Align Technology (NASDAQ:ALGN): Downgraded to Sell from Buy at Northcoast; target lowered to $13 (!)

Northcoast Research is out with a very negative call on Align Technology (NASDAQ:ALGN) downgrading the name to a Sell from Buy and lowering their price target to $13 (prev. $21)

Firm notes they believe ALGN’s proficiency program will transition from a revenue growth tailwind to a headwind beginning July 1, 2010. During the past several quarters, firm's research indicates ALGN’s revenue has benefited from doctors actively working to achieve proficiency status. In total, they believe this
one-time benefit has added 5-10 percentage points to ALGN’s North American case start growth rate.

In 2H10-1H11 (second-half FY10-first-half FY11), ALGN will compare against these inflated results and they believe growth will slow as a result. Later this year, doctors will simply not have the same incentive to aggressively grow their Invisalign cases (in some cases by 2x-4x) to maintain active status. Separately, many doctors are upset by ALGN’s proficiency requirements and will simply discontinue using Invisalign.

Even more concerning, Northcoast's research indicates that the GAC division of Dentsply (XRAY) will soon enter the market with a new clear aligner product. While there is no public data available on the new GAC product at this point, they believe it will be a multi-aligner system (10+) that will initially be able to treat about 50% of Invisalign cases at a retail price of $700, or a 55% discount to ALGN’s Invisalign Full.

Firm notes they already have a solid case study to suggest what could happen in the clear aligner market when a formidable competitor enters the market with a considerably less expensive product. Privately-held OrthoClear’s market share increased from 2.5% in 2Q05 to approximately 23% in 3Q06. If XRAY’s new clear aligner product can achieve the same level of market penetration as OrthoClear did in its first six quarters on the market, they estimate it would reduce ALGN’s 2H10 EPS by $0.01 and 2011 EPS by $0.09 due to unit share erosion alone. Firm estimates additional margin compression and lower Invisalign ASP’s could increase ALGN’s EPS risk to $0.18 in FY11.

Finally, they believe recent changes to the Invisalign Teen promotion will expose the adult cases that were causing strong teen procedure growth. Later in the year, the firm believes Invisalign Teen growth rates will slow significantly as doctors that were using the teen product on adult cases transition back to the traditional Invisalign.

Notablecalls: This is one fine piece of research from Northcoast Research's team. They are highlighting several possible (and real) headwinds, some of that are likely to materialize in the next 6 months.

The dental space, as many of you know has gotten hit particularly hard during the recession, yet ALGN stock is up quite nicely over the past couple of years.

There is no short interest to speak of which shows the negative side of the story is yet to be known.

I suspect ALGN will get hit as the call circulates around trading desks today and in the coming days.

Note that Northcoast has put real work into this, as the call is 24 pages long.


PS: This may be the first time I have highlighted Northcoast Research here, so welcome aboard!