Frank Voisin is the author of the popular value focused website Frankly Speaking, found at http://www.FrankVoisin.com

The following is a reader submission on PhotoMedex (NASDAQ:PHMD).

Frank’s Disclosure: No position in any of the securities mentioned.

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IS PHOTOMEDEX POISED FOR A SHORT SQUEEZE?

SUMMARY

Photomedex (“PHMD”) is a heavily shorted stock which we think is a compelling long, especially considering the possibility of a major short squeeze.  Despite the large short position (25%+ of float, ~20% cost to borrow), PHMD is actually an undervalued (5.1x 2013E Adj EBITDA) , unlevered (20% of its market cap is in net cash), growing (revenue and EBITDA should increase organically in 2013),  high free cash flow company (D&A significantly higher than maintenance capex,  an nol reduces cash taxes and non-recurring items distort LTM results) with a buyback waiting to be used (the company has been restricted from repurchasing stock for many months but the window reopens in May) and a management team which owns ~30% of the company and is incentivized to create shareholder value.

BUSINESS DESCRIPTION

The current PHMD was formed in December 2011 with the merger of Radiancy (which makes a number of products including the no!no!) with Photomedex (which has a strong proprietary consumer marketing engine based upon the direct to consumer sales model).  PHMD’s largest product (~85% of revenue) is the no!no! hair removal product, which is short for No Hair, No Pain.  The product is for home use and unlike other products that use methods that are painful, have side effects or are limited in body areas that can be treated,  the no!no! is based on a proprietary heat-based technology and therefore can be used for all hair colors and skin types, can be used on all body areas, and is virtually painless.

PHMD’s revenue is derived 61% by direct to consumers (infomercials, radio and newsprint), 23% by distributors (primarily in Japan) and 16% via Home Shopping network and select retailers including Bed Bath and Beyond (which, after a test run, recently decided to sell the product at ~950 of its stores nationwide), and  Bergdorf Goodman.

PHMD outsources most of its fulfillment and manufacturing.  This enables the company to minimize its capital expenditures and to locate its operations (call centers, manufacturing) in the most advantageous (based on cost, proximity to customers, etc.) locations.

VALUATION

Stock Price: $15.00
Shares: 21.6 (including itm options)
Equity Cap: ??317.2
Cash: 69.6 (including options proceeds)
Debt: ?0.6
Enterprise Value?: 248.2
EV/2013E ADJ. EBITDA ($48.7) 5.1x
EV/2012 ADJ. EBITDA ($45.1) 5.5x

Note: the $48.7 million 2013 Adj. EBITDA estimate is our own, based on an 8% increase in revenue and zero margin improvement, both assumptions we consider to be conservative.  Canaccord’s estimate is approximately $50 million (after adding back the stock comp).

WHY IS THE STOCK MISUNDERSTOOD

  1. Misunderstood financials causing stock not to screen well – Many data sources show 2012 EBITDA to be $32.9 million (implying a 7.5x EBITDA multiple).  However, this figure includes a $6.1 million non-recurring expense and $6.2 million of non-cash stock compensation.  Adding back these two items would yield an adjusted EBITDA of $45.1 million and reduce the EV/EBITDA to 5.5x.

  2. Cash flow greater than it may appear :

    1. PHMD’s D&A is significantly higher than its maintenance capex.  Last year, D&A was $5.6 million and capex was only $0.5 million (again, the company outsources most of its manufacturing and has limited PP&E).  Last year the company did spend $3.2mm for lasers placed into service, which we consider growth capex.  This relates to the Xtrac laser to treat psoriasis which PHMD places in a physician’s office and then charges the physician a fee per treatment.  This Xtrac business is currently small (less than 5% of PHMD’s revenue) and due to the payback time required for these laser investments, the money spent last year to install the lasers (which is large relative to maintenance capex) yielded little contribution to PHMD’s overall profitability.
    2. The company has an NOL which will reduce its cash taxes for many years to come.  The company estimates its cash tax rate in 2013 will be 28% – 30%.
    3. Last year PHMD generated $25.1mm of cash flow from operations.  However, this figure was negatively impacted by approximately $8mm of taxes that the company essentially prepaid, so a more normalized cash flow figure would have been closer to $33 million.
    4. Limited analyst coverage – the stock is currently covered only by Maxim, Ascendiant and Canaccord.
    5. Limited guidance – Management is very conservative and provides only limited formal guidance (revenue for the following quarter).  This lack of guidance makes it harder for investors to understand the company.
    6. Management doesn’t do a great job telling its story to investors –we feel they could do a better job of explaining to investors why the stock is such an attractive investment (instead of just explaining what the company does), and expect management will learn to do a much better job of doing this.

WHAT SOME SHORTS ARE CLAIMING

  1. Some shorts claim PHMD is a one product company whose main product has peaked.  However, the no!no! has not peaked and will likely grow in 2013 (Q1 revenue guidance for the entire company is 13%+).  Furthermore, as evidenced by last quarter’s results, the company is beginning to experience growth in some of its other products, although the no!no! likely will be PHMD’s  major product for some time.  Some of the factors that will drive PHMD’s growth are:

    1. No!no! domestic revenue should continue to increase as the company further penetrates the US market and introduces new products such as the no!no! pro (a higher margin, high priced product).
    2. Domestic no!no! sales should also benefit as the company broadens its advertising (using shorter commercials during the day in addition to the current longer late night commercials), and begins to advertise in Spanish to market to the large Spanish speaking population in the USA.
    3. International sales (currently ~ 30% of revenue) should increase as the company continues to penetrate existing markets and, importantly, enters new markets such as Brazil (a very large market), German and South Korea.

As illustrated below, no!no!’s revenues do not appear to have peaked.  Q1 and Q2 showed sequential growth.  In Q3 advertising rates were unusually high (due to the elections and summer Olympics), so management reduced marketing expenditures for that quarter which resulted in a decrease in Direct sales, but an increase in overall profitability.  The company could have spent more money on marketing (and thus increased revenue) but felt it would not have generated a high enough ROI.  This demonstrates that management is focused on long term profitability, not driving revenue growth just for the sake of growth.  Q4 reflected additional growth, except for revenues from Distributors (primarily Japan) which is always seasonally weak that quarter.  In addition, we believe Q4 Direct revenues were hampered by the closure of the distribution facility for a few days for the holidays at year end (but that those sales were not lost, they slipped into Q1 2013).

The following table shows the 2012 revenue ($MM) for the Consumer segment (which is primarily no!no!).

 

  1. Some shorts also claim the company does not reserve adequately for returns.  There are many ways to assess a company’s reserves, but the below table from the 10k seems to illustrate the company has not under-reserved for sales returns or doubtful accounts.

Valuation and Qualifying Accounts:

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