How Worried Should Align Technology Investors Be About the SmileDirectClub Threat?

I received an email recently from a former coworker. He lives in the Nashville, Tennessee, area and wanted to know what I thought about SmileDirectClub, the largest provider of clear aligners for the at-home teeth-straightening market. He told me that SmileDirectClub, or SDC, which is headquartered in his hometown, appeared to be growing like crazy.

And he was right. SDC has quickly risen to the top of what it calls "the doctor-directed at-home invisible aligner industry." The company claims a 95% market share in the space. It has also attracted a lot of favorable attention from private equity investors, raising $380 million in a funding round that pegged the company's value at $3.2 billion.

Meanwhile, Align Technology (NASDAQ: ALGN) -- still the dominant player in the overall clear-aligner market -- disappointed investors with its slowing sales and earnings growth in the third quarter. The company's Q3 results, combined with the broader market pullback, caused Align to give up all of its 75% year-to-date gain racked up by early October. With growth already slowing, how worried should Align Technology investors be about the threat from SDC?

Assessing the current threat

SDC's clear aligners have helped more than 300,000 patients improve their smiles since the company was founded in 2014. By comparison, more than 850,000 patients used Align's Invisalign clear aligners in the last year alone.

But those numbers don't tell the full story of the potential threat that SDC presents. The small company's clear aligners cost roughly 60% less than Invisalign. That difference is important considering that the biggest reason Americans don't receive needed orthodontic care is cost.

It's also possible to underestimate the appeal of the convenience factor that SDC offers patients. Instead of going to visit an orthodontist or general dentist to have a 3D scan of their teeth, customers can use SDC's at-home dental impression kit. All communication with dental professionals can be done remotely.

However, in Align's Q3 conference call, CFO John Morici reiterated the company's view that there's only around a 10% overlap between Invisalign cases and SDC clear-aligner cases. Morici acknowledged that SDC represents the most significant change in the U.S. market that Align has seen. But he added that because SDC operates in "a completely different segment" with its direct-to-home model, "that's not where the competition is right now."

SDC certainly has some challenges of its own that could limit how much it hurts Align's sales. The company faces significant pushback from the American Dental Association and the American Association of Orthodontists, which filed complaints against SDC in 36 states for alleged violations of regulations and statutes applying to orthodontic treatment.

What about the future?

While Align might not have much to worry about with SDC right now, it could be a different story in the future. Ultimately, the cost and convenience advantages of at-home teeth straightening could prove to be difficult to compete against.

We've already seen at-home delivery of products and services disrupt other industries. Telehealth is already growing by leaps and bounds. Teledentistry could be next.

And with SDC flush with cash from its latest funding round, the company is likely to spend the money in ways that directly threaten Align. SDC stated the $3.2 billion raised will be used for several purposes, including research and development, product innovation, and international expansion.

Don't think that Align will dismiss the potential threat, though. The company is trying new approaches to attract customers in ways that don't undermine its dental professional partners. Align launched its Smile Concierge program in 2017 to help consumers streamline the process for teeth alignment and connect them with Invisalign doctors. This program is now active in several international markets as well.

Align also is testing its Invisalign Experience retail locations. These locations are like stores (although Align doesn't call them stores anymore because of the confusion and concerns it created among its dental professional partners). They build consumer awareness for Invisalign and -- like the Smile Concierge program -- help connect customers to Invisalign doctors.

The company has hedged its bets, too. Align owns a 19% stake in SDC. If the at-home clear-aligner market really begins to take away market share, Align could always acquire SDC or one of several other companies with similar at-home offerings.

The big picture

Investors should keep in mind that the overall market for clear aligners should be able to support multiple players. Align currently claims only a 13% share of its available market. And Invisalign can currently be used for only 70% of the total addressable market.

Those figures reflect orthodontic case starts. There's an even bigger opportunity in attracting customers who need orthodontic care but don't receive this care. Align estimates that around 75% of all people need some type of tooth-movement treatment with only 1 in 5 of those individuals following through with treatment.

Should Align investors worry about SDC? Not really. But they certainly should keep their eyes on the changing dynamics in the clear-aligner market. The good news: That appears to be exactly what Align is doing already.

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Keith Speights owns shares of Align Technology. The Motley Fool owns shares of and recommends Align Technology. The Motley Fool has a disclosure policy.