|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||75||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
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The Female Health Company (FHC) is the only approved manufacturer of female condoms in
• In Feb ‘07, FHC
started shipping its FC2 2nd generation product manufactured in
• Recent AMEX listing and newly issued guidance (recently revised upward, still low).
• EBIT margins are currently 13-14%, incremental margins on revenue growth are ~40%.
• The Company is solidly profitable (thus NOLs are relevant). NOLs are worth > 50% of current enterprise value.
What drives revenue growth?
The bulk of sales go to third world countries as part of disease-prevention allocations made by organizations such as UNAIDS and USAIDS. Once allocations are made into organization or country budgets, they stick. Overall funding for disease-prevention and specifically for condoms has increased every year for over a decade and this trend is expected to continue as AIDS rates in several third world countries exceed 30% and continue to climb. Clinical studies have shown that when female condoms are made available with male condoms, there is a 10%-35% increase in protected sex acts, and in October 2006, a study was published indicating the incremental cost of providing female condoms is less than the cost of treating the HIV infections they prevent. FHC is in a favorable position for continued revenue growth due to 1) continued acceptance of the female condom’s efficacy, 2) the failure of competing solutions, and 3) the introduction of the lower-priced FC2 (which generates higher margins for FHC).
The FDA categorizes female condoms as class III medical devices. This creates a sizable barrier to entry into the
The two most promising substitutes for female condoms as an AIDS preventative device have recently suffered significant setbacks.
– AIDS vaccine research has yielded poor results in testing with one of the most favorable vaccine candidates, V520, pulled from Phase II trials in September ’07. Seven similar trials based on similar principles have been halted. “"None of the products currently in the pipeline has any reasonable chance of being effective in field trials," Ronald C. Desrosiers, a molecular geneticist at Harvard University, declared last month at an AIDS conference in Boston. "We simply do not know at the present time how to design a vaccine that will be effective against HIV." The
– Microbocides have witnessed similar setbacks. At the 2006 world AIDS conference, AIDS microbicide research promised an alternative to condoms and abstinence for protection against AIDS. Several promising candidates gave hope for a successful microbicide within 2 years. Since then, 4 major microbicide trials have failed including nonoxynol-9, Ushercell, and most recently Carraguard. Nonoxynol-9 showed an increase in infection rates among users. Funded partially by the Gates Foundation, Ushercell trials began in 2005 and was terminated in January 2007 also due to higher infection rates. Carraguard, which work similarly to Ushercell, began trials in 2004 and ended in March 2008 showing no statistically significant different in infection rates between users and the placebo group. Currently, experts confirm we are a long way off from having an effective microbicide.
Management is headquartered in
FC2 (female condom 2) began shipping in early 2007. The product utilizes a proprietary design using Nitrol instead of latex, and is manufactured in
Current FC2 capacity is 30M units annually. FHC can expand FC2 capacity by 7.5M units for ~$0.5M in CapEx with 6 months lead time. 7.5M units of FC2 generates an additional $2.7M gross margin dollars/year, yielding a greater than 500% ROI on this CapEx spend. The bulk of FC1 allocations should convert to FC2 in the next 1-2 years (FC2 has the same efficacy at ¾ the price), allowing FHC to close the UK plant and eliminate significant fixed costs (at an all-in closure cost of approximately $1-2 million), resulting in company-wide gross margins approximating FC2’s 60%.
The President's Emergency Plan for AIDS Relief was originally enacted in 2003 for $15B over 5 years. Funding has grown from $2.3B in 2004 to an estimated $6B in 2005 representing a 29% CAGR. Of the total funds, 20% is spent on prevention programs made up of condoms and abstinence programs. The original PEPFAR contained a provision stipulating 1/3rd of funds be spent on abstinence programs. Abstinence programs have been shown to be ineffective in slowing the spread of AIDS and the provision was highly criticized. The new version of PEPFAR, passed on April 3rd 2008 by the House, increases spending to $41B over the next 5 years and removes the clause requiring 1/3 of prevention funds be spent on abstinence programs. Instead, the administration has been directed to promote “balanced funding for prevention activities”. Given that prevention funds are spent exclusively on condoms and abstinence programs, the removal of the 1/3rd requirement should increase demand for female condoms.
The U.K. Department for International Development
On June 3rd, 2008, the British Department for International Development announced the British government will spend nearly US $12 billion) over seven years to improve health services and systems in developing countries to fight HIV/AIDS. This is a significant step-up from
• Despite numerous upside triggers, we conservatively estimate revenues to grow 25%, 20% and 20% the next 3 years, reaching $34mm in 2010. We expect full conversion to FC2 by 2010 (if not sooner), resulting in $20mm gross margin and $12+mm EBIT less CapEx (equal to cash earnings as FHC’s high NOL’s shield it from cash taxes for the foreseeable future). Until full conversion occurs, EBIT for ’08 and ’09 will be affected by one-time costs related to: completion of FC2 FDA approval; employee training for capacity increases in
• FHC’s organization and country allocations have low - if any - correlation to global economies or the macro-economic environment. Although trading at premium multiples, few if any healthcare companies possess as much stability in their business as FHC. We expect FHC to trade at an earnings multiple more consistent with the growth, operating leverage, and stability of its business, in the 25-35x P/E range, at a minimum.
=> At a “too-low” 25x target multiple (earnings and free cash generation are growing greater than 100%/yr) FHC is worth $300 plus roughly $25mm cash on books by YE 2010, or $11/share. Discounting back 2 years produces a FYE ‘08 $9/share price target. Ultimately we expect FHC to be acquired by a male condom manufacturer for obvious public sector and commercial market sales channel synergies.
Although we hate this part as it falls under "technical," to some degree its real and meaningful to certain investors. As such, we offer the following: The stock is closely held, with the Board owning 35% of the Company and one institution owning just over 5% through a 4/07 tender offer. This leaves nearly 16mm shares in the float. Three month average daily volume is just over 17,000 shares but mature/ discovered companies typically trade at 1-2% of their float on a daily basis, equating to a 10-20 fold increase in volume. This type of volume increase is not at all uncommon as under-followed companies are discovered. For this to occur, investors of size will have to purchase FHC in the $2.90-3.00 range – something they have done 26 different times in the past nine months at a 3x higher avg. daily volume. In fact we began writing this after FHC’s May 14th Q2 earnings release, whereupon the stock climbed to $2.92.
Given FHC can be purchased in volume for $2.90-3.00/share (we believe it is worth $9+ and is thus a highly attractive purchase at that level), has enough float to trade at greater volumes at that price level, and has traded at greater volumes at that price level, the stock can be bought and should not be mis-categorized as a “dead money” micro-cap. On the contrary, the Company has utilized its significant free cash generation to repurchase maximum permitted number of shares every quarter for five consecutive quarters. We expect repurchases to continue and increase in line with volume increases - including at levels well above current prices - as management and the Board recognize this as a highly accretive use of cash.
FHC lost Wall Street’s interest and de-listed to the bulletin board after heavy historical losses (as it gained product approval). Although long forgotten by Wall Street, it is half-way into its fourth consecutive 25%+ growth year, has a new, lower-priced product generating significantly higher margins, and has turned the corner to ongoing and accelerating growth and profitability. The business requires minimal reinvestment of capital to grow and is thus incredibly high ROI, FHC is the sole solution in its category as alternative solutions have failed, the business gets stronger as the Company continues to grow (additional manufacturing synergies will further reduce cost/unit, FHC can offer lower prices for very large orders which will further entrench customers), and the NOLs alone are worth more than half of today’s enterprise value. There is significant insider ownership, the Company is buying back as many shares as it can despite a higher stock price vs. recent years, and the Company makes for an intuitive takeover by male product manufacturers upon further growth. As such, this is both a value and growth investment at misunderstood prices and with material upside.
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