Company Update
Expanded regulatory strategy could open a significant opportunity
Investment Recommendation
TSO3 announced plans to pursue FDA clearance for the sterile reprocessing of two individual duodenoscopes, including the likely market-leading Olympus TJF-Q180V.
We view this to be a positive expansion of its regulatory strategy, with the potential to significantly grow the market for its VP4 sterilizer, if approved. Because we previously did not expect the Olympus duodenoscope to be part of the initial regulatory filings, this approval should open an incrementally larger opportunity. Recall that the Olympus TJF-Q180V scope has been linked to several high-profile superbug outbreaks that
were associated with a number of patient deaths; as such, we believe that the ability
to sterilize this scope has the potential to change healthcare practices. Further, this expanded strategy fits with our thesis that hospitals will eventually need to adopt VP4, which permits the sterilization of these complex scopes. TSO3 expects to file for the approval of both scopes in July, with potential FDA approvals before the end of the year.
We believe that VP4 has the potential to dominate the low-temperature sterilizer market. For investors with a two to three-year time horizon, we believe that the expansion of FDA approvals will be essential to driving longer-term market share growth.
Investment Highlights
• Potential for additional expanded claims in 2017. We believe that seeking additional expanded claims for individual duodenoscopes has the potential to greatly expand the market opportunity for VP4. We expect these claims could be granted before the end of the year, which would provide two significant potential catalysts for the stock.
• VP4 launch should be steady, but extended claims drive upside to our peak forecasts. Given the long-sales cycle for low-temperature sterilizers, we do not expect the impact of extended claims to be felt for a few quarters. However, we believe that the upside potential from this market opportunity is immense.
• The potential to be the dominant low-temperature sterilizer on the market. As a larger proportion of medical devices needs to be processed using low-temperature sterilization, we believe TSO3 is best positioned to ultimately replace legacy technologies like steam sterilization. This advantage is due, in our view, to VP4’s larger capacity and ability to process mixed loads relative to competitors.
Valuation
We value TSO3 based on a DCF model, using an unchanged 13.5% discount rate and 3.0% terminal growth. Based on this analysis, our target remains C$5.25, which represents an annualized return of 80.4% and continues to support our BUY recommendation.