Description

I self-identify as a short seller. Nearly all my VIC ideas are shorts. 

CUTR is now my biggest long position. AviClear has the potential to be a gamechanger, presenting an asymmetric risk/reward that could 10x+ over the next five years. CUTR has a margin of safety as a result of its recent boardroom brawl. 

About Cutera

Cutera is a medical aesthetic company headquartered in Brisbane, CA. The company was founded in 1998 and has been public since 2004. Cutera designs and manufactures energy-based aesthetic systems for dermatologists and med spas. Products range from lasers for hair and tattoo removal to electric stim body contouring. See the latest company presentation and 10K.

Bull Case

Cutera’s AviClear is the first FDA-approved device for acne treatment.  

“I can assure you in the next few years that I do think this is going to change acne”  Dermatologist, Professor, Key Opinion Leader

This is a disruptive treatment vs. alternative acne treatments. Accutane is dangerous, antibiotics are temporary and can be harmful, and other wavelength lasers are expensive and temporary. The initial data and checks on AviClear’s efficacy are positive.  

AviClear’s TAM is enormous. Over 60mm people suffer from acne annually and 6mm people see a dermatologist (9% mild, 85% moderate, 6% severe). Americans spend over $3b a year on OTC acne medications and over $3b on acne prescription drugs. If AviClear captures 10% of the market, just 600k patients a year, at $1.5k per patient and 65% EBIT margins results in over $20 of EPS. Aviclear has the potential to be the next Invisalign. Just as clear aligners are a less burdensome treatment for malocclusion, so too is Aviclear a better way to treat acne. Over 3.5mm teens start wearing braces each year at a similar cash-pay price point to AviClear.

AviClear is already winning. Aviclear received FDA approval in March 2022 and the commercial rollout really started in Q4 22. From my checks of the AviClear doctor locator, Aviclear currently has over a thousand units placed and is adding 250+ practices per quarter. Demand from new doctors is high and efficacy of the treatment is excellent. AviClear has a strong IP portfolio to fend off future competition and FDA approval takes years. 

AviClear has a unique and innovative business model. AviClear is placed as a revenue share device. Cutera charges an annual $5K fee and $1500 fee per patient, instead of selling the device for $100k+. Cutera is maximizing long term profits at the expense of short term results. This new sales model lowers the barrier for adoption and helps AviClear break into new segments of the market, such as medical derms, who are reluctant to purchase and use lasers. Cutera is capitalizing on its first mover advantage to build a brand, like LASIK or Invisalign, and is marketing directly to consumers on social media. This will help AviClear’s long term moat. AviClear helps its customers, both core dermatologists and non-core medspas, monetize acne treatment for the first time removing the “no money in acne” stigma. 

Cutera has historically been an unprofitable player in the aesthetic space. The company has gone through a turnaround the past five years. New management improved all aspects of the business; operations, manufacturing, sales, strategy, and R&D and drove increased sales of consumables. This has improved Cutera’s reputation in the channel. Cutera has ramped R&D investment to create additional breakthrough products, like AviClear, to solve other unmet needs in aesthetics such as cellulite, stretch marks, and eye bags.

Why Now

CUTR stock jumped into the mid $70s last spring on the excitement of AviClear’s FDA approval. Shares have since fallen 70%. The primary drivers of the collapse are 1) two convert offerings, $200mm in May and $100mm in December, which drove over 3mm shares of short delta hedging, 2) missing numbers, 2022 sales and EBITDA missed expectations due to weakness in core lasers and currency headwinds, and light 2023 guidance, 3) fast money leaving as a result of AviClear being a multi-year drag to sales and profits, and 4) broader market weakness and fears a recession will weaken elective procedures.

CUTR’s stock fell last month following a delay to its 10K filing and then was down even more last week as a result of an epic boardroom brawl. The CEO and Chairman called for a special meeting to remove 5 of the 6 other directors. This was filed on Good Friday. The Company’s delayed 10K was also filed on Friday. On Monday, the CEO and Chairman issued statements explaining their position. On Wednesday, the board fired the CEO and Chairman for cause and pulled guidance. Craziness!

I believe this sets up an attractive long-term opportunity. 

1. Peak fear and uncertainty. No management, no guidance, and no analyst support. The stock puked on 10x average daily volume. Most analysts went to the sidelines. Peak fear and uncertainty is often the best time to buy. 
2. The guidance pull is not overly concerning to me:
   1. The company did not pre-announce or guide-down with theFriday or Monday releases. There is a good chance the business is tracking fine and lawyers made the board pull the guide as a result of the Company firing the CEO.
   2. The ex-Chairman on Monday noted in his last bullet point that the board was pressuring management to issue higher guidance than management wanted. This suggests 2023 guidance was set conservatively. The CEO made this point in my post earnings call with him. This doesn’t mean CUTR will beat, but it does mean guidance for the year was viewed conservatively.
   3. Near term results are less important. I am focused on AviClear’s efficacy, long term performance, and placements, which are tracking well. 4Q results missed guidance as a result of the sales team focusing on AviClear instead of the base business, according to management. I am comfortable with AviClear outperforming operationally at the expense of near term headline numbers.
3. I believe the board turmoil is actually a positive development. Dan Plants, the ex-Chairman, seems universally despised. His removal is a clear positive. The remaining board is inexperienced and has also been problematic to previous management. They, too, need to be replaced. Lastly, while Dave Mowry (ex-CEO) was well respected within the organization, he is focused on operations and may not be the best leader to take Cutera to the next level. 

I believe CUTR board seats and management roles are in high demand. Cutera is one of few public medical aesthetic companies with a revolutionary product with a razor/razorblade business model. I believe the board will work with the two well respected biotech firms that are activist filers to upgrade Cutera leadership. 

AviClear vs Accure

AviClear has no other laser competition beyond Accure. Both lasers utilize the 1726 nm wavelength to permanently shrink the sebaceous glands. Neither company is aware of any potential new entrants to the 1726nm arena. AviClear has a strong IP portfolio to fend off future competition and the process of getting FDA approval takes years. 

AviClear received 501(k) approval in March 2022 and Accure received FDA approval for the same indication in December 2022. Channel work suggests AviClear is superior to Accure. 

AviClear is less expensive, less painful, and less time consuming than Accure. Aviclear’s $5k annual rental fee and $500 usage fee is more practice friendly for a new device. Accure is sold only to dermatologists for $119k with a consumable cost of $125/treatment. AviClear has a patented cooling system in the delivery tip. Accure requires 30 minutes of face numbing prep. Time is money for doctors. AviClear recommends three 30 minute treatments for $3k. Accure recommends four 1 hour treatments for $4k. Both treatment regimens appear equally effective in treating acne, although Aviclear argues their approach is better on darker skin tones.

AviClear has placed over a thousand units and has the capital and salesforce to continue growing 250+ devices per quarter. Accure has only 15 units in the field, no historical sales team, and is rumored to be struggling with funding. Accure has no doctor locator to help build the brand. Accure is structurally more expensive than AviClear because of a high cost licensing contract with their manufacturing partner in Italy. 

Accure was co-founded by the godfather of medical aesthetics, Rox Anderson. Dr. Anderson practices derm at Mass General, teaches at Harvard and MIT, and runs the Wellman Center. The Wellman Center has developed a majority of the new and innovative technologies in the industry. AviClear took Dr. Anderson’s discovery of 1726nm and made it better, faster, and cheaper. 

Valuation and Target

I see Cutera’s numbers as open-ended. Building a model to forecast units placed, and utilization is futile. If AviClear works as well as checks suggest, the S curve of adoption is inevitable. At that point, CUTR’s financial profile will flip from that of a low growth, low margin, low(ish) recurring profile to a high growth, high margin, and high recurring model. With over 1,000 units in the field and doctors gaining experience, influencers will spread the word and demand could go viral in late 2023.  

If AviClear is able to capture 10% of the derm-seeking acne market of, 600k patients, AviClear will drive over $20 of EPS for CUTR. 600k patients x $1.5k = $900mm of sales. At a 65% margin, that is ~$600mm of EBIT, or ~$450mm of post-tax net income / 20mm shares (convert dilution is capped with calls) = $22.50 of EPS. A 15x multiple + $25/share for core business = $365 stock ($7.3b mkt cap), for a 15x return.  

CUTR has ~$420mm mm of debt but $320 mm of cash, giving the Company ample runway to execute on the AviClear opportunity. Despite being a modestly cash burning small cap with net debt, I believe CUTR has a healthy margin of safety in the low $20s. $20 stock = $500mm EV, which is 2x 2022 sales, or 16x core EBIT at 12.5% normalized margins.The core business is one third recurring and consists of legacy products with loyal customers who upgrade over time. The core business was hurt in 2022 by devaluation of the Yen along with increased fees from implementation of a new ERP system. CUTR has no near-term maturities on its low interest rate converts. 

Other Stuff + Risks

There are many calls on Tegus and Stream supporting this thesis. Independent channel checks are easy to do and also confirm. I attended ASLMS in Phoenix this past week talking to customers, competitors, and ex-employees. This is the industry’s largest event and the meeting further strengthened my conviction in the thesis. 

But, it is still early days for AviClear, and the outcome is not certain. Disrupting workflows and switching to a recurring business model carries execution risk.  That is why the opportunity and asymmetry exists. 

Key risks I am monitoring:

• The leadership transition, both board and management, could be messy. This could prevent quality leaders from joining, prove a distraction to the execution of current business plans, and burn capital and other company resources. 
• AviClear might be good, but not great. 1726nm could prove similar to 1450nm (Smoothbeem).
  • Device efficacy could wane over time. Although checks currently suggest the opposite.
  • Adoption could be lower or slower than expected because the device is painful, it takes 3 visits/treatments, acne can get worse before it gets better (called shedding after first treatment), and $3k is expensive for some patients. These are all hurdles that strong efficacy can overcome. 
  • Some doctors are convinced AviClear is a game changer while others think efficacy is good (60% effective) but not great. Time will tell. 
• The business model could change. AviClear might need to change pricing or sales model depending on doctor and consumer uptake, and efficacy. There is ample opportunity to do this and drive increased adoption by bringing prices down for the consumer, driving even higher utilization rates. Cutera needs consumer and growth oriented leadership who understand marketing and the acne market. The company currently has more demand for AviClear than supply and checks suggest utilization of existing units keeps growing.
• Cutera spends $100+mm building a market and a new competitor  ultimately steals the opportunity before AviClear can build a successful moat. This seems unlikely based on IP, manufacturing, and FDA hurdles. 
• Recession hits and CUTR re-rates lower as hardware sales/EPS fall before less cyclical, recurring AviClear sales show up. 

Catalyst

AviClear success. Earnings.