids) and “gehoorapparaat” (hearing aid). Imagine what the influence of a show like that might be on the decisions of prospective customers that do some basic online research. It must be a thorn in the eye of Beter Horen and Schoonenberg.
Audika looks attractive to me. The stock trades at rougly 9 times 2011 earnings and these are earnings that look depressed from a historical standpoint. The healthy cash flows, substantial management ownership and dividend policy are all positive factors as well. What has kept me from investing are my worries about the sustainability of the historical margins. Management has provided some explanations for the slipping margins, but competitor Amplifon seems to be doing a little better in France. Also negative media attention and changes in reimbursement policies by insurers could aggravate the situation.
I will continue to follow Audika and will try to find answers for these concerns. Perhaps I will be able to buy the stock at that point. The stock price might also reach levels that will just make me accept the risks and take a position.
Disclosure: no position.