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How Envista Holdings failed to do its due diligence in Carestream Dental’s IO scanner acquisition?

Updated: Jan 12, 2022

Since Carestream Dental spun-out of Carestream Health in FY17, the company continued to remain privately owned by PE groups CD&R (75%) and HK based CareCapital Inc (25%). Unlike other major dental manufacturers in public markets, private ownership allowed Carestream Dental not to be heavily scrutinized by IP regulators. Moreover, Envista Holdings’ stockholders relied on the company’s internal M&A team to take care of extensive due diligence on Carestream dental’s intraoral scanner patents portfolio – obviously a potent recipe for another acquisition disaster.

In this article, we are trying to understand the impact of the recent 3Shape lawsuit on NVST’ transaction (pending Q2 2022).

1. In light of the recent US patent infringement complaint, one thing is evident – NVST’s IP counsel failed to consider the potential IP issues and developing a backup plan.

2. We estimate the size of the tipping basket to be USD 6M (1% of total deal value). That is, NVST is entitled to indemnification for damages if the claims exceed the tipping basket sum. Please read our disclaimer here.

In recent years, all major dental manufacturers have relied strongly on M&A as well as strategic partnerships to build or acquire CAD/CAM & digital capabilities. The latest to join this digital club franchise is the new kid on the block - Envista Holdings.

With the recent deal announcement, NVST announced that it expects Carestream Dental’s IO scanner business unit to have a revenue run-rate of USD 60M in FY21, effectively valuing the business unit at USD 600 M. This deal amount roughly translates into 9 percent of NVST market cap on the day of Dec 20, 2021. Now there are two questions we would like to ask the NVST CFO here:

1. What royalties/ licensing fee ($) is Carestream Dental obligated to pay out to Exocad (now owned by ALGN)?

That’s because, DentalCAD and ChairsideCAD from exocad form the basis for Carestream Dental’s IO scanners (CS ScanFlow®) software. In other words, Carestream Dental does not have a proprietary software integration backbone for its intraoral scanners. Additionally, we would also like to understand about how the payments to exocad are structured:

A. What percentage of forecasted FY 21 revenue USD 600 M goes to exocad as royalty fee?

B. Does exocad get paid a one- time royalty for each unit of intraoral scanner sold OR is there a yearly subscription amount?

C. Is exocad paid out for every new software upgrade that’s made available to existing CS3600/CS3700 users? If yes, how are the payments structured?

2. What impact will PE Group Care Capital’s strategic alliance with Medit Corp will have on soon-to be NVST’s portfolio of intraoral scanners? HK-based CareCapital holdings owned 25% equity stake in Carestream Dental, and 67% ownership stake in China’s domestic market leader in the clear aligner segment: Angelalign Technology Inc. You can read more about the company’s ownership in one of our recent articles here.

On Jan 5, 2021 3Shape filed a U.S. patent infringement complaint against Carestream Dental for its intraoral scanner portfolio. Based on historical data about how 3Shape has dealt with ALGN’s patent infringement complaints at U.S. International Trade Commission (ITC), one can conclude that 3Shape definitely has a strong background and know-how in IP protection. While it is impossible to predict what the outcome of the U.S. District Court for the Western District of Texas would be, however we can place the bets in 3Shape favor without a second doubt.

Looking at the bigger picture, we are also trying to get a better sense of what is it that Envista Holdings expects to pay USD 600 M in the acquisition deal for?

1. Carestream Dental has discontinued its in-house milling unit after a combination of lackluster commercial performance and a series of quality issues.

2. Carestream Dental’s CAD software CS Scanflow™ is based on exocad’s software API (lack of proprietary CAD software).

3. The intraoral scanner’s commercially stellar performance in Mainland China (strong co-selling or bundling with Angelalign) remains non-replicated in any other major market worldwide.

4. Carestream Dental’s IP portfolio and its R&D capabilities have come under the lens with the recent 3Shape patent infringement claim with ITC.

5. Envista Holdings is paying a huge sum based on Carestream IO scanner’s future growth story – led by protagonist CS 3700 that has managed to generate quite an attention, but still remains to be seen how the product will perform commercially in the upcoming quarters.

6. Has NVST developed its IT integration plan which could ultimately enable top line growth within the specified time horizon (24-36 months)?

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