|Shares Out. (in M):||7||P/E||0||0|
|Market Cap (in $M):||31||P/FCF||0||0|
|Net Debt (in $M):||8||EBIT||0||0|
Oh Noooo! Not another Nanocap idea. :/
The story of Cryo-Cell is a case study on focused, effective activism used to create shareholder value. The good news for Value Investors Club readers is a majority of the increase in shareholder value is still on the come. This undiscovered, over-the-counter traded nanocap ($31M marketcap), stock boasts all the characteristics an investor looks to find: a long tail of recurring cash flow, high gross margins and low capital expenditure requirements.
After a failed attempt in 2008, the Portnoy brothers successfully ousted management and board via a proxy fight in 2011. Spending the past several years cleaning up the business and investing in a salesforce, the business seems to be growing quite nicely. Further, the Portnoy’s have managed to overcome distracting proxy fights, unsuccessful but costly, as well as several other lawsuits, to use the cash on the balance sheet, free cash flow and modest debt to retire over 40% of the shares outstanding.
David Portnoy is a finance guy with a stint in investment banking and venture capital and has an undergraduate degree from Wharton. Mark Portnoy as worked with David in various roles and also on the debt side as a trader at DLJ as well as on buyside at a hedge fund. Mark has a degree in economics from Chapel Hill.
Founded in 1989, the Company was the world’s first private cord blood bank to separate and store stem cells in 1992. All aspects of its U.S.-based business operations, including the processing and storage of specimens, are handled from its headquarters facility in Oldsmar, Florida. The specimens are stored in commercially available cryogenic storage units at this technologically and operationally advanced facility.
Cord Blood banking refers to the process of collecting blood left in a newborn’s umbilical cord, harvesting the rich stem cells, which can be used to fight 80 diseases, including a wide range of cancers, genetic diseases and blood disorders. The service is sold as an affordable, long-term “insurance” for your baby. In addition, the newly harvested stem cells can be used on family members as well. In most states Doctors are required by law to inform expected mothers of their choices regarding various cord blood banking services. This usually entails the doctors handing out pamphlets to 3 or more blood banks.
Business Model Generates Healthy Recurring Free Cash
Cryo-Cell generates revenue from two different sources, processing & storage as well as licensing revenue. There are various pricing plans to choose from but the basic plan includes a one-time processing fee of $1700-$2200 and annual storage fees for the life of the baby. Customers can pay the storage fee each year or prepay for a discount. The storage fee is $150 if paid annually and $110-120 if prepaid. The “hook” to the investment is the very low, if any churn in the customer base. Why is the churn so low? If a consumer fails to pay the annual storage fee, Cryo-Cell removes the specimen from the storage unit. Can you imagine the grief a parent would feel if it failed to pay the $150 annual storage fee to save money (maybe in hard times) and the child or other family member was diagnosed with one of the 80 life-threatening diseases? This fear of missing out results in very low churn rates.
Cryo-Cell’s business model generates a great deal of free cash from selling the multiple-year pricing options as well as collecting annual storage fees from 140,000 storage specimens. We calculate Cryo-cell generates roughly $13.0M in recurring revenue from storage fees. At 90% gross margins, our estimations of free cash flow (before marketing spend) from the storage customers is close to $11.8M annually.
Management Are Good Stewards of Shareholder’s Capital
Since 2011, the Portnoy’s have shown investors they are serious about increasing shareholder value via smart capital allocation decisions. Management has repurchased 5.68 million shares or 42% of shares outstanding at an average price of $3.34 via open market purchases and one formal tender offer. It’s important to note the illiquid nature of the stock creates a big hurdle when trying to repurchase stock. This hasn’t stopped the Portnoys, earlier this year they were able to negotiate a deal with the company’s largest shareholder, Yong Ki Choi, a disgruntled shareholder left over from the prior management team. Removing Choi not only resulted in a reduction in the share count but also removes future unneeded expenses from potential proxy fights. Choi lost a proxy fight and also tried to sue the company but failed. He did succeed in costing the company hundreds of thousands of dollars in lawyer fees. In June 2016, management borrowed $9.8M in a 5 year amortizing note from a small regional bank to finance the 2.19M share block purchased from Choi and another related person. We think management can repay the entire note in less than 3 years, which would lower the EV/EBITDA multiple by almost 2 turns.
In addition to significantly reducing the share count, the Portnoys have negotiated opportunistic deals to cancel Revenue Sharing Agreements (RSAs). I know what you’re thinking, “WTF are RSAs?!!” The prior management team sold “royalties” to investors entitling them to a 50% participation right to all future processing revenue originated in various states. Since 2011, David and Mark have spent $3.9M canceling RSA agreements. Buying back the RSAs reduces future “interest expense” on the income statement making the investments immediately accretive to earnings per share and cash flow. According to management, the price paid to cancel the RSAs is roughly 5x cash flow or a 20% return on capital.
Management is also adding positive economic value by aggressively investing in marketing. We calculate a standard annual-pay specimen has a NPV of $2,050. Since 2013, annual marketing costs dividend by our estimate of the number of new specimens added is less than $2,000.
Industry Transaction Multiples
There have been two sizable acquisitions in the industry; most notable is AMAG Pharmaceuticals’ (AMAG) purchase of Cord Blood Registry (CBR), the leading private cord blood banking, for $700M in August 2015. CBR is the 2000 pound gorilla in the industry (we calculate 50% market share) ~roughly 600,000 stored specimens. AMAG paid 5.5x proforma revenue, 15.5x, adjusted EBITDA and roughly $1,200 a specimen. According to AMAG’s management, the acquisition will lower the cost of capital and provide flexibility and borrowing capacity to pursue additional acquisitions.
Less notable but also very meaningful is PerkinElmer’s (PKI) acquisition in October 2007 of Viacell, which owned Viacord, for $300M. According to a Boston Globe article, Viacell’s proforma revenue is “less” than $70M. While a bit more vague, we calculate the acquisition at nearly 5x proforma revenues and $2,700 a specimen. The article sites the acquisition will “bolster PKI’s genetics screening business for pregnant women and new born children.”
Next Leg of Growth
Since the 2007 recession, baby births have been trending lower. According to the Centers for Disease Control and Prevention, there were 3.99M babies born in the US in 2014, down from 4.32M in 2007. This creates a headwind for Cryo-Cell’s growth but fortunately it has been able to grow via gaining market share.
Of all baby births, only a small fraction of parents decide to privately store cord blood. By our calculations approximately 2.5% store privately, translating to 97,500 specimens annually. The big players, CBR and Viacord, capture most of the demand, leaving only a small piece of the market for the other 25 smaller players. We calculate Cryo-Cell has 4.5% market share and is adding 4,000-5,000 new specimens a year.
Call Option On Stem Cell Research
After learning about all the research going into stem cell research and the exciting early results, we started to get more confident Cryo-Cell is early in the stage of growth. If and when there’s a big breakthrough in the use of stem cells, the single digit participation rate of private cord blood banking should increase significantly. Let’s say baby births stay flat for ten years but the participation rate increases at 12% a year, in 10 years the number of specimens processed annually will increase from 97,500 to 300,000 by 2025. Holding Cryo-Cell’s market constant at 4.5%, Cryo-Cell could see the number of specimens processed annually grow to 14,000. Using a first year revenue of $1,695, new specimen revenue could reach nearly $23M by 2025.
Specifically, we are excited about the stem cell research being done at Duke University Medical Center by Dr. Joanne Kurtzberg. Joanne and her team are working to test the ability of cord blood stem cells to help the brain heal after injury. The results from their findings are beyond encouraging as more than 30% of the 63 children involved showed positive effects in motor function. This type of research can be applied to disabilities like Cerebral Palsy, which affects one in 323 children.
There have also been numerous other applications of using stem cells in news over the last few years.
21th Century Cures Act
In December, President Obama signed the 21st Century Cure Act after overwhelming approval from both Houses. The Act will boost funding for medical research as well as ease the development and approval of experimental treatments. Further, the bill provides for $4.8B in new funding for the National Institutes of Health, including $1.8B reserved for the “cancer moonshot” launched by Vice President Biden to accelerate research. Another $1.6B is earmarked for Alzheimer’s research. The Act could allow stem cell–based regenerative medicine products to undergo a faster, more flexible pre-market approval process. This could open the door for researchers such as Dr. Kurtzberg.
Background of Cord Blood Storage
It’s important for investors to know the difference between public and private storage banks.
Public banks operate like an organ or blood bank, if you need it and there’s a match, it is yours
Private banks offer the security of ownership and a cost
Basically, the major difference between public and private is public is free and donors have no claim on their own baby’s cord blood. Publicly donated units are available to any patient in any nation who needs it but there are only 200,000 units in public storage. If there is a breakthrough of any kind, there doesn’t seem to be a lot to go around.
We calculate Cryo-Cell is trading at 12.8x Adjusted EBITDA. It’s important to note this includes the large marketing spend to ignite growth in the specimen count. Given the very low capex requirements and growing deferred revenue, we calculate free cash flow is higher than Adjusted EBITDA. At a stock price today of $4.56, implies the business is trading at a 11.0% free cash flow yield. Current EV/Revenue multiple is 1.7x versus transaction multiples of 4.5x and 5x.
We feel very confident management will be able to add equity value by paying down the debt. Holding free cash flow constant, we calculate the stock price will begin to move up to $6 a share, or 31% higher, by just paying down the debt.
Using a price per specimen metric, the current share price implies Cryo-Cell is trading for $277 per specimen. According to our calculations, transactions were made in the closer to $1,200 per specimen. We think the transactions still left a lot of value for the acquirer given the NPV of a standard package is $2,050.
|CBR||Aug-15||AMAG Pharm (AMAG)||$700,000||$142,000||4.93||600,000||$1,167|
|Viacell (Viacord)||Oct-07||PerkinElmer (PKI)||$300,000||$70,000||4.29||110,000||$2,727|
|*Specimen count is estimated|
Using transaction multiples, one can argue Cryo-Cell’s customer base is worth $170M or $24.50 a share. As the size of the platform grows, we think value will migrate towards transaction multiples. Since Cryo-Cell has a smaller market share, we think a more appropriate value is closer to $10-12 per share or $600 a specimen, half the CBR transaction.
Continued marketshare gains
Stem cell research breakthrough
|Entry||12/31/2016 12:12 PM|
are there any instances of therapeutic use of ccel's specimens? i understand ccel is a call option on future stem cell therapies, but has any of ccel's specimens ever been used to create a therapeutic outcome to date?
|Subject||A few things|
|Entry||12/31/2016 10:41 PM|
Thanks for the interesting idea.
1) Do you have any more color on the management team/ have you had the chance to meet or talk with them? Specifically, what do you make of the previous lawsuit, which basically alleged the co-CEO's were enriching themselves at great waste to common shareholders? The Co-CEO structure is highly unusual and they both make quite a nice salary for such a small company. It seems weird that the largest shareholder would leave if it was such a great opportunity?
2) What do you think the endgame is for the Portnoy's? Are they planning to maximize their % ownership and then sell at the deal multiples you cite? Or are they planning to stay in this asset for the long haul becuase they believe in the LT medical trend/growth?
3) How fast do you think the overall private cord blood bank is growing in the U.S.? AMAG (CBR) seems to having 2.5% total growth "with volumes stabilizing." Do you think you need a breakthrough in medical research for this market to be more than a LSD grower? It is surprising to me this market is not growing faster.
|Entry||01/03/2017 01:37 PM|
Just expanding on the management questions...
From David Portnoy's LinkedIn, it looks like he is currently in an MBA program at Wharton and was an investment banking analyst as recently as June 2013.
He made $856K in total compensation in 2015... while being a part-time CEO (MBA candidate) and he graduated in 2011. That seems excessive and fails the smell test given the lawsuit from the largest shareholder.
I like the story but can't get comfortable with management as of yet so would love some color if you have any.
|Entry||01/03/2017 06:03 PM|
Thanks for the interest in our idea. I think you might have choosen the wrong "david portnoy" on Linkedin. I see 2 Davids, one an investment banker and the other, the Co-CEO of Cryo-Cell. The correct David graduated for Penn in 1984.
To address your other questions. We have spoken to Mark in the past. He is a great guy. In our opinion, David and Mark know what they are trying to do and know this is their shot to make themselves a lot of money. That being said, the Board is compensating them for good work. Is $856K a lot of money for this tiny company, yes, but the Portnoy's are creating tens of millions of dollars for shareholders.
The lawsuit was a poor attempt to get back at the company. Choi didn't have a case and made a desperate attempt to get back at the company. Choi sold out because he was part of the prior poor management. He was basically trapped in the stock and waited until the Portnoys offered him a fair price.
The end game is to sell. I honestly don't think they will sell the company for a cheap price. I feel they want to wait until the price is right or there is a "breakthrough" in stem cell research which will increase the storage participation rates.
We calculate the private cord banking rates are not growing. We look at 2 factors, rate of babies being born times the banking participation rate. Baby births is going down 1-2% and partipation is flat. CCEL is taking market share so it is growing near 10%. The top line growth (y-o-y) in the last 3 quarters has been 7.4%, 10.4% and 12.7%. It's too bad this site acts so quarky because I wasn't about the include my excel model.
|Subject||Re: therapeutic history?|
|Entry||01/03/2017 06:05 PM|
There are therapeutic use for stems cells but I don't think they include the stored specimens. I'll try to learn more and share with the VIC readers.
|Subject||Re: Re: Management|
|Entry||01/04/2017 11:03 AM|
Thanks a lot for the prompt response jhu.
Ha-- you're right... mistook him for another David Portnoy who also went to Penn.
Can you help us understand how they have taken market share as a small player? What is the typical selling process for this type of service... and do consumers differentiate between a big player like CBR versus CCEL?
Finally, are there any newer companies that have entered this market, and do specimens have to be stored close to where they are collected? I imagine the regulatory and maintenance costs make it difficult for a new entrant to compete... but the gross margins are so high maybe it could work.
|Subject||Re: Re: Re: Management|
|Entry||01/11/2017 07:56 PM|
Management has reallyy gotten involved to understand the buisness. For example, they visit the doctors themselves to establish a relationship with the doctors. The Portnoy's have tried to communicate with the doctors so the doctors refer CCEL.
I do think consumers gravitate towards the big players. But I think the commsumers go with the company the particular doctor likes. And CCEL has made a push in that direction.
There are 20-25 companies in the space, most are small are basically low quality. The distance of the speciman doesn't really matter.
|Subject||Re: Re: Re: Re: Management|
|Entry||01/16/2017 11:55 PM|
Can you walk through your comment quoted below? Specifically, how did you: a) arrive at an estimate of 140,000 specimens and b) 90% gross margins vs ~75% reported?
It seems like separating the value of existing specimens on a run-rate basis as well as the value of growth makes a lot of sense in this situation given the unusually long contract life and I appreciate any color you can provide on how you arrived at your run-rate FCF number.
"Cryo-Cell’s business model generates a great deal of free cash from selling the multiple-year pricing options as well as collecting annual storage fees from 140,000 storage specimens. We calculate Cryo-cell generates roughly $13.0M in recurring revenue from storage fees. At 90% gross margins, our estimations of free cash flow (before marketing spend) from the storage customers is close to $11.8M annually."