Audika Groupe: can you hear the call of value?

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:

Audika Groupe stock 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:

Year: 2011 2010 2009 2008 2007
Revenue € Mln: €110.7 €105.7 €106.5 €101.8 €92.7
Operating Income: €15.4m €17.1 €18.5 €17.7 €18.1
Net Income: €8.5m €9.4 €10.7 €10.2 €11.1
Cash from operating activities: €15.5m €11.7 €13.6 €12.9 €16.2
Capital expenditures: €4.4m €6.9 €6.6 €9.0 €7.3
Shareholders Equity: €59.9m €55.4 €50.0 €43.1 €37.0

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.

And:

“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.

Conclusion

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.

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Posted in European Stocks and tagged .

NeverLoseMoney

Author of ValueInvestingBlog.net. Private investor.

7 Comments

  1. Nice, quality business that I’ve looked at. Nothing wrong with the sustainability of its margins or with its growth prospects. It is worth ~9.85 without growth. In my judgment, it’s worth waiting for that price point before considering it good value.

    Cheers for the post and for the blog generally.

  2. Hello
    Very interesting article.
    You are spot on regarding the negative media attention.

    Audika has been recently accused by competitor Sonalto of having prohibitive margins and Sonalto pointed out the monopolistic situation of audiologists.

    Sonalto sells its product much cheaper direcly to customers. Audiologists have launched lawsuits against Sonalto.

    http://www.itrpress.com/cp/2012/2012-09-26_120926-SonaltoTribune.pdf

    Some media are starting to cover the fight and mention that the government is looking at the subject (social security pays part of the hearing aid), which is never a very good sign.

    http://www.20minutes.fr/economie/1018251-prix-protheses-auditives-polemique-commence-faire-bruit

    Regards

    • Thank you for the comment and the two interesting articles.

      I had read about Sonalto and it did make me think about a possible “commoditization” of the hearing aid industry. If cheaper and more basic solutions like Sonalto become suitable for a large group of customers it will probably permanently impact the hearing aid business, destroying margins.

      From what I have seen in my environment (grandma with a hearing aid 🙂 ) and the reactions I read on some articles about hearing aid chains, I believe service from hearing aid chains is still very important. These things need to be finely adjusted. Also hearing loss will get worse over time. All in all it’s a lot more service intensive then say, correcting someones vision problems by getting them a good pair of glasses. So, I think it is very tricky to come up with a product that fixes the problem for a large group of people for a number of years.

      However, I do see the dangers of margin compression like the ones pointed out in the second article. The current economic times could act as a catalyst in this regard. You have on the one hand a product with attractive margins for a seller like Audika, but on the other hand a product that could be considered a necessity that proves to be too expensive for a large group of cash-strapped people.

      The hearing aid business has been a good business, but how good will it be going forward?

  3. Thanks for your very thorough and insightful post. I know this French microcap since its IPO on the “Second Marché” more than 14 years ago. It give me a nice reason to intervene (at last) on your blog.

    I was a Junior analyst at that time and it had been one of my first stock picking selected stock that proved to be a great winner in the following years. At first it was not seen as the most fashionable stock (especially during the 99-2K years of the “Tech-mania”) but it delivered for the first 10 years of listing a very significant growth, both at operational and stock price performance levels (between 15 and 30% per year for both).

    Since 2008 this seems to be a very different story, on both metrics as well.

    The fact that I’ve always kept an eye (even though sometime distant) on this stock/company helps me to share with you some of my thoughts on this, that I hope you’ll find useful. Some of them derive from exchanges with analysts at small French brokerage firms that tracks the company performance on an ongoing basis.

    The two founders/senior managers of the company have been great managers since inception in general and between the float and 2007. At this point in time it looks as if they had not seen that their environment had changed. The financial community over there seems to be concerned by the fact that management does not change its explanation to the market on guidance and result.

    Indeed since 2006 the competition on Audika’s sector has been more and more structured. Amplifon recently took over the 1st position in revenues and other small groups are active on some “niche” segments of the sector. Therefore we experience at the same time a fragmentation and a structuration of the competition. Also and as importantly, based on what I’ve read/heard, the acquisition price of small/independent retail network/shops in their sector is still very high (still on the multiples that applied to Audika before 2007). That’s probably related to the fact that powerful competition from abroad (amplifon and co) is trying to win market share by external growth (at any price?). This new competition is not a good news fro Audika and there is few reason to see this changing over the next years.

    I see another threat that relates to the franco-french environment: the optician networks. There is a lot of very powerful networks active in that sector. France is among the country where you’ll find an optician shop almost everywhere, even (sometimes) in some villages of 3-4K inhabitants. And those networks are more and more trying to enter the hearing aids market. Some are already quite active, some are beginning to split their shop in two to allocate a dedicated place to this new offering. Not only does this have an impact on the competition (by increasing the supply/volume), but also on the price (as they try to differentiate from existing/historic actors on price/services levels). Therefore one can expect a continuing trend in declining selling price.

    That’s on the supply side.

    Then on the demand side, there is indeed a growing concern by (French) consumers and national health authority regarding the price and quality/price ratio offered by this sector. The high price paid upfront has always been explained by Audika and its peers by the fact that several unpaid services are offered to customers, before the purchase and after. This economic model is more and more challenged and it would not surprise me if someone within the sector (maybe a new entrant) comes with a very different business model in the coming years. Would that happen and become a real game changing strategy in this sector, how would Audika adapt itself to the change?

    All in all I think all those can explain the falling angel status for the stock since 2008 and limited rebound in stock price over the last 6 months.

    But all those negative signals can be balanced by other positive ones. The first one being that Audika could be a nice target for a large competitor from abroad, but more surely for a large French optician network that would like to expand rapidly on this segment. The other being that this hearing aids sector is clearly showing growth perspective based on demographic and technological innovation.

    Quite a well balanced situation then. The value based approach for the valuation can apply but I’m afraid that until the company is able to prove the market that it can show growth in revenues (and ultimately profit), the share will not perform as well as it should.

    As a conclusion please note that over there the stock is monitored (more or less closely) by 7 micro/small cap analysts (3 at buy ; 3 at hold and 1 at sell).

    Best,

    Opcvm123

    • Thanks for the detailed comment opcvm123. I was hoping for some comments from people with a much better view of the French market than me and I have certainly received that on this post!

      You make a very good point about the competitive forces that are at work. Audika has been quite aggressive in growing their hearing centers over the last few years. I usually look at serial acquirers skeptically and you are right to look at the acquisition prices critically. Even though the purchases of individual small chains are fairly small, combined over the years these numbers add up. Plus, Audika might be forced to expand like this to retain their market share.

      Great point about the optician networks. They are also well established in my country and are starting to sell hearing aids as well. They could be a great competitor. The larger ones can quickly get the scale to make it work. I’m not sure if people would be deterred from buying a hearing aid there, but lower prices would certainly help in convincing them.

      If competitors would only charge the actual services the customer uses this could also lower prices and depress margins. Audika might not have any other choice than matching those lower prices.

      The most interesting thing I found when reading about the hearing aid business is the relationship between audiologists, the hearing aid chains and the customers. Audiologists hold a powerful position because they are required in the whole process and they are relatively scarce. Their incentives don’t seem to be well aligned with the customer’s interests. Audiologists benefit from high selling prices and succesful, dominant hearing aid chains with pricing power.

      The question I ask myself is: why would audiologists participate in a race to the bottom of hearing aid prices? This problem could be solved though by regulation or by increasing the number of new audiologists that finish their education each year.

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