LCAV:

After the worst industry downturn, LCA Vision is experiencing a turn in the fundamentals and on the cusp of turning profitable again. Pent-up demand, reduced industry capacity, and significant cost cutting have set up the company to reach/exceed prior peak EBIT margins at 15-20%. While the stock has bounced off the bottom (up 150%), it is well below prior peak of $50+. With 40% of market cap in cash and 0.5x forward sales, the stock is essentially a long dated option on the eventual recovery of the laser vision correction market with multi-bagger potential.

Company/Industry Overview: Based in Cincinnati, LCAV is one of the largest providers of LASIK surgeries in US and operates 53 centers (down from 75 in ’08). There are around 60m people in the US who are eligible for laser eye surgeries. The procedure/industry has been around for some time and experienced significant growth in late 90’s before plateauing around 1.25-1.4m procedures/year from 2000 to 2007. The industry is dominated by individual surgeons, while chains make up 20-30% of total procedure volume, with LCAV/TLC Vision being the two largest players, each claiming 13% of market during the peak in ’07.

The average cost per procedure is around $2K. Unlike most other surgeries, most laser vision correction procedures are not covered by insurance and thus paid out of pocket. The big ticket make the procedure as discretionary as it gets, and not surprisingly the industry took a big hit in the recent recession, with volume down 40% from the peak.

Why LCAV now? The industry downturn hit LCAV and TLCV very hard. TLCV in fact filed for bankruptcy in Dec ’09 (since emerged under PE fund ownership). LCAV had its share of issues (over-expansion during the boom years, bad debt, proxy fight). Total procedures performed fell from 192K in ’07 to 57K in ’10. Under a new mgmt team, the company closed 1/3 of its centers, reduced headcount by 54% and cut G&A by 40% since ’07, yet still lost serious money after doing 15%+ EBIT in the previous 4 years. The company only survived by the virtue of its great balance sheet.

After four tough years, procedure volume is finally rebounding, with five straight quarters of positive SSS, 18% SSS growth in Q3 and 33% in Q4 as pre-announced. It is hard to pinpoint exactly what is behind the rebound, but an improving economy is most likely the biggest driver. LCAV is also taking some market share. Since there is no other technology break-through, I do not see any structural reason why the decline in procedures over the last few years is permanent – the benefit is clear, and price was likely the only reason why people chose to defer the procedure. We have seen this movie before after the ’02 recession, when the industry suddenly sprung to life in early ’04 up 30%. There is also some conforming evidence in other types of semi-discretionary surgeries (orthopedic) showing signs of life with fewer people deferring.

During the downturn, LCAV shut 1/3 of its centers. I couldn’t find much information on TLCV since it is no longer public, but it is probably reasonable to assume that it has also closed some under-performing centers during/after the bankruptcy restructuring process. My guess is that the industry probably saw 10-15% reduction in capacity from a peak of 1300 LVC centers in ’07. In the mean time, population has grown a bit, and if normal procedure volume is 1.2m (2% of eligible population, some also estimate 1.2m is the number of new patients who become eligible each year), then we also have built up more than 1 full year of pent-up demand over the last 4 years, much like the same exercise many have gone through for housing and autos. Encouragingly, pricing actually held up pretty well during the downturn, although some of it was likely the result of the mix benefits.

So the setup of the story looks pretty good -- an industry rebounding after a long/deep downturn, a company that is extremely lean, has high operating leverage (incremental gross margin over 65%), and could produce high FCF (low capex, NOL shielding tax).

Numbers:

I am attaching a model with historical data as well as my projections for ’12 and ’13 and “Normal”, which is assuming LCAV has 8% of market share of 1.2m industry volume.

LCAV finished ’11 with 60K procedures. Mgmt has guided that the company will be cashflow positive at 70K volume, while I am actually modeling the company do double digit SSS in ‘12/’13, hit 70k target in ’12 and reach decent profitability in ’13. The company is also testing providing some other ancillary procedures to boost topline and leverage the fixed costs. I am not modeling any of that.

One may question on whether my margin assumptions are too aggressive. In many ways, I feel LCAV is similar to a trough margin retailer experiencing a turn-around in sales. I have encountered many of these turn-around stories, where the eventual margin/profit progression far exceeds original expectation – most analysts tend to way under-estimate the operating leverage in the model. URGI and KIRK were both VIC ideas that worked out great. More recent examples (that I have missed due to conservative assumptions) were PIR and CPWM, both of which came back from near death experience. If I am right, LCAV can do $1+ in fully-taxed EPS vs. $1.80 prior peak and $1.50+ FCF. Even a low teens multiple + $2 cash can get you to $15+, or a 3 bagger from here. If I am wrong, the company should still generate low-mid single digit EBIT margin and generate decent FCF, so downside appears somewhat limited with 40% of market cap in cash. What’s interesting to me is that the stock had traded higher in ’10 and ’11 when fundamentals were arguably much worse. If you stare at the long-term price charts over 20 years, you will see the stock has periodically gone through boom and bust cycles. I am not arguing the business is great/stable over the cycle, but if one can time the cycle, upside is tremendous.