TS03 Inc Trust Units TSTIF

Canaccord Genuity (Re-)Initiates Coverage

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Summary taken from research report by Neil Maruoka and Matt Bottomley, 27 Jan 2016. Full report 25 pages.

TSO3: VP4 a potential industry game-changer

We are initiating coverage of TSO3 with a BUY rating and a $3.25 target price. TSO3 is a developer and manufacturer of hospital sterilization equipment, with a core product offering called STERIZONE VP4. We believe that the stock is an excellent defensive pick, as the company serves a very steady replacement market. Hospital sterilization equipment has a finite lifespan, but is a critical component of healthcare infrastructure. While many incumbents are entrenched, we believe that the capital equipment replacement decision in the current environment hinges largely on cost efficiencies and the mitigation of infection risk – two advantages of TSO3’s product.

Explosive growth potential. We believe that TSO3 is poised for rapid growth, with
a projected four-year top-line organic CAGR of 90%, and an EBITDA organic CAGR of ~60%, as the company transitions to positive cash flow next year. The company’s VP4 sterilization system represents a potential game-changing technology, in our view. While the sterilization equipment market is mature, capital equipment turnover is approximately 10% or 3,000 units annually and presents a huge opportunity for TSO3. Backed by partner Getinge’s global marketing clout, we project that the widening of the VP4 installed base will lead to rapidly growing and recurring consumables revenue and longer-term margin expansion.

Market penetration will be key over the next several quarters, as Getinge will need to gain traction in the replacement market to meet our forecasts. We believe that the key factor that could derail the story and our thesis would be slow uptake and high competitive hurdles that could make the Getinge partnership a short relationship.

Valuation

Scenario analysis suggests valuation floor and blue-sky upside. We value TSO3 based on a ten-year discounted cash flow analysis, using an 11.0% discount rate and 2.0% terminal growth. While we have modelled out both upside and downside scenarios based on high and minimum market penetration, we have taken a relatively conservative stance on product sales in our base-case model. Based on this analysis, we arrive at a target price of $3.25, which implies a 73.8% annualized return and supports our BUY recommendation.

We believe the minimums within TSO3’s deal with Getinge provide downside protection to our valuation of ~$2.50 per share. Further, a solid balance sheet (~$20 million of net cash on hand) presents further valuation support as the company transitions to positive EBITDA and cash flow over the next couple of years. Conversely, our blue-sky scenario where TSO3 successfully establishes claims for the sterilization of flexible endoscopes suggests a risk-adjusted upside valuation of ~$5.50 per share.