TS03 Inc Trust Units TSTIF

CG's Sara Elford's Research Update

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Investment recommendation

We are maintaining our SPECULATIVE BUY rating and C$3.00 target price following the successful closing of an C$11.5 million unit offering and the announcement of a non- exclusive distribution agreement for the STERIZONE VP4 with Getinge Infection Control, the world leader in sterile reprocessing of reusable medical devices.

Investment highlights

• TSO3 raised C$11.5 million -- including the over-allotment option -- by issuing 9.2 million units at a price of C$1.25. Each unit consists of one common share and one share purchase warrant (strike price of C$1.875; until March 5, 2017).

• The dilution associated with the unit offering was greater than forecast; however, this is more than offset by the expected [improved] economics of the Getinge distribution agreement relative to the old 3M channel partner agreement that, until now, formed the basis of our financial model and associated valuation work.

• Specifically, we think the NPV of a single sterilizer (i.e., TSO3's retained share of capital plus consumables gross margin dollars over a 12-year life) is potentially more than 2.5 times the same NPV derived using our prior assumptions.

• We do assume the initial ramp takes longer (no take-or-pay requirements, for example) and costs a bit more in terms of opex (support and supplementary direct-to-market efforts), but very critically, in our view, TSO3 also continues to hold all the cards
  and almost all the future value. Given our longstanding view that the company will eventually become a takeover target, this is an excellent outcome, likely made possible by the above-noted equity raise.

• To the extent that additional distribution agreements are signed -- and most notably with similarly credible players like Getinge -- we think it is possible that TSO3 will find itself in play in the relatively short term (within 12 months). To quote Getinge, as per the press release announcing the current agreement: "The TSO3 technology fills a gap in our portfolio and is a natural fit for our commercial team. Our entire organization is anxious to get started assisting our mutual customers understand how this technology improves their process and reduces the cost of sterilization while improving patient outcomes." The first statement confirms the strategic nature of the technology, while the second underscores its relative value proposition.

  Valuation

  Our target price is now easily supported by our DCF analysis (18% discount rate and
  2% terminal growth rate). There is ample room to lower our discount rate, but given the potential return to our existing target price, we see no need to make any adjustments at this time.