GN Store Nord

Attractive markets, depressed price: but is it also cheap?

GN Store Nord A/S is one of the global leaders in hearing aid and intelligent audio solutions. Headquartered in Bellerup (Denmark) and listed on the Nasdaq OMX Copenhagen exchange with a $3bn market cap, it operates in 40+ countries with 43% of revenues generated in Europe, 36% in North America and 21% in the rest of the world.

Started as a telegram company in 1869, after a number of acquisitions and divestments the company focused on hearing aids from 1977 and expanded its offering with headphones in 2000.

“Our purpose is Making Life Sound Better

We bring people closer through the power of sound and vision - letting you hear more, do more, and be more in life and at work than you ever thought possible”

Today GN Store Nord operates out of two segments: Hearing and Audio. Hearing is the traditional core business and sells hearing aids from the ReSound and Beltone brands, while audio (headsets, speakers and video) includes Jabra, BlueParrot and, more recently, SteelSeries. Both segments operate as standalone companies under one roof, a structure that enables GN to operate efficiently and reap significant technological synergies.

Source: GN Store Nord investor presentation

GN shares are 100% free float with no dominant shareholder. However, and quite surprisingly, a couple of months ago William Demant A/S (another, larger Danish hearing aid company) notified GN that it increased its aggregate holding of shares to above 10%. The only other shareholder with more than 5% is Norges Bank.

GN Hearing

GN offers a full range of hearing aids and accessories and creates innovative solutions for all types of ear-related diagnostics.

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Source: GN Store Nord investor presentation

This is the product segment that GN is most famous for, but today the hearing division represents just 33% of revenues, despite having grown at a very respectable CAGR of 10% from 2010 to 2021.

GN distinguishes itself from other manufacturers by operating a dedicated wholesale manufacturer model with no vertical integration: it prefers to work closely with so-called independent audiologists and only operate few of its own stores under the Beltone brand.

The hearing aid market remains very attractive and robust in the mid- to long-term: worldwide 80% of people with a hearing loss currently live without hearing aids. The most common answers to the question “What prevents you from buying hearing aid?” are:

1. I can wait

2. It won’t work for me

3. It costs too much

4. Stigma and self-perception

5. It’s too difficult

Source: William Demant

Market size is estimated at around US$6 billion annually, with historical growth rates in the 4% to 6% range. Growth stems from a number of underlying trends, the main ones being the aging society and increasing adoption by relatively young people in developed countries. On the other hand, there is the adoption of hearing aids in developing countries, where there is still significant under-penetration, even among the very hard of hearing. Finally, there is a technological cycle in which older hearing aids are replaced by more expensive versions with rechargeable batteries and with new functionalities. The hearing aid market has shifted from analog to digital and is developing in the direction of highly specialised artificial intelligence.

Source: Willima Demant

Current positive megatrends:

• 65+ population expected to grow significantly in the years to come: 35%-40% of this group is hearing impaired, yet only ~20% take advantage of hearing aids (sources: Hearing Health Matters, Amplifon, Sonova)

• Baby boomers generation reaching retirement age

• Increasing noise pollution drives prevalence of hearing loss

• Increasing acceptance: cultural changes, technological developments, miniaturisation, awareness, retail experience

Source: BofA Merrill Lynch Global Research

Source: GN Store Nord investor presentation

Europe is the biggest market accounting for 45% of global sales: it is fairly mature although penetration is still low at only 20%. North America is the second biggest market at around 30% of sales: it is highly fragmented with an also low penetration rate of 25%. (source: Hearing Health Matters, Amplifon)

Source: BofA Merrill Lynch Global Research

The industry has significant barriers to entry with six manufacturers controlling over 95% of the global market: there have been virtually no new entrants to the industry for the past three decades with technology, know-how and relationships with distributors representing the key obstacles for the new players.

Regulation

• Hearing aids are medical devices, so they are subject to local authorisation (FDA in the US, EU Medical Device Regulation, …)

• Extensive investments are needed into quality management systems

Technology

• Significant investments required in R&D

• Extensive intellectual properties

Distribution

• Users of hearing aids tend to choose based on inputs from hearing care professionals

• Sticky distribution as hearing care professionals tend to partner with the same manufacturers

While I’m sure there are precise estimates of market shares, the data I found is most of the times inconsistent. According to Statista, for example, the market is dominated by Sonova (31%), followed by Demant (30%), WS Audiology (19%), GN Store Nord (15%) and Starkey (4%). This is in line with GN’s own claim to have a 15%-20% share of the global market. However, it is highly suspicious as it does not include Amplifon, which is likely to be #3 or #4 worldwide. (Australia’s Cochlear is usually not included in these rankings as it offers surgical implants rather than hearing aids, which do not require surgery: implants are the next step when hearing aids are not enough and are best suited for people with more severe hearing loss in one or both ears and poor speech understanding.)

Regardless of rankings, this is an industry in continuous consolidation: Siemens Audiology was a business unit of Siemens until 2015, when it was sold to EQT Partners and renamed Sivantos Group (based in Singapore); in 2019 Sivantos merged with yet another Danish company, Widex, to form WS Audiology.

This is a good depiction of the current offerings.

Source: Hearing Tracker

In contrast, the retail market is highly fragmented: a large portion is represented by hospitals and other government entities (for example the Veteran Administration in the US), but the largest segment is made up of independent retailers.

According to Amplifon, the pure retail market is so composed:

• Around 50% is made up of independent players with few points of sale or very small chains

• 25% is made up of specialty players (the vertically integrated hearing aid manufacturers with an international presence listed above) and the so-called national champions, companies with a presence limited to one or two countries (such as Kind in Germany, Neuroth in Austria and Rion in Japan)

• over 10% is represented by non-specialty players such as pharmacies, supermarkets and opticians' shops

• less than 3% is made up of online retailers, who play a marginal role. The few successful online players are those who use the internet and digital marketing tools to direct potential customers to their physical shops for tests and fittings by a hearing care specialist. Last year GN spent $100 million to acquire US-based Lively, a leading online hearing care and digital marketing platform, enabling consumers to explore, purchase and receive hearing care from licensed hearing care professionals in the US all from the comfort of their home (Lively is today called JabraEnhance.com).

GN Audio

This is GN’s “newest” division, but also the fastest growing with a 23% CAGR since 2010: it offers a full range of wireless and corded headsets for users in call centres and offices, and also develops headsets for voice communication, headphones for sports as well as in-car speakerphones.

Source: GN Store Nord investor presentation

While it also serves consumers, most of the sales in this division are generated by corporate clients. In particular, the number of headphones in the office segment has increased sharply in recent years as a result of the emergence of IP telephony, whereby PC and headphones replace the traditional telephone. This trend has of course been further exacerbated by the rise of video calling and the increase in office workers who have been forced to work from home. Before that, however, there was already a trend towards working in flexible work setups with so-called open-floor concepts: comfortable "over ear" headphones, which are suitable for wearing for several hour stretches, are therefore often used to create your own space and to minimise unwanted noise and distraction by colleagues.

Source: GN Store Nord investor presentation

During the past two years, we have experienced a permanent change with more opportunity for working from home and remote collaboration, with leading platforms seeing a massive uptake in the number of users. While the core target customer traditionally was an office-based worker, there is an opportunity beyond the traditional office, also referred to as “deskless workers”: these more than two billion workers include teachers, doctors, retail staff, logistics personnel, first responders, and many other key roles.

Source: GN Store Nord investor presentation

The intelligent audio solutions market is currently worth around US$2.5-3 billion: GN is the #1 globally in the Unified Communication and Collaboration (UC&C) and #2 in the traditional Contract Centres & Offices (CC&O) segments: both are highly consolidated with only two players controlling over 75% of the markets. GN is also (likely) #2 globally in the more traditional bluetooth headset market.

Similar to hearing aids, this is also an industry in rapid consolidation. Plantronics (US) first merged with Polycom to form Poly, only to be acquired this year by HP. Also this year Sonova Holding completed the acquisition of Sennheiser Electronic’s consumer division, while Demant has a joint venture with the same Sennheiser under the EPOS brand to sell high-end audio solutions designed for enterprise, gaming and air traffic control.

To further expand its product offering, earlier this year GN closed the acquisition of SteelSeries for an enterprise value of around $1.1 bn (SteelSeries was owned by the private equity firm Axcel).

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SteelSeries is particularly known for its premium gaming headsets, keyboards and mice that are software-enabled and system-integrated, which significantly enhance the user experience and reinforce customer loyalty. The gaming gear market has experienced significant growth over the past few years and is expected to continue to grow in the mid-term at around 7-8% per year.

Strategy: R&D and no physical locations

Innovation is the key driver of success in this industry. GN invests 9% of sales and employs 15% of its workforce in R&D functions, with research centres in Denmark, US, France, the Netherlands, Poland and China. Over the years, this has allowed the company to reach a series of “world first milestones”:

• 1990: first telephone headset for call centres

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• 1998: first Bluetooth headset

• 2014: first made-for-iPhone hearing aids

• 2020: first hearing aid with a microphone and receiver in the ear

• 2021: first new-normal-ready intelligent video bar for video conferencing

• 2022: first all-in-one earbuds with advanced hearing technology (Jabra Enhance Plus)

Source: GN Store Nord investor presentation

In particular in the hearing segment, GN’s strategy is to focus on being the preferred partner with no vertical integration. By focusing on independent retail markets (85% of the global market is NOT locked by hearing aid manufacturers), GN believes it has significant room to grow its market share: partner with the customer by going the extra mile, proactively reach out and support, deliver services far above expectations.

Personalisation is indeed the key: the sale of hearing aids is inseparable from the fitting process since everyone’s “ocular canal” is unique, and the success of a product largely depends on accurate diagnosis, technical specification and personalised adaptation of the device to a customer’s need (i.e., trained audiologists/hearing aid specialists, long-lasting relationship). The fitters of hearing aids, like dentists, are keen to sell high-end products which earn them more money: a hearing aids might cost around US$1,500, and on top of this the fitter might charge another US$2,000 for customised services.

Financials

Glancing rapidly at the numbers, with the exception of the Covid year 2020 the GN story is one of 10 years of relentless growth:

Source: GN Store Nord investor presentation

But the consequences of the corona pandemic resulted in divergent advances for the two divisions, with Hearing severely affected by the lockdown measures in stark contrast to the positive developments of Audio. While the latter was definitely a Covid-winner, the former has not yet returned to 2019 levels:

Source: GN Store Nord annual reports (revenues are in billion of DKK)

The company boosts of a strict focus on capital allocation: over the last 10 years to 2021, GN has indeed returned to shareholders the equivalent of $1.6 bn in today’s dollars via share repurchases and $200 million in dividends (in total, ~60% of current market cap).

Source: GN Store Nord investor presentation

However, the share buyback plan has been put on hold following the acquisition of SteelSeries, which was consumed entirely in cash and financed with a bridge loan and a new €600 million bond maturing in 2024 (still with a very cheap 0.875% coupon). Leverage, which was typically held below 2x net debt/EBITDA, shot up to 6x following the acquisition: the company expects to focus on deleveraging in order to be within its capital structure policy again within a couple of years (so do not expect buybacks in either 2023 or 2024: dividends should still be paid unless the situation deteriorates dramatically).

Source: GN Store Nord investor presentation

Similar to many other “growth stories” of the last decade, GN’s price chart shows an exponential rise starting around 2016, with an acceleration in 2020 and the subsequent crash: from June 2021 (DKK 580) to today (DKK 165) it has now lost over 70% of its value.

Source: Google Finance, as at 14 December 2022

And in early November the company surprised (or maybe not) the market with a revised guidance for 2022 “to reflect the impact of the worsened macroeconomic environment, lower consumer sentiment and general higher uncertainty which impacts the markets in which GN operates”. Particularly hit across GN Audio (especially consumers, less so enterprise), it now expects earnings to decline ~30% in 2022.

Compare the change in guidance from early 2022:

Source: GN Store Nord press releases

Free cash flows were also depressed by continued inventory build-up, especially in SteelSeries:

“At the beginning of the year, we were focusing on sourcing as many critical components as possible due to the global chipset supply challenges. That resulted in very long lead times of certain components, creating the need for long-term commitments and planning. As the consumer-oriented markets experienced a demand shock, there's a short-term mismatch between inventory build-up and revenue, while we are currently running on a higher inventory level than normal. During the coming quarters and years, we will focus on reducing these inventories towards historical levels.”

“Consequently, we are reducing our operating expenses for the coming years, while we are going to take cost out immediately. This will drive run rate savings for 2023 and beyond of the magnitude of DKK 200 million to DKK 300 million per year. To execute these savings, we experienced a further DKK 100 million in nonrecurring items in 2022 on top of the already communicated DKK 400 million. However, it is important to stress that we will continue to invest in areas where we see strong growth potential in the short and long term.” (GN Store Nord Q3 2022 call transcript)

The following table shows some relevant metrics for the listed companies in the space (WS Audiology and Starkey are private). For GN, profitability is in line with peers but it also has the highest debt load.

Source: Morningstar, own calculations, as at 14 December 2022. Cochlear trades at a premium due to the higher expected growth in the implant sector (10%-15%), although from a smaller initial base (US$1 bn vs US$5bn for hearing aids). All multiples are trailing 12 months (TTM)

While the entire sector has de-rated over the past few months, GN has underperformed the listed peers and is the only one with negative results over 5 years.

Source: Google Finance, as at 14 December 2022

So, is GN Store Nord a high-quality company and a good investment?

I would say it’s good quality, not excellent.

I like the hearing aids segment, a market with steady (although not exponential) growth of around 5% driven mostly by favourable demographic trends and that has proven resilient in economic downturns (2020 was different: not a recession, but rather impossible to get the products). But hearing aids are quite expensive (especially for emerging markets living standards), one of the main reasons why markets are still under-penetrated. And although technological innovation should support pricing power, oligopolistic does not mean that there is low competition on prices.

For example: Costco is the biggest private provider of hearing aids in the USA, a product it has been offering since 1989 both through the main brands (including GN Store’s Resound) and their own label (“Kirkland Signature”, but manufactured by Sonova). As everything else, Costco’s own brand is generally cheaper by $100 compared to branded products.

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Audio also has some tailwind from underlying trends (working from home, collaboration, gaming, …), but the jury is still out on whether companies can keep up with the exploits of the last couple of years: recent results from GN show exactly this, although it expects to raise prices by 10% next year in the enterprise sub-segment to counter inflation.

Despite the current market price being back to 2017 levels, the stock is as cheap as it was before it started ramping up (P/E 16x, FCF yield 6%) only on a “normalised” basis: today those multiples are much worse on 2022 results because fundamentals have also collapsed.

The current price could be a good entry point if we assume that GN can ‘relatively quickly’ return to at least 2019 profitability (2021 was even butter but less likely to be repeated): it’s a story of “earnings/FCF/margins returning to normal levels” rather than “buy cheap and wait for multiples to re-rate”. This is obviously definitely possible (especially with the introduction of new products in the hearing segment as GN I currently doing), but you must also have conviction in the continued growth and high profitability of the audio segment.

Last but not least, there is the question of what Demant will do: will they launch a full takeover of GN Store Nord? Asked during the Q3 earnings call whether they engaged with the new shareholder, management simply moved over and didn’t answer the question.

Considering the industry structure and the similarities between the two companies (not last the common culture), some sort of M&A is likely to be beneficial in terms of synergies, but I’m not too familiar with Denmark’s antitrust regulation to assess if such a combination could be blocked by regulators.

1. There are several types of hearing aid that differ by size, placement and the degree to which they amplify sound.

• Behind-the-ear (BTE): hard plastic case worn behind the ear and connected to a plastic earmold that fits inside the outer ear

• In-the-ear (ITE): fits completely inside the outer ear and is used for mild to severe hearing loss

• In-the-canal (ITC): fits the size and shape of the ear canal

• Completely-in-canal (CIC): fits the size and shape of the ear canal and is nearly hidden when worn

2. There must be something really good in Danish air: SteelSeries is also originally from Denmark (although it now has offices in France, US, China and Taiwan), as is the audio and video consumer electronic company Bang&Olufsen!

3. Jabra Corporation, acquired by GN in 2000.

4. The KS10 hearing aid was actually discontinued in October (apparently for long-term problems with recharging), but future newer versions of the product are expected to be introduced.