IRIDEX CORP IRIX
December 28, 2020 - 3:00pm EST by
Bill
2020 2021
Price: 1.94 EPS -0.50 -50
Shares Out. (in M): 14 P/E 0 0
Market Cap (in $M): 27 P/FCF 0 0
Net Debt (in $M): -12 EBIT 0 0
TEV ($): 15 TEV/EBIT 0 0

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Description

Thesis:
 
Iridex Corp. (IRIX) is a compelling buy, that I estimate could have 6-month upside potential of 200-650%, and longer-term upside of much more. IRIX represents a rare opportunity to own a high-growth under-the-radar stock, at a deep discount valuation. I believe the stock market has created a huge imperfection
in IRIXs valuation as evidenced by IRIXs FYE20 Enterprise Value to Revenues (EV/R) of only 0.45x, versus its closest peer Glaukos Corporation (GKOS) at 13.8x. IRIX is an ophthalmic medical technology company, at a growth inflection, that has developed a revolutionary proprietary laser system to treat Glaucoma (Cyclo G6), with a total addressable yearly market (TAM) of $1.2 bil. The Cyclo G6 (G6) has significant advantages over competing treatments and is currently in the commercial ramp-up phase, with broad industry support and acceptance. I project G6 will drive significant 25%+ growth in revenues and cash flow for years to come. There are several near-to-long-term catalysts I expect to propel this stock to fair value, most notably I expect a significant revenue rebound as the company gains traction with is G6 system, and the Covid related weakness abates. Given the small size of IRIX, and the current management composition, I believe the company is being positioned for an eventual sale. Due to IRIXs current depressed stock price, I would not be surprised to see an offer at any time, if the stock does not appreciate substantially.
 
Why Does This Opportunity Exist?
 
This dramatic under-valuation for IRIX exists for several reasons; 1) It is an underfollowed nano-cap; 2)Covid has temporarily depressed sales due to the decrease in non-essential procedures, masking the underlying strength of the company’s G6 product; 3) tax loss selling and end of year portfolio adjustments.
 
The Company:
 
According to IRIXs 10K, IRIDEX Corporation is an ophthalmic medical technology company focused on the development and commercialization of breakthrough products and procedures used to treat sight- threatening eye conditions, including glaucoma and retinal diseases. Certain of our laser products are powered by our proprietary MicroPulse™ technology, which is a method of delivering laser energy using a mode which chops the continuous wave laser beam into short, microsecond-long laser pulses. Our products consist of laser consoles, delivery devices and consumable instrumentation, including laser probes.
 
IRIX is comprised of two primary segments; 1) Glaucoma, which primarily derives its revenues from sales of the G6 laser system used for the treatment of glaucoma, and comprises 33% of revenues year-to-date (YTD) 2020; and 2) Retina/Other (Retina), which includes IRIXs medical and surgical retina products, as
well as service contracts, and comprises 67% of revenues YTD. I will spend most of this report focusing on the Glaucoma (G6) segment, because the G6 system comprises the vast majority of IRIXs current value, and growth potential. However, since the Retina segment currently comprises 67% of revenues, I
should briefly outline my view.
 
The Retina segment has been a good business over the years, although it has declined 27% YTD due to patients avoiding and delaying non-essential medical procedures and visits. I project the Retina business will rebound and grow 25% in FY21 as patients get accustomed to the new normal, are forced to get their delayed medical treatments to maintain their health, and Covid vaccines are deployed. We already started to see a significant recovery from the lows of the Retina business in 3Q, with revenues up 47% sequentially, although still down 22% year-over-year (YOY). Beyond FY21, I expect this division to grow low single digits, with low teens EBITDA marginsIRIXs experience with the Retina segment led to the development and strategy behind the Glaucoma division.
 
The company used the technology they developed in the retina area, to invent the G6 systemIRIX is known as one of the leaders in ophthalmological laser technology, yet they were never able to fully capitalized on this market, because their retina laser systems were primarily one-time sales, resulting in multi-year product cycles with lumpy revenues and declining margins. Realizing thlimitations with the Retina business model, in late 2015 IRIX started the Glaucoma division and commercialized the G6 laser system, which is a razor/razor-blade business model with a sizable annual TAM of $1.2 bil. IRIX sells the G6 console (razors) for approximately $14,000, and the MP3 probes (blades) for roughly $200 per unit. A G6 MP3 probe (probe) can only be used once, and it is estimatethat each person electing this procedure, will need to repeat it 4-6 times through-out their life. IRIX gets 90%+ margins on every probe sold, which could enable the company to generate tremendous cash flow and EPS as sales ramp.
 
IRIX’s 10k states that, “The Cyclo G6 is an infrared (810nm) laser designed to treat patients diagnosed with a range of glaucoma disease states. The Cyclo G6 system is sold with a family of probes that are disposable, including our patented MP3 probe (MP3) that utilizes our MicroPulse technology. The MP3 probe is used with our Cyclo G6 laser system to perform MicroPulse TLT. The MP3 is used on an anesthetized eye in the doctor’s office or in the OR. The non-incisional procedure takes just a few minutes and results in minimal post-operative recovery for the patient. MicroPulse TLT may be used to treat a wide variety of glaucoma types, including open-angle and closed-angle glaucoma, and a broad range of disease severity.
 
The G6 system has substantial patent protection and significant advantages over competing treatments. IRIXs 10k states, Our patent portfolio includes 23 active United States patents and 5 active foreign patents on the technologies related to our products and processes. In addition, we have 4 patent applications pending in the United States and 12 foreign patent applications pending. IRIX built much of the technology for the G6 system into the probes, which they upgrade every year or two, creating huge barriers to entry for any potential competition.
 
 The safety and efficacy of G6 has been widely proven and accepted by the industry. IRIX has performed over 150k G6 procedures in 60 countries since launch, and has stated in their company presentation the following attributes of G6; 1) Safe 70+ posters and presentations show low adverse evenoccurrence; 2) Effective 19 peer-reviewed papers demonstrate sustained IOP reduction of 30-45% in
60-85% of patients; 3) Durable 500+ eyes in studies demonstrating durability greater than 1months; 4) Versatile 2,500+ eyes studied in a wide spectrum of glaucoma types and stages. Furthermore, the company recently announced on 12/22/20 that the European Glaucoma Society has accepted IRIXs MicroPulse Therapy (G6) into its guidelines, which should dramatically speed up the adoption of the G6 and potentially increase the TAM. I don’t believe the stock market has properly absorbed the magnitude of this announcement, which I estimated could add significantly to revenues.
 
 
 
The obvious question which must be answered, is why hasn’t G6 grown faster since its launch in late 2015, and still only represents 33% of sales ($12.4 mil in FY19)? IRIX clearly bumbled the initial launch of G6, but all these issues seem to have now been resolved, and I believe we are at an inflection point where revenues are poised to grow significantly. The company made two primary mistakes at the initial launch of G6 including the following: 1) The G6 system is a new modality for Glaucoma treatment, that requires a meaningful amount of physician training and support, which IRIX was not adequately providing. IRIXs sales representatives were initially incented to sell systems, and not on probutilization, thus leaving physicians underserved with new complicated equipment. This dynamic negatively impacted the ramp of probe sales, which is where the company makes its highest margins and should generate the most revenues; 2) The initial probe that IRIX released, had some complexities that made it difficult for some physicians to use, further negatively impacting probe utilization. Taddress these problems the company took the following measures; 1) In May 2019 IRIX appointed a new CEO (David Bruce), who has implemented a plan focused on physician education and training, which had started to bear fruit, until Covid hit, causing a steep short-term decline in the entire industry; 2) The company introduced a new MP3 probe in the fourth quarter of FY19, with improvements and modifications which make it much easier to use; 3) the G6 system has received many additional endorsements and positive research publications since its initial launch, so many more physicians are familiar with the system and ready to give it a tryIRIX has begun to see a meaningful recovery in business trends as the companys CEO stated during their third quarter 2020 earnings release as follows: We are encouraged by continued recovery from the trough we experienced during the second quarter as a result of COVID. We are particularly pleased to see our glaucoma probe volume exceed last year’s third quarter, despite the continuing worldwide impact of COVID on our customers and their patients.
 
The Industry:
 
According to IRIXs 10k Glaucoma is a leading cause of blindness in the world. Glaucoma is a progressive, chronic disease and vision loss resulting from glaucoma currently cannot be regained. According to Market Scope, in 2018, an estimated 129.9 million people worldwide had glaucoma, but only about 30% will be diagnosed as having it. Glaucoma is most commonly associated with elevated levels of pressure within the eye, or intraocular pressure (“IOP”). Elevated IOP often occurs when aqueous humor, the thin watery fluid that fills the front of the eye, is not circulating normally and draining properly. Currently, reducing IOP is the only proven treatment for glaucoma with treatments primarily focused on improving the flow of aqueous humor through the eye’s trabecular meshwork and
outflow pathways. Global sales of products used to diagnose and treat glaucoma are expected to total $5.8 billion in 2018, according to Market Scope’s 2018 Global Glaucoma Surgical Device Report. Pharmaceutical products represent a majority of this revenue estimate but have significant shortcomings. Pharmaceuticals are typically the first treatment method prescribed for glaucoma. These pharmaceutical treatments are commonly self-administered in drop form by the patients. Patients often have difficulties applying the pharmaceutical drops properly and may fail to appropriately or timely apply the medication, which may significantly reduce the effectiveness of the pharmaceutical. This poor adherence to and lack of persistence with glaucoma medication regimens have been documented in numerous independent studies, which often place the incidence of patient noncompliance up to or above 50%, particularly in patients on two or more prescription eye drops. Evenwhen administered correctly, pharmaceuticals have demonstrated reduced efficacy over time. When pharmaceuticals lose their effectiveness, appropriate treatment options are determined based on the progression and severity of the disease and include traditional laser therapy (e.g. selective laser trabeculoplasty (“SLT”), minimally invasive stents/shunts (e.g. MIGS), and open surgery (e.g. trabeculectomy)). These treatment alternatives also have significant shortcomings due to treatment effects that dissipate over time, repeat procedures that are less effective or not clinically advised, limited indications of use, and significant complication risks. We believe that because of the limitations of these traditional treatment alternatives, a clear unmet medical need exists in the management of glaucoma patients.
 
Valuation: 
 
Thinking about valuation is where this company gets very interesting, because I estimates the companis currently fairly valued in a range of $6-$15 per share. IRIX is currently valued at an EV/Revenue (EV/R) of only 0.45x my FY20 estimated revenues of $33.3 mil, which seems outrageously cheap compared to
any company within IRIX’s sector, or any other industry I can think of. IRIXs closest comparable is Glaukos (GKOS), that sells a system to treat glaucoma with minimally invasive surgeries, and implants small devices in the eyes to relieve interocular pressure. GKOS is currently valued at an EV/R multiple on FY20 estimates of 13.8x, with an enterprise value of around $3 bil. GKOS is much further along the growth and development curve than IRIX, but IRIXs business model has the potential to generate much higher margins at some point. At the bottom-end of my valuation range for IRIX of $6, I assume IRIXs FYE20 G6 revenues are valued at roughly a 60% discount versus GKOS, at an EV/R of 5.9x, and IRIXs retina business is valued at only 1x revenues. At the mid-point of my valuation range of $10.50, I assume IRIXs FYE20 G6 revenues are valued at roughly a 15% discount versus GKOS, at an EV/R of 11.7x, and IRIXs retina business is valued at only 1x revenues
 
Over a longer-term time-horizon IRIX has much more upside potential as similar EV/R multiples could be applied on higher revenue levels in the out years. Looking at valuation on a DCF basis, also demonstrates long-term upside potential to a stock price of $137, or 6700%+ over a ten year period. I know it sounds a
bit silly to discuss upside potential of this magnitude, but this is where the numbers lead me, assuming favorable scenario for the company. IRIX estimates that their current TAM in the US is $500 mil, and rest of world (ROW) $700 mil, growing in line with population growth. If the G6 works as reported, it would
seem reasonable or even conservative to assume the company will eventually gain a market share of at least 15%, which would equal revenues of $180 mil ($75 mil US, and $105 mil ROW). Since IRIX gets incremental margins of 90%+ on probe sales, and the vast majority of revenues will be from sales of probes, the company could eventually become a huge cash generating machine. By my estimates, at 15% market share the company will generate $95 mil in FCF, which could grow in perpetuity at least in line with population growth. Assuming the market gave IRIX a 20x FCF multiple, the markecapitalization would be $1,904 and stock price $137 - that’s not a bad trade. As a sanity check GKOS currently has a market capitalization of $3.3 bil. The obvious question is how long could it take IRIX to get 15% market share if at all, and what discount rate should we use? Assuming it takes 10 years with a 20% discount rate, would result in the upper-end of my valuation range resulting in a current stock price of $15.
 
Balance Sheet: IRIX has a healthy balance sheet with $11.9 mil of net cash as of last quarter (3QFY20). expect the company to have adequate cash to reach profitability. I project IRIX will burn approximately $1.5 mil per quarter for the next four quarters, but begin to be cash-flow breakeven by 1st half FY22. IRIX management has done a great job cutting expenses during the Covid induced downturn. However, it is obvious that IRIX would benefit from significantly increased marketing spend to drive penetration of the G6. IRIX could continue down its current path or potentially use any one of several funding sources to drive faster adoption, including a sale of the retina division, a partnership/licensing deal with a larger company, or an outright sale of the company.
 
Income Statement: I project the company will grow revenues 25% in FY21 and 30% per annum over the next 5 years driven by the G6 system. I expect the company to report and EPS loss of roughly ($0.50) in FY21 and breakeven in FY22, as the G6 system begins to ramp significantly.
 
Catalysts: There are several potential catalysts including the following; 1) Acquisition of IRIX by a larger entity; 2) Announcement of partnerships or licensing agreements for the G6; 3) Resumption of revenue growth as the Covid induced slowdown abates, and IRIX gains traction with its G6 sales initiatives; and 4)
Additional announcements of new papers validating G6 and/or additional governmental/regulatory approvals and recommendations (such as the recent acceptance of the G6 into European regulatory guidelines).
 
Risks: Potential production or reliability issues with the G6 system as supply is ramped up. If G6 achieves
significantly lower levels of penetration than I am assuming for any number of potential reasons.
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

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