Spruce Point Capital Management is pleased to announce it has released the contents of a unique short idea involving TSO3 Inc. (TSX: TOS / OTC: TSTIF or “the Company”), a Canadian manufacturer of low-temperature sterilization systems to eliminate microbial contaminants that cause infection. We have conducted an extensive fundamental and forensic accounting review, and believe TSO3 is an over-hyped Canadian healthcare stock destined to fail; its financial presentation, accounting, and limited disclosures obscure the pressures it is facing selling and installing its product to end market customers.
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As a result, we have a "Strong Sell" opinion and a long-term price target of approximately C$0.25 - C$0.50 cents per share, or approximately 80% to 90% downside risk.
Executive Summary
Spruce Point Is Short TSO3 (TSX: TOS / OTC: TSTIF) For The Following Reasons, Sees >80% Downside:
TSO3 Inc. (“TSO3” or “the Company”) makes low-temperature sterilization systems to eliminate microbial contaminants that cause infection. Founded in 1998, TSO3 is a regular stock promotion that has repeatedly disappointed investors by failing to broadly commercialize its product and show a profit. Déjà vu, now on its 3rd attempted generation STERIZONE VP4 and its 3rd sales/distribution partner Getinge (previous partner 3M sued it), TSO3 is again baiting investors, who’ve bid its share price up 6x since 2014. Our fundamental and forensic analysis suggests investors should brace for disappointment and >80% downside
1 TSO3 Is Just Another Canadian Healthcare Promotion: The Canadian markets are littered with recent examples of healthcare stocks in need of urgent medical attention, wounded from over-promotion, questionable practices, and poor performance. Short sellers made early warning calls on many names down >80%: Valeant, Concordia, Nobilis, CRH Medical
2 Disclosure Issues & Obfuscating Its Actual End Market Sales: TSO3 is not disclosing its installed base and the reason is obvious – if it did, investors might see just how poor its product’s end market acceptance actually is. In Q3’16, TSO3 suggested it would provide clarity on its installed base in early 2017 – investors are still waiting…. TSO3 even stopped disclosing consumables sales in Q2’16. It currently recognizes as revenues shipments to Getinge, its 3rd party distributor (183 units since Q1’16). However, our math and field checks suggest at best 10 units are actually installed at end customers (95% difference to shipments)
3 TSO3 Using the “Partnership” Playbook To Hype Its Potential: Déjà vu, TSO3 is repeating a twice failed playbook. Recently from 2009-2013, alongside of 3M: TSO3’s single product cycle ended with no material sales, termination of their partnership, and a legal settlement in favor of 3M. TSO3’s prior two generations of this product also failed (the current 3rd generation VP4 appears eerily similar to the 2nd generation – not surprising given the low R&D spend)
4 TSO3 Overstating Its Total Addressable Market (TAM): All good promotions involve baiting investors with big addressable market opportunities. TSO3 appears to have overstated its true market potential by >30% units and C$170m. We provide evidence of the Company playing fast and loose with its numbers
5 Getinge Is Not The Solution To TSO3’s Problems: Bulls think the new Getinge sales partnership is the catalyst needed to spark a run towards C$87m in sales and C$0.22c of EPS in 2020. In reality, Getinge can walk away from the partnership for various reasons, and owns competing sterilizers that likely generate better margins. Getinge has actually purchased 9 sterilization companies prior to this glorified agreement with TSO3, including a low temperature solution called Stericool. Meanwhile Getinge has its own problems: its stock is down to multi-year lows, it has been forced to restructure, and churn through various CEOs, It is also going through an FDA investigation into quality control at its plants, and a regulatory inquiry by Brazilian authorities for alleged cartel activities
6 Outclassed By Larger, Better Capitalized Incumbent Competition, TSO3 Stands Little Chance: Sterrad, owned by Johnson and Johnson (J&J), is the industry leader with a product that is cheaper, better on functionality and maintains a market leading installed base for >20 years. TSO3’s has hyped investors on the potential of solving the superbug issue at hospitals – FDA presumably disagrees as it has recommended four potential solutions, none of which include TSO3’s product (VP4). TSO3’s markets that its key value add is the VP4’s ability to sterilize scopes that no other device can; except it quietly recognizes that the VP4 may be damaging the medical devices being sterilized – an admission that the current generation may be doomed
7 Mgmt & Employment Issues: TSO3 management owns less than 1% of the company’s shares, and has no alignment with investors. Their main incentive is to collect bloated salaries, and care little if TSO3 continues to stuff shareholders with losses.
Management itself is quite poor: its last CFO (Benoit Deschamps) left after its apparently pivotal 510k approval – another ominous sign. TSO3’s new CFO Glen Kayll was a board member at Argex Titanium (a failed stock promotion). CEO Ric Rumble was director at Bioexx which is now delisted. Employees typically know best: we estimate almost one third of TSO3 employees have left the Company since early 2015. The majority of employees that left lasted less than 18 months
8 Everything Must Be Executed Perfectly For TSO3 To Hit Lofty Analyst Goals And Price Target: To be long shares of TSO3, investors are ascribing a near certain likelihood that it will (i) displace current technology and entrenched incumbents, (ii) Getinge will win sales and push TSO3 ahead of competitive products (some that it owns), (iii) It will capture >30% of the market;
(iv) it will surpass an 18 year track record of failure, and (v) it will achieve margins that no one else has in the space. Investors must also gain comfort around TSO3 specific risks: that it is a one product company that could be damaging medical devices, has a history of failed partnerships, no meaningful sales or evidence it can turn a profit in its long history, questionable disclosure practices, and limited alignment with insiders which own <1% of stock
9 Valuation Downside Risk Potential 80%+: Our downside scenario likely plays out with Getinge walking away from TSO3, and not being willing to purchase anything further. In the absence of additional sales growth, TSO3 will continue to accumulate losses (cumulative life-to-date losses are $128m given it has spent 2x as much on SG&A than R&D over the same time period). TSO3 currently trades at a preposterous 15x LTM sales and 19x book value, but bulls point to it being “cheap” at 2.7x and 12x sales and EPS in 2020. We believe that TSO3 is nothing more than a stock promotion, and it cannot generate a profit. Investors wanting exposure to sterilization products are better served owning a basket of peers which are profitable, pay dividends, and trade around 2x sales and book value on average. Ascribing a similar multiple range to TSO3 would result in 80%+ downside risk
Canadian Healthcare Companies In Need of Medical Attention
Highly promoted Canadian healthcare names often run into problems. Activist Short Sellers have played an early role in resetting market expectations around these stocks.
TSO3’s Dirty Little Secret: Limited End Customers Actually Buying Its Product
Be wary of TSO3 disclosures of units shipped to its marketing partner Getinge vs. units sold/installed to end customers.
Spruce Point estimates max 10 units installed to end customers vs. 183 shipped to Getinge: A 95% Difference
- TSO3 doesn’t disclose units installed at end customers, and we think we know why. Our math suggests 5% of units shipped have been installed by Getinge; the VP4 has been approved since 2014 and been shipping since Q1’16!
- Recall that prior life cycles of this same product yielded less than 50 installs. TSO3 points to its arrangement with Getinge for not disclosing the information, but our review of the agreement doesn’t indicate to us they would be precluded from disclosing
- Until Q1 2016, TSO3 disclosed consumable sales which could provide a proxy of installed base, even this was removed in Q2 2016. Don’t worry, if the company won’t provide the info, Spruce Point’s math and channel checks will help shed light. Note: TSO3 stated it stopped disclosing consumables because they were immaterial, does this imply the installed base is immaterial?
- TSO3 itself tells you that the middle man, aka Getinge, is buying this product to sit on it: “Additionally in the quarter we shipped our proprietary consumables to Getinge, who warehouses these along with sterilizers for resale to end customer healthcare institutions. ” (Q2 2017 CEO Commentary)
Deja Vu: We’ve Seen TSO’s Partnership Hype Story Before
TSO3 is repeating a playbook from its past, the promotion of a key partnership that will result in millions of dollars in product sales. In the recent past it was 3M, and today it is Getinge.
TSO3’s previous deal with 3M resulted in a terminated agreement, a lawsuit, and no installed base!
| Round 1: Partnership with 3M (2009-13) | Round 2: Partnership with Getinge (2015-current) | Spruce Point Commentary |
| Sep 2, 2009: TSO3 entered into a 90 days exclusive negotiation period with 3M, for the distribution of the STERIZONE® 125L Sterilizer | Mar 6, 2015: TSO3 enters into first non-exclusive commercial agreement for Sterizone VP4 Sterilizer with Getinge | Step 1: Sign on a big partner |
| Dec 16, 2009: TSO3 and 3M announced 3M as exclusive supplier of Sterizone 125L+ Sterilizer | Nov 25, 2015: TSO3 and Getinge sign exclusive global distribution agreement | Step 2: Sign an exclusive agreement with that big partner |
| Dec 17, 2009: 3M marketing supervisor: “3M Canada looks forward to expanding its product offering with TSO3’s new sterilizer to better meet customer needs” | Nov 25, 2015: Joacim Lindoff (Pres of Getinge Infection) “The STERIZONE® VP4 Sterilizer uniquely addresses an unmet global need” | Step 3: Get your big partner to state the world needs your product |
| Dec 29, 2009: TSO3 files supporting documentation for exporting Sterizone 125L+ to US and Europe | Dec 17, 2014: TSO3 receives 510k approval from FDA | Step 4: Expand the capabilities of your product |
| Mar 17, 2010: TSO3 received initial purchase commitment from 3M | Jul 24, 2015: TSO3 receives purchase orders for VP4 | Step 5: Get initial purchase orders and announce them as a key moment |
| Mar 2010: 3M Optreoz 125-Z exhibited at tradeshow AORN gathering 7k healthcare decision makers | Mar 6, 2015: VP4 sterilizer showcased at AORN Surgical conference which brings together 6k registrants | Step 6: Pay to have a booth at a big conference (even if it’s the same conference), but tell the world your product is being exhibited there! |
| Sep 30, 2011: Customers report high satisfaction with new sterilizer | Aug 3, 2016: From Q2 2016 results: “initial feedback from end customers has been strong” | Step 7: State high customer satisfaction with your product |
| Aug 2, 2012: TSO3 terminates agreement with 3M Jul 2, 2013: TSO3 settles dispute with 3M paying 3M $2m in settlement fees and other | To be determined, see Spruce Point commentary à | Will TSO’s fate suffer the same end twice? |
Read the full article here by Spruce Point Capital Management
