El.En Group (ticker ELN IM) represents an opportunity to own a company at approximately one third of the valuation of its peers (~ 5x 2015 EV/EBITDA vs peers at 13-15x+), strong downside protection (cash and equivalents at 34% of market cap, no debt), and strong business momentum (50% y-y EBITDA growth in 1H15). However, this is not the crux of the story. ELN has developed a technology that is just now taking off in the US giving US-based investors who do primary research a leg-up vs. the Italian investors and small-cap analysts who cover ELN. We think this technology has the potential to be transformative to ELN’s EBITDA above and beyond the core business’s strong EBITDA growth, and the impact will be felt potentially as soon as 2H15.
ELN is an Italian manufacturer of medical, aesthetic, and industrial laser systems. The primary use is for medical and aesthetic applications where laser systems are used for everything from removing tattoos to treating acne to hair removal. Industrial applications are primarily cutting devices used in machinery/manufacturing.
Peers in the US are Cynosure (CYNO), Syneron (ELOS), and Cutera (CUTR), and there has been significant consolidation in the industry. Lumenis was just acquired this past week by the private equity firm XIO at ~ 15x trailing EBITDA. CYNO also trades at ~ 15x trailing EBITDA, Syneron is trading at ~ 20x trailing EBITDA, and CUTR is not profitable.
Despite the medical uses, the industry does not have the type of IP that comes with pharma although R&D typically ranges from 4-8% of revenue. Success typically comes from a strong sales force as well as developing regular new products/technologies which gives the innovating company a year or two year head-start before competitors catch-up.
ELN is under-valued as the company is trading at 5.1x trailing EBITDA (EV of 128M Euro including ELN’s shares in CYNO at market value as cash, our estimate of 2015 EBITDA) vs. peers at 13-15x+. Due to strong business momentum and benefitting from the Euro/USD depreciation, ELN has been growing EBITDA at strong rates (31% y-y in 2014, 50% y-y in 1H15). With a portion of ELN’s business being industrial applications and with a focus on Europe vs. its peers which focus on the US (the largest laser market), some EBITDA discount multiple may be warranted although ELN has a strong history of innovation which is the real value generator in the industry.
However, as a small-cap in Italy, there are no clear catalysts to cause the multiple to rerate to 15x EBITDA or even 10x EBITDA, and our thesis is not predicated on that. Rather, ELN’s latest innovation, the Mona Lisa Touch, is catching on fire in the US and as US-based investors, we have an advantage in seeing this before Italian analysts understand how meaningful this new product can be (as with most new innovations in the industry, the US is the first market and if it works here, it is expanded globally). We think the Mona Lisa Touch can cause EBITDA to potentially double, and this EBITDA growth combined with the excitement about the Mona Lisa Touch once it is fully understood could cause a more appropriate 10x EBITDA type of multiple. This could lead to 3-4x returns in 1-2 years with strong downside protection given the low EV/EBITDA valuation, significant excess cash, and the strong business performance even without the Mona Lisa Touch.
The Mona Lisa Touch:
The Mona Lisa Touch (hereafter referred to as Mona Lisa) is a new laser application for vaginal rejuvenation – a common issue for women post pregnancy and post menopause. Rather than discussing the area and the treatment in full and perhaps inappropriate detail, we refer you to the following sites for the Mona Lisa as well as the existing two competitors (private laser companies Alma Laser and Thermi Aesthetics):
The Mona Lisa was developed by ELN but as ELN is primarily focused on the European market, in late 2014 ELN formed a distribution agreement with Cynosure in order to bring the product to the US. ELN and Cynosure did something similar in 2006/2007 with the SmartLipo laser system which proved to be a big success in the industry, and ELN and Cynosure are affiliates in the sense that ELN has owned a part of Cynosure for many years and until recently was on their board. ELN still owns ~ 1M shares of CYNO today.
The vaginal rejuvenation application for laser technology is still early, but we think it has tremendous potential for growth in 2016 and 2017 and indeed is already taking off in 2015 YTD. The first core market for most new laser medical technologies is the US, and once established in the US it is taken abroad. ELN has already begun selling the Mona Lisa in Europe, however it plans to ramp up marketing once it can point to strong traction in the US.
As the US market in this category is just now developing, there is limited hard data beyond scuttlebutt research. We will share with you some of our findings but encourage you to do your own work.
First, we have spoken to a few OB/GYN doctors who have demoed the technology, reviewed the clinical studies, etc. and are now considering purchasing a system for their own office. Second, we hear that all the major laser companies who do not have a product in this category are rushing to develop one, with Syneron perhaps coming into the market as soon as Q116. Third, and most importantly, we recently attended a trade show (American Society for Dermatologic Surgery) where we met sales reps for Alma and Thermi Aesthetics who are selling these products every day. We informed these reps of our investment in ELN which via Cynosure is their main competitor in the category – as such, we don’t think they stood to benefit in any way by inflating their expectations and as will be discussed told us both negatives as well as positives. Key things they told us were:
- This is the hottest category within the entire laser industry currently and is just now getting on the cusp of becoming widely known. Most physicians are not yet aware that a non-invasive, laser treatment exists.
- Based on the trajectory of past hit products, they estimate the industry could grow 5-10x from 2015 levels just in the US market with further potential internationally.
- The biggest factor for a physician purchasing a laser system is return on investment – the ROI for this category is an order of magnitude better than anything the industry has seen before with as little as 30 treatments (a typical patient needs at least three treatments so only 10 patients) leading to a full payback.
- Industry executives expect this product to soon be on shows like Oprah, the Ellen DeGeneres’ show, etc. and gain further buzz.
There are currently over 10,000 potential points of sale for OB/GYN practices in the US and 7,500 points of sale for plastic surgeons, let alone other potential categories such as urologists, dermatologists, and medical spas. This year is the first year for the vaginal rejuvenation category and per the scuttlebutt roughly 500 systems will be sold across Mona Lisa, Alma, and Thermiva with MonaLisa holding 70%+ market share and the clear market leader.
If we assume ~ 25,000 points of sale and 20% eventual market penetration (the median base case for the industry professionals we spoke with), that would be 5K systems at ~ 100K ASP (post discounts) or $500M in revenue. The ROW opportunity is typically on 1-2 year lag vs. the US and is 100% the size of the US opportunity or a total market size of $1B. If we assume a four year product cycle with the strongest years being 2016-2018, one could see $300M+ in industry revenue in those years. There is limited consummables associates with the systems, although after the initial product cycle there will be a long tail due to upgrades.
In terms of the negatives we heard, the main one is that there is no special IP for a vaginal rejuvenation laser. As such, new competition will enter and there will be pricing pressure which could in 1-2 years lower the ASP to the $80K range. Secondly, while Mona Lisa is the strongest brand currently and is being distributed by the industry’s leading sales force (Cynosure), with competition Mona Lisa’s market share will likely fall.
Another complication is that ELN doesn’t bear any marketing costs with the Mona Lisa – Cynosure does the distribution and pays ELN a transfer price in return for developing the product. This transfer price is not disclosed, but we were able to learn from ELN management that Cynosure and ELN both make above their normal company-wide gross margins on the product. CYNO currently has a 57% gross margin and ELN has a 44% gross margin.
So if we assume CYNO earns 66% gross margins on this product and ELN earns 50% gross margins, $100 of CYNO revenue would lead to ~ $17 of ELN gross profit. We assume nominal below the line expenses for ELN as the main cost in the industry is sales/distribution which CYNO is providing.
If we assume Mona Lisa’s share falls to 40% over the product cycle, an ASP over the product cycle of $80K, and EBITDA margins on international Mona Lisa revenue of 15% (conservative as ELN EBITDA margins currently ~ 10% and this is skewed lower by industrial and commodity medical applications) , the annual EBITDA contribution in peak years in 2016-2018 could be 14M. Given our estimate of ~ 25M Euro in 2015 EBITDA, if we assume core business EBITDA growth slows to 20% next year from the 50% in 1H15, core EBITDA and Mona Lisa EBITDA together could cause EBITDA to nearly double.
There is also the chance that the excitement surrounding the Mona Lisa and the strong EBITDA growth causes ELN’s multiple to re-rate closer to its US peers. We have been encouraging ELN management to list the company in the US where its peers trade, but it’s unclear if we will have any success with this concept.
We like the investment as there is a clear reason why the opportunity exists: US-based investors who do primary research, attend industry trade shows, etc. are likely to have a large advantage over Italy-based investors, especially given ELN’s small-cap status and the fact that only 1-2 local Italian brokers cover it. Furthermore, there is clear downside protection as cash and investments make up 34% of the market cap (no debt), the company is trading at a low EV/EBITDA multiple vs. peers even before the Mona Lisa, and the company is growing EBITDA nicely again even without the Mona Lisa.
There is much work we have left to do on the Mona Lisa and its potential; however as a free option, we like the asymmetry. We encourage interested investors to do their own work in this area and we can compare notes. We will also update the board as we continue to learn more.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Mona Lisa flowing through the numbers
|Subject||Re: Interesting post|
|Entry||05/20/2016 02:24 PM|
Thanks Tac. On the IP I wouldn't say laser companies typically have anything that is that proprietary. What usually happens is someone develops something first and that gives them a year or two head start vs. peers. That said, the industry always has new products coming out and the strength of one's R&D division is a key differentatior. When you ask people in the industry about ELN, you will hear that they are a quiet company run by engineers and that their R&D effort is one of the best. Indeed, two of Cynosure's biggest product launches in the last ten years have been developed by ELN.
In terms of updates, ELN reported a strong Q116 (EBIT up 50+ y-y) due both to the medical division (Mona Lisa the driver) but even more so their industrial laser division which was a positive surprise at least to us. Management didn't raise guidance for the full year but they have done this in the past where they wait until Q2 or Q3 to raise the full year's guidance. The company also has monetized its invetment in Cynosure and added $45M USD to its cash pile, helping to reduce that hidden asset discount. As an aside, I think they sold their shares to Point72 (Steve Cohen's new firm).
Even if we assume no growth in EBITDA off of 2015 levels, the stock is at ~ 9x EBITDA whereas CYNO is at 16x and M&A in the space recently has been in the 13-15x EBITDA range. We think EBITDA will grow in 2016 so ~ 7x EBITDA may be more reasonable.
The big risk remains any cyclical downturn/recession. These companies sell consumer discretionary products and they perform very poorly in downturns. ELN given net cash is now ~ 33% of the market cap has some protection here.
|Subject||Re: Re: Interesting post|
|Entry||05/28/2016 10:54 PM|
Briarwood - thank you for sharing a very interesting idea, and congrats on the performance so far. A couple of questions:
- what are the right comps for the industrial part of the business? The key medical aesthetic comps you cite don't have the more commoditized/presumably lower growth industrial business that ELN has so wondering how you think about multiples for that part of the business
- have you spoken to management about their attitude towards being acquired? it seems ELN would be highly accretive both in financial and strategic terms to any number of their comps, even at a large premium to current. CYNO in particular has a diversified portfolio but MonaLisa is one of, if not the best, of their growth products and surely they would love to enjoy all the economics. They have been acquisitive in the past, though ELN would be a much bigger bite and presumably they would try to divest the industrial portion of the business and/or pay partially in stock. How realistic do you think this scenario is?
- ELN seems at least peripherally focused on shareholder value (they are splitting the stock, and pay a solid dividend) but post the CYNO sale have a decent amount of excess cash and the shares still trade at attractive absolute levels. Have you had any conversations w/ management re buybacks and/or special divs or is the focus on further strategic investments with the CYNO cash?
|Subject||Re: Re: Re: Interesting post|
|Entry||05/29/2016 06:47 PM|
Thanks for the message Puppyeh.
1) Take a look at the last few slides on ELN's investor presentation (on their IR site), they have a good list of industrial comps. One recent M&A transaction I would note would be Coherent's acquisition of Rofin (https://www.coherent.com/investors/index.cfm?fuseaction=Popups.ViewRelease_v3&ID=1070). I think this was at 13x EBITDA. However, I generally agree that the industrial business, particularly ELN's business, should be lower than the medical/aesthetic - I have been using 7-8x EBITDA which is an attempt to adjust the comps' EBITDA multiple for ELN's lower R&D mix.
2) Of course one never knows but the CEO and co-founder is still young (just turned 50 I believe) and has said he has no plans of selling anytime soon unless the price is unusually good. So I read that as very low chance.
3) This one is quite interesting. The CEO recognizes that the main issues holding back the multiple are a) the high cash balance b) the combination of medical and industrial in one and c) the listing in Italy vs. the US. He has told investors he wants to work on at least 1-2 of these over the next 1-2 years and has told investors on the last earnings call that he is especially looking at US acquisitions. It's possible he will separate the medical from the industrial and keep the industrial company listed in Italy while IPOing the medical business in the US to get additional cash + the US listing and acquire a US laser business. The IPO valuation could likely be set closer to the US peers like CYNO which would be very value accrettive. That combination of corporate actions would achieve his three stated goals and, assuming a good acquisition, be great for ELN shareholders. The very successful investment in CYNO gives us some hope at least that he use the cash wisely. He could also theoretically use the cash and the medical business to reverse merge into a struggling listed US laser company and achieve his goals that way. All this is pure speculation, but we have been following this company since 2014 and it's only recently where he has been quite specific with investors in terms of what he wants to achieve on the corporate action front.
|Subject||Re: Re: Re: Re: Interesting post|
|Entry||05/29/2016 09:13 PM|
briarwood, thanks very much for the detailed responses, much appreciated.