TS03 Inc Trust Units TSTIF

Canaccord Genuity Research Report of 14 Mar 2016

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Authors: Neil Maruoka and Matt Bottomley

Investment Recommendation

Incremental positive. TSO3 has provided an update on its discussions with the FDA regarding extended claims for its VP4 low-temperature sterilizer. We view the FDA’s feedback to be constructive, as it begins to delineate a potential path to the approval
of these claims. Although there remains work to be done including additional testing on specific manufacturers’ devices, we believe that the initiation of discussions on labelling may be demonstrative of the FDA’s willingness to find a solution to this healthcare problem. Current disinfection procedures are insufficient, in our view, and US Medicare no longer covers the costs of hospital-acquired infections. If the claims are granted, we believe TSO3’s VP4 could become an important risk-mitigation tool for US hospitals.

We would be buyers of the stock at these levels with an eye towards the sales ramp for VP4 and a potential decision from the FDA on expanded claims for the sterilization of flexible endoscopes, which remains on track for this year.

Investment Highlights

• Expanded claims provide upside to our forecasts. We believe the claims around the sterilization of multichannel flexible endoscopes could lead to substantial upside to our market penetration forecasts. If the expanded claims are granted by the FDA, we believe that VP4 will be the only low-temperature sterilizer approved to sterilize these devices.

• Getinge minimums set a valuation floor. We believe the minimums within TSO3’s distribution deal with Getinge provide downside protection to our valuation of ~$2.50 per share. Further, a solid balance sheet presents additional valuation support as the company transitions to positive EBITDA and cash flow over the next couple of years.

• Bridging the gap. We forecast that TSO3 will transition to positive cash flow in fiscal 2017. Based on our expected sales ramp, we estimate that the company will have cumulative negative cash flow from operations in the range of -$5 million to -$10 million in the interim. With current cash on hand in excess of 3x the potential funding gap, we believe TSO3 has sufficient cash to fund its projected burn and reach positive cash flow.

Valuation

We value TSO3 based on a DCF model, using an 11.0% discount rate and a terminal growth rate of 2.0%. We have made no changes to our forecasts on the back of this update and our target therefore remains unchanged at C$3.25, which represents an annualized return of 54.8% and continues to support our BUY recommendation.