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.
IS PHOTOMEDEX POISED FOR A SHORT SQUEEZE?
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.
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.
|Shares:||21.6||(including itm options)|
|Cash:||69.6||(including options proceeds)|
|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
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.
Cash flow greater than it may appear :
- 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.
- 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%.
- 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.
- Limited analyst coverage – the stock is currently covered only by Maxim, Ascendiant and Canaccord.
- 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.
- 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
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:
- 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).
- 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.
- 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!).
- 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:
Additions Charged to:
Cost and Expenses
|Other Accounts (1)|
For The Year Ended December 31, 2012:
Reserve for Doubtful Accounts
Reserve for Sales Returns
For The Year Ended December 31, 2011:
Reserve for Doubtful Accounts
Reserve for Sales Returns
For The Year Ended December 31, 2010:
Reserve for Doubtful Accounts
Reserve for Sales Returns
Represents additions due to the reverse merger on December 13, 2011.
Represents write-offs of specific accounts receivable and returns.
Some shorts also claim the no!no! does not work and they point to some negative online reviews for the product. In its defense, PHMD has some studies that demonstrate the product does work. We generally take negative online reviews with a grain of salt as we believe people are more likely to post a negative review than a positive review for any product. While the return rate for the no!no! is high, we note the company adequately reserves for such returns. Management claims most of the returns occur because people are not using the product properly and that it offers a 70 day full return policy. Management is also attempting to better educate consumers about the proper way of using the product. We also note the product is sold by some well-known retailers and we doubt they would want to jeopardize their relationship with their customers by selling a product that was really terrible. Finally and most importantly, we are suggesting you buy PHMD’s stock, not its product.
Some shorts have also complained about the company’s auditor Fahn Kanne & Co. Grant Thornton Israel, which is a member firm within Grant Thornton. To address this concern, in 2013 PHMD will pay extra to have Grant Thornton USA also sign the audit.
- Strong Q1 results – PHMD will report Q1 results in early May.
- They have guided to revenue of at least $57 million which would be a year over year organic increase of at least 13% (and they tend to be conservative on guidance).
- Q1 2013 results also won’t be hurt by the $2.7mm litigation expense that hurt Q1 2012 results
- As the following table illustrates, Management has been very conservative regarding its revenue guidance and typically exceeds guidance :
- Resumption of buyback – the company has $14.3 million left on a $25 million buyback announced last August. The company has been in a blackout period since mid-December due to the timing of its 10k and Q1 releases. The company’s window to repurchase stock opens 2 days after it files the 10q (which should be early/mid May) and we expect the company to be active in the market. On the last earnings call, when the stock was at higher prices than today, management said “The Board is committed to continuing to execute this program as the trading windows permit.”
- Short squeeze/capitulation – We are not sure what the catalyst is for the shorts to maintain their expensive short position, but at some point they may just move on to better opportunities.
- Increased IR – Management is becoming more proactive and effective regarding speaking to the investment community and will be doing more conferences and non-deal roadshows.
Insiders have sold stock and have a 10b5 plan in place. While we never like to see insider selling, the market seems to be digesting these sales (it’s a hard for large institutions to buy this illiquid stock so they are happy to buy blocks insiders are selling) and despite these sales, management retains a significant interest in the company.