Echelon Maintains $6.25 Target While some of you have no doubt seen this analysis put out just following the last Q3 #'s and CC, I thought you might be happy to see a pleasant reminder of the incredible fundamental value in TOS. My apologies that the tables did not paste; but, this is just how I found this in my inbox. I thought you might be interested in this insightful analysis...
Again, I am hoping for and expecting a series of positive PR's in the run-up to and by the Investor Day, that will renew long investor enthousiasm, lift the share price out of these ridiculous doldrums, and squeeze out the manipulating short players! (As GoPats has suggested, I can't imagine the shorts holding on into January 7.)
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7 November 2016 Healthcare & Biotechnology
Douglas W. Loe, PhD MDA | 416.775.1004 | Doug.Loe@echelonpartners.com Siew Ching Yeo (Associate) | 416.479.8995 | Siewching.Yeo@echelonpartners.com
Event: TSO3 reported FQ316 financial data for the Sept-end quarter that were essentially in line with expectations on unit sales and on revenue, though with modest upward trajectory on both measures. We are maintaining our BUY rating and $6.25 PT on TOS, with our valuation still based on NPV (20% discount rate) and multiples of our discounted F2019 EBITDA/EPS forecasts and with our investment thesis still assuming that VP4 can rapidly ascend to market share leadership in the global hospital low-temperature sterilization market. Our PT corresponds to a one-year return of 101.6%.
TOS-TSX: $3.10
Buy
Target $6.25
Target Return: 101.6%
Valuation: NPV (20% disc rate), 20x EPS, 12.5x EV/ EBITDA (F2019 ests)
Market Data Basic Shares O/S (M) Fully-diluted Shares O/S (M) Market cap (C$M) Ent Value (C$M) Pro forma cash (rec. Q, C$M) Net Debt (rec. Q, C$M) 52 Week Range (C$) Avg. Daily Volume (M) Fiscal Year End Financial Metrics In US$000's Sterizone VP4 systems Maint/service/consumables Total revenue EBITDA EBITDA margin (%) Net income Fully-taxed EPS (fd) P/E EV/EBITDA Quarterly Data EBITDA ($M) 2015 2016 EPS (fd) 2015 2016 Company Description TSO3 is a QC-based low-temperature hospital steriliz-ation equipment developer, focused on its ozone-based Sterizone VP4 platform; alliance partner identified (Getinge AB) & regulatory approvals granted in North America and Europe, so firm is poised to accelerate revenue/EBITDA growth trajectory in F2016/17 $0.01 ($0.02) ($0.02) ($0.00) 1.0 (1.1) (1.0) (0.1) ($0.02) ($0.02) ($0.02) ($0.03) Q1 Q2 Q3 Q4 (1.6) (1.4) (1.4) (2.5) NA 89.7x 16.5x NA 43.8x 9.5x ($2,595) $2,507 $13,645 ($0.03) $0.03 $0.14 ($1,724) $4,379 $20,290 NA 15.2% 33.7% 2016E 2017E 2018E $13,852 $28,738 $60,128 $13,405 $24,200 $49,390 $447 $4,538 $10,738 91.2 96.1 1.2840 Dec-31 285.0 257.2 27.8 0.0 $3.82-$1.42
00.5 11.5 22.5 3 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16
TSO3
FQ316 Data Reveals Flat VP4 Unit Sales, But With Growth Drivers On The Horizon - BUY
Essentially flat FQ316 VP4 unit sales are admittedly neutral to our valuation, but certainly not negative to our longer-term investment thesis. TOS share value is clearly undergoing post-conference call compression that we see as strongly disconnected from VP4’s commercial prospects, even before considering future sales traction that its surgical suite-targeted 80L platform could garner if approved/launched in F2018 (80L is not yet embedded in our forecasts). Clearly we would like to see VP4 sales ramp more substantively in FH216, mindful that the original FDA VP4 approval was indeed granted many quarters ago and equally mindful that endoscope-sterilizing FDA claims were in play for all of FQ316 and conceivably could have impacted FQ316 US unit sales more robustly than they clearly did.
On that basis, we get the caution. But still, we stand by our view that VP4 has well-documented performance advantages over its ethylene oxide or steam formaldehyde or hydrogen peroxide-based peers – and the FDA has effectively agreed through differentiated claims already granted – and so we are confident that VP4 commercial traction can be sustainably and sequentially strong in future periods. Perhaps investors are disappointed that no F2017 unit sales or revenue guidance was provided on the FQ316, just as they were disappointed when Novadaq management failed to do same (among other speculative factors that we described in our last NDQ research update), but it would be unusual for any firm, and especially one still immersed in an early launch period for a core product, to provide forward annual guidance after a FQ3 conference call and we were not surprised that such disclosure was not forthcoming. TSO3’s balance sheet was strong (quarter-end cash US$20.7M, FQ316 operating cash loss <US$0.73M), as we will describe, so financial risk is low, and comparable to FH116 anyway.
Steady progress on VP4 sales to channel partner Getinge, with more substantial unit sales ramp probably awaiting EU launch and claims on duodenoscope reprocessing. We move on. Taking the income statement first, revenue of US$3.5M corresponded to 30 VP4 systems sold to partner Getinge AB (GETI.B-STO, NR) in the quarter, up from US$3.0M/25 in both FQ116 and FQ216, and thus indicating to us that TSO3 is still selling the device to partner at a transfer price of around US$117,000 per system, actually a bit above our US$110,000 forecast. We were encouraged to see in the FQ316 MD&A that the installed base of Sterizone VP4 is growing, implying that Getinge/TSO3 are in fact placing VP4 within central sterilization units in US/Canadian hospitals and not just transferring systems into Getinge’s inventory for future sale (though we suspect that is happening to some degree).
Modest-but-manageable operating cash loss in the quarter minimally impacts TSO3’s existing financial risk. Gross margin of US$1.14M/32.5% was sequentially strong in comparison to US$0.8M/28% in FQ216 though down from EBITDA loss of (US$1.0M) and
Source: Capital IQ TSO3 (TOS-TSX) | 7 November 2016
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Douglas W. Loe, PhD MBA | 416.775.1004 | Doug.Loe@echelonpartners.com
operating cash loss of (US$1.1M) were trivial in comparison to the firm’s quarter-exiting cash level of US$20.7M and thus confer no added financial risk to our investment thesis. Consumables revenue from sale of chemical and biological indicators required for each sterilization cycle were assumed by us to be low just because the installed base, though not quantified by management, is likely still low, but we look forward to higher-margin consumables positively impacting gross margin and EBITDA as VP4 installed base climbs in future quarters. Management indicated that conventional hospital practice for installed systems has been to conduct 5-6x sterilization cycles per day, well above the 3x cycles per day that our model currently assumes. We expect to revisit this assumption as consumables contribute more substantively to top-line performance.
Exhibit 1 – Revised Income Statement & Financial Forecast Data for TSO3
(US$000, except EPS) 2014A 2015A 2016E 2017E 2018E 2019E 2020E 2021E 2022E Sterizone VP4/125L+ systems 0 1,233 13,405 24,200 49,390 69,080 90,860 99,990 105,160 Maint/service/consumables 433 400 447 4,538 10,738 18,588 28,913 40,275 52,225 Total revenue $433 $1,633 $13,852 $28,738 $60,128 $87,668 $119,773 $140,265 $157,385 Revenue growth (%) 70% 277% 748% 107% 109% 46% 37% 17% 12% VP4 Unit sales NA 22 115 220 449 628 826 909 956 Gross margin (686) (423) 5,017 14,498 31,352 47,815 66,908 81,243 94,325 Gross margin (%) (158%) (26%) 36% 50% 52% 55% 56% 58% 60% EBITDA ($4,859) ($7,065) ($1,724) $4,379 $20,290 $36,601 $55,510 $68,831 $81,664 EBITDA growth (%) NA NA NA (354%) 363% 80% 52% 24% 19% EBITDA margin (%) NA NA NA 15% 34% 42% 46% 49% 52% Net Income ($5,948) ($8,133) ($2,595) $3,582 $19,493 $35,803 $52,022 $48,182 $57,165 Net income, fully-taxed ($5,948) ($8,133) ($2,595) $2,507 $13,645 $25,062 $38,299 $48,182 $57,165 Fully-taxed EPS (fd) ($0.07) ($0.08) ($0.03) $0.03 $0.14 $0.26 $0.39 $0.50 $0.59 P/E NA NA NA 89.7x 16.5x 9.0x 5.9x 4.7x 3.9x EV/EBITDA NA NA NA 43.8x 9.5x 5.2x 3.5x 2.8x 2.3x
Source: TSO3, Echelon Wealth Partners Inc.
TSO3 is well on pace to achieve ‘guidance’ for >100 VP4 unit sales to Getinge in F2016, an encouraging sign that the TSO3-Getinge alliance is meeting early expectations. Our model previously assumed that TSO3’s guidance for ‘at least 100’ systems sold in F2016 was a bit conservative but with three quarters of data showing that this semi-quantitative guidance corresponds more to reasonable-case VP4 volume than base-case, we are revising our FQ416 VP4 unit sales forecast to 35 systems, and thus revising our F2016 VP4 unit sales forecast to 115 from 132 previously. While we are pleased to see VP4 generate sustained unit sales traction after kick-starting US marketing initiatives in FQ116, it is nonetheless true that VP4 was FDA-approved back in Dec/14 and thus equally true that this time-gap between positive regulatory regard and measurable VP4 commercial traction has been longer than we originally envisioned.
Getinge’s own T9M operating challenges, independent of VP4, presents both opportunities and risks to VP4 launch. The fact that Getinge itself has been experiencing some corporate challenges in recent quarters is a separate risk factor that we are monitoring closely – the firm indicated in its own FQ316 financial update last month that order intake (gross revenue) across all divisions (including but not limited to Infection Control) was down 3.2% y/y on a constant currency basis and of course, the firm made substantial changes to its executive team (both CEO & CFO) that at minimum would have been distracting to operations. And yet despite Getinge’s corporate challenges, we still believe the firm remains a credible VP4 channel partner for TSO3, not only because it does have existing sales bandwidth in infection control and thus in sales channels where we expect VP4 to be sold worldwide. And separately, we have certainly seen positive signals from Getinge that it is focused on VP4 commercial success both through issuing its own press releases on VP4 regulatory milestones (including the granting of FDA expanded claims on flexible multi-channel endoscope sterilization in Jul/16) and on hiring its own US-based VP4-dedicated marketing professionals. TSO3 (TOS-TSX) | 7 November 2016
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Douglas W. Loe, PhD MBA | 416.775.1004 | Doug.Loe@echelonpartners.com
Taking all initial launch characteristics into consideration, we still expect robust VP4 unit sales ramp but not quite to our previous expectations. We take a back seat to no one in our positive view on VP4’s technical superiority and medical utility in hospital sterilization markets (TOS is still our 2016 medical technology Top Pick, after all), and we are maintaining our expectation that VP4 can eventually capture dominant market share in the 30,000-unit global installed base/3,000-unit annual turnover hospital sterilization market (and this is before considering the installed base and annual turnover for surgical suite-directed 80L, for which F2018 launch is still expected by TSO3 but which we do not officially embed in our financial forecasts as yet), thus implying that annual unit sales can approach 1,000 units during our forecast period (in F2023 to be exact). As we have described many times, we do not see 1,000 annual unit sales as being especially aggressive when compared to J&J (JNJ-NY, NR)/Advanced Sterilization Products’ timelines to achieving this same unit sales threshold for its hydrogen peroxide/gas plasma-based Sterrad system (FDA-approved/launched in 1992, sold its 5,000th system by early 2001) and we believe VP4 has superior technical elements (and we know it has superior regulatory regard just on endoscope reprocessing alone) that could accelerate timelines to achieving a Sterrad-like installed base.
Exhibit 2 – Valuation Scenarios For TSO3
NPV, discount rate 10% 15% 20% 25% 30% 40% Implied value per share $10.98 $8.41 $5.43 $4.49 $3.77 $2.75 Price/earnings multiple, F2019 10x 15x 20x 25x 30x 40x Implied share price1 $2.15 $3.22 $4.29 $5.37 $6.44 $8.59 EV/EBITDA multiple, F2019 5x 10x 12.5x 15x 17.5x 20x Implied share price1 $1.75 $3.31 $4.10 $4.88 $5.67 $6.45 One-year TSO3 target price (US$) $4.61 One-year TSO3 target price (C$) $6.18 Discounted projected share price to mid-2017 1 Based on fully-taxed F2019 EPS (fd) forecast of US$0.26, EBITDA of US$36.6M. Valuation based on NPV (20% disc rate), EV incorporates FQ316 net cash of US$20.7M (no LT debt), fd S/O of 97.3M
Source: TSO3, Echelon Wealth Partners Inc.
But with duodenoscope-specific claims still pending and with Getinge still a distracted (though committed) partner and with our sense that many of TSO3’s VP4 sales sold to Getinge still await future placement at client hospitals (thus slowing down pace at which Getinge could request new VP4 shipments in F2017 until existing inventory is placed), we are pulling back a bit on our near-term VP4 unit sales expectations in F2017-F2019. We still project strong sequential unit sales ramp, just not quite as aggressively as we previously assumed, and we now are forecasting F2017 revenue/EBITDA/unit sales of US$28.7M/US$4.4M/220 (was US$43.5M/US$12.0M/344), increasing to US$60.1M/US$20.3M/449 in F2018 (was US$77.5M/US$29.7M/576) and to US$87.7M/US$36.6M/628 in F2019 (was US$102.1M/US$44.5M/718).
We are separately shifting forward our NPV valuation to exclude F2016 losses (we expect FQ416 operating cash loss to be <US$1.0M as in FQ316 and thus to be trivial to our valuation anyway), which offsets the impact of our modest EBITDA/EPS revisions, as shown in Exhibit 2. We have observed before that we are somewhat disappointed that Getinge does not feature VP4 at all in any of its EU hospital markets even though the device has been approved in that market for far longer than it has in the US, but we suspect that Getinge was awaiting development of TSO3’s double-door VP4 configuration and completion of prion inactivation testing before aggressively marketing the device in the EU. Both should conclude by end-of-F2016 and thus allow for more comprehensive VP4 EU launch in FQ117, as TSO3 confirmed during its conference call commentary. Our model still assumes 50 VP4 unit sales in the EU next year, increasing to 85 in F2018 and 106 in F2019. TSO3 (TOS-TSX) | 7 November 2016
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Douglas W. Loe, PhD MBA | 416.775.1004 | Doug.Loe@echelonpartners.com
TEARSHEET - TSO3 (TOS-T, $3.10, BUY, PT: $6.25) Company Description Consensus Return Rating: Outperform Target: $5.29 70.5% Median: $5.50 77.4% High: $6.25 101.6% Low: $4.00 29.0% # Est: 7 Consensus Distribution Sector Outperform/Buy 7 Sector Perform/Hold 0 Sector UnderPerform/Sell 0 Historical Valuations Financial Summary/Key Metrics 2011 2012 2013 2014A 2015A 2016E 2017E 2018E Key Statistics Value C$000 to F2015, US$000 in F2016-2018 data 52-Wk High: $2.85 91.9% Total Revenue 3,355 2,854 254 433 1,633 13,852 28,738 60,128 52-Wk Low: $1.06 34.2% Growth y/y N/A (14.9%) (91.1%) 70.2% 277.2% 748.1% 107.5% 109.2% Avg Vol (3-Mo) 1.28 Cons. 2,890 2,189 375 417 3,341 18,033 37,534 69,073 Shares O/S: 91.9 Cons. 3 Mts. Ago 2,890 2,189 375 417 3,341 18,491 39,848 77,205 Market Cap: 285.0 EBITDA (6,934) (4,895) (6,307) (4,859) (7,065) (1,724) 4,379 20,290 Net Debt: 36.1 Margin -206.7% -171.5% -2479.6% -1122.1% -432.6% -12.4% 15.2% 33.7% Ent. Value: 192.0 Cons. -6,851 -6,886 -7,036 -4,857 -5,898 -4,316 2,092 11,756 Div Yield: 0.0% Cons. 3 Mts Ago -6,851 -6,886 -7,036 -4,857 -5,898 -4,290 2,204 15,186 Website: www.tso3.com Net Income (7,655) (5,796) (9,270) (5,948) (8,133) (2,595) 2,507 13,645 FYE: Dec 31 Adjusted EPS ($0.12) ($0.08) ($0.11) ($0.07) ($0.08) ($0.03) $0.03 $0.14 Employees: 61 Cons. ($0.14) ($0.11) ($0.12) ($0.08) ($0.08) ($0.04) $0.02 $0.13 Cons. 3 Mts. Ago ($0.14) ($0.11) ($0.12) ($0.08) ($0.08) ($0.04) $0.03 $0.15 Operating Cash Flow (8,645) (6,469) (8,651) (2,903) (6,774) (5,814) (509) 9,961 Top Inst. Ownership M Shares % Held Fidelity Investments 9.05 9.8% Sprott Asset Management, LP 8.11 8.8% Valuation Caisse de dpt et placement du Qubec 7.69 8.4% NPV, Discount Rate 15.0% 20.0% 25.0% Gilder Gagnon Howe & Co. LLC 5.79 6.3% Implied value/share1 $8.41 $5.43 $4.49 IG Investment Management, Ltd. 2.88 3.1% Price/Earnings Multiple 15.0x 20.0x 25.0x HSBC Global Asset Management (Canada) Limited 1.10 1.2% Implied value/share1 $3.22 $4.29 $5.37 AGF Management Limited 0.94 1.0% EV/EBITDA Multiple 10.0x 12.5x 15.0x Formula Growth Limited 0.70 0.8% Implied value/share1 $3.31 $4.10 $4.88 Guardian Capital LP 0.70 0.8% One year TOS Target Price1 $6.25 Desjardins Global Asset Management Inc. 0.15 0.2% Comparables and Peer Analysis Trading Current Target Div Implied Market Enterprise Ticker CCY Price Price Yield % Return Cap Value 1-Week 1-Month 3-Month 1-Year T12 2016E 2017E T12 2016E 2017E TSO3 TOS CAD $3.10 $6.25 0.0% 101.6% 285.0 257.3 (6.1%) (5.2%) (15.5%) 79.2% -5.0 -3.2 1.6 ($0.05) ($0.03) $0.02 3M MMM USD $166.48 $178.44 2.7% 9.8% 100,132.1 109,873.1 0.7% (2.8%) (6.7%) 4.5% 8,659.0 8,880.8 9,129.4 $8.11 $8.17 $8.55 Balchem Corp BCPC USD $70.42 $64.00 0.5% (8.6%) 2,233.8 2,499.4 (7.2%) (10.0%) 7.4% 8.3% 134.9 141.7 160.9 $1.77 $2.50 $2.56 Getinge AB GETI.B SEK SEK 147.90 SEK 180.00 1.9% 23.6% 34,580.7 55,108.7 (0.1%) (10.6%) (17.7%) (32.3%) 5,859.0 5,555.3 6,418.2 SEK 5.05 SEK 5.58 SEK 9.59 Ion Beam Applications IBAB EUR €42.58 €48.98 3.3% 18.3% 1,217.3 1,158.8 (1.6%) (2.5%) 0.5% 25.8% 29.6 44.5 56.1 €1.93 € 1.10 € 1.44 Johnson & Johnson JNJ USD $115.11 $125.37 2.8% 11.7% 313,160.4 296,847.4 (0.8%) (3.5%) (6.7%) 12.9% 23,766.0 25,265.2 27,031.0 $5.78 $6.71 $7.13 Nanosonics NAN AUD $3.24 $3.39 0.0% 4.8% 964.6 917.5 (6.6%) (3.0%) 14.5% 96.4% 0.8 -0.6 14.1 $0.00 $0.00 $0.05 Steris STE USD $65.34 $86.50 1.7% 34.1% 5,619.3 6,869.1 (2.2%) (8.3%) (10.0%) (13.4%) 540.5 432.4 589.0 $1.99 $3.52 $3.90 Average 1.6% 24.4% 57,274.1 59,191.4 (3.0%) (5.7%) (4.3%) 22.7% Comparables - Multiples Analysis 2015 2016E 2017E T12M 2016E 2017E T12M 2016E 2017E T12M 2016E 2017E N12M 2016E 2017E T12M 2016E 2017E TSO3 2.7% -2.5% -1.2% NA -79.9x NA N/A NA NA 27.8x 14.3x 6.9x NM NM 134.8x NA NM NM 3M 4.8% 4.9% 5.5% 12.7x 12.4x 12.0x 12.7x 12.4x 12.0x 3.7x 3.6x 3.4x 19.6x 20.4x 19.5x 16.8x 15.5x 14.6x Balchem Corp 3.5% 3.2% 4.1% 18.5x 17.6x 15.5x 18.5x 17.6x 15.5x 4.6x 4.6x 4.3x 27.5x 28.2x 27.6x NA 0.0x 0.0x Getinge AB 4.3% 4.8% 7.5% 9.4x 9.9x 8.6x 9.4x 9.9x 8.6x 1.9x 1.8x 1.8x 16.4x 26.0x 15.1x 11.6x 8.6x 7.7x Ion Beam Applications 1.2% 0.9% 1.5% 39.2x 26.0x 20.6x N/A NA 20.6x 3.9x 3.5x 3.0x 38.2x 38.2x 29.3x 8.4x 16.4x 29.2x Johnson & Johnson 5.3% 4.7% 5.7% 12.5x 11.7x 11.0x 12.5x 11.7x 11.0x 4.1x 4.1x 3.9x 16.6x 17.2x 16.1x 16.7x 18.3x 13.8x Nanosonics -0.2% 0.3% 1.1% 1156.9x NA 65.2x N/A NA NA 21.4x 0.0x 13.0x 66.3x 0.0x 66.3x -45.5x 0.0x 63.9x Steris 0.0% 3.6% 5.0% 12.7x 15.9x 11.7x 12.7x NA 11.7x 2.7x 0.0x 2.6x 15.8x 0.0x 16.8x 15.2x 0.0x 13.9x Average 180.3x 2.0x 20.7x 13.2x NA NA 8.8x 4.0x 4.9x 28.6x 18.6x 40.7x NA 8.4x 20.5x 1Targets, forecasts and valuations reflect consensus estimates derived from Capital IQ P/CFPS TSO3 is a QC-based low-temperature hospital sterilization equip-ment developer, focused on its ozone-based Sterizone VP4 platform, for which regulatory approvals have now been granted in all major markets, including the US in Dec-14, and global channel partner Getinge AB is actively building out VP4-specific marketing & support infrastructure to drive unit sales in F2016/17. Specific claims have been granted in Canada & US for sterilizing flexible multichannel endoscopes, differentiating VP4 from other sterilization platforms. % Return Consensus Valuations EBITDA EPS LTM EV/EBITDA FCF Yield Current - EV/EBITDA Target - EV/EBITDA EV/Revenue Forward P/E 1 Based on fully-taxed F2019 EPS (fd) forecast of US$0.33, EBITDA of US$44.5M. Valuation based on NPV (20% disc rate), EV incorporates FQ216 net cash of US$21.3M (no LT debt), fd S/O of 94.9M 00.5 11.5 22.5 3 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 $4.00 Nov-13 Jan-14 Mar-14 May-… Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-… Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-… Jul-16 Sep-16 Volume (M Shares) Stock Price ($) Last Sale Price 50-day MA 200-day MA 0.0x 10.0x 20.0x 30.0x 40.0x Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Sep-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Oct-16 Nov-16 Nov-16 TSO3 Steris
FDA claims on endoscope sterilization were highly positive when granted, but duodenoscope-specific claims would be even more positive if granted next year, as we assume. TSO3 re-affirmed its intention to submit new microbiology/ sterilization data on duodenoscope reprocessing to FDA by FQ117 (and thus to have assembled submittable data by end-of-F2016), and we believe that if TSO3 has shown strong antimicrobial activity against thermoresistant spores trapped therein that is as positive as data must have been to support favorable FDA claims review on flexible multi-channel endoscopes as granted in Jul/16, then we believe FDA will be sufficiently motivated to opine favorably and quickly on VP4’s differentiated utility in duodenoscope sterilization, perhaps as early as FQ217. TSO3 (TOS-TSX) | 7 November 2016
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Douglas W. Loe, PhD MBA | 416.775.1004 | Doug.Loe@echelonpartners.com
Our model thus assumes that VP4 unit sales can still ramp appreciably in FH217 and into F2018/19. The seminal duodenoscope for which TSO3 will need to show approvable sterilization potency is still Olympus’ (7733-JP, NR) market leading Q180V, the model for which so many of the US-based acquired carbapenem-resistant Enterobacteriaceae infections have transpired in recent quarters, leading FDA to more aggressively identify sterilization platforms that can truly sterilize duodenoscopes and for Olympus and its peers to identify same.
Still a sizable ‘awareness gap’ for VP4 to overcome in duodenoscope reprocessing markets, but FDA claims if granted would certainly help. We again mention in passing that we remain surprised by VP4’s lack of profile in recent peer-reviewed manuscripts that describe the need for next-generation post-ETO duodenoscope reprocessing technologies and yet do not mention VP4 at all even though the device has long been FDA-approved (since Dec/14 as stated above) and even though it has differentiated claims on endoscope reprocessing that, at least, should put VP4 on the radar screen of medical professionals seeking credible changes to current practices on duodenoscope reprocessing. One recent paper published just this month in Current Gastroenterology Reports, and by UCLA researchers no less (UCLA Medical Center being one of the US hospitals for which duodenoscope-associated GI infection cases have been diagnosed in recent years), did not even mention VP4, let alone comment on its feasible use in that application. We expect the VP4 Zeitgeist to rapidly recalibrate if/when VP4/duodenoscope-specific claims are granted, but as stated, we remain surprised that VP4’s brand awareness in this market is, based on evidence available to us, far lower than we would have thought.
Summary & valuation – multiple milestones on duodenoscope reprocessing and EU launch that should drive VP4 unit sales adoption in F2017 and beyond. But looking forward instead of backward, we do see catalysts that could drive near-term share value in ways that should be relevant to our near-term revenue/EBITDA forecasts, and these include: (1) completion of prototype development for the EU-targeted double-door VP4 design, leading then to (2) EU launch by partner Getinge in FQ117, (3) completion of duodenoscope sterilization testing by end-of-F2016, itself leading to (4) 510(k) filing on duodenoscope-specific sterilization claims in FQ117 and then (5) potentially garnering favorable FDA review on duodenoscope sterilization claims by FQ217, with more rapid VP4 unit sales ramp than achieved-to-date clearly achievable in FH217. TSO3’s smaller-but-still-hydrogen peroxide/ozone-based 80L sterilization platform is still in development and if still on pace for F2018 launch, we would expect prototype design lock to conclude in FH217, and we will watch closely for that timeline to remain feasible.
As stated, we are maintaining our BUY rating, C$6.25 PT, and Top Pick status on TOS, with valuation still based on NPV and multiples of our F2019 EBITDA/fd EPS forecasts (now US$36.6M & US$0.26, respectively).Recall that our forecasts do not overtly incorporate 80L unit sales and consumables, and we expect to revisit this assumption once we have firm timelines on prototype development and to regulatory filing. But just on this device alone, we see upside to our F2018-F2023 revenue/EBITDA forecasts; we suspect Getinge could be as motivated to be TSO3’s channel partner on 80L, but it will have to earn that opportunity in our view through strong VP4 global sales performance, performance we have not yet seen but are confident that we will by F2017. TSO3 (TOS-TSX) | 7 November 2016
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Douglas W. Loe, PhD MBA | 416.775.1004 | Doug.Loe@echelonpartners.com
Important Information and Legal Disclaimers
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U.K. Disclosures: This research report was prepared by Echelon Wealth Partners Inc., a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund. ECHELON WEALTH PARTNERS INC. IS NOT SUBJECT TO U.K. RULES WITH REGARD TO THE PREPARATION OF RESEARCH REPORTS AND THE INDEPENDENCE OF ANALYSTS. The contents hereof are intended solely for the use of, and may only be issued or passed onto persons described in part VI of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. This report does not constitute an offer to sell or the solicitation of an offer to buy any of the securities discussed herein.
U.S. Disclosures: This research report was prepared by Echelon Wealth Partners Inc., a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund. This report does not constitute an offer to sell or the solicitation of an offer to buy any of the securities discussed herein. Echelon Wealth Partners Inc. is not registered as a broker-dealer in the United States. The firm that prepared this report may not be subject to U.S. rules regarding the preparation of research reports and the independence of research analysts.
ANALYST CERTIFICATION
Company: TSO3| TOS:TSX
I, Douglas Loe, hereby certify that the views expressed in this report accurately reflect my personal views about the subject securities or issuers. I also certify that I have not, am not, and will not receive, directly or indirectly, compensation in exchange for expressing the specific recommendations or views in this report.
| IMPORTANT DISCLOSURES Is this an issuer related or industry related publication? | Issuer |
| Does the Analyst or any member of the Analyst’s household have a financial interest in the securities of the subject issuer? If Yes: 1) Is it a long or short position? Yes; and, 2) What type of security is it? Common shares | Yes |
| Does the Analyst or household member serve as a Director or Officer or Advisory Board Member of the issuer? | No |
| Does Echelon Wealth Partners Inc. or the Analyst have any actual material conflicts of interest with the issuer? | No |
| Does Echelon Wealth Partners Inc. and/or one or more entities affiliated with Echelon Wealth Partners Inc. beneficially own common shares (or any other class of common equity securities) of this issuer which constitutes more than 1% of the presently issued and outstanding shares of the issuer? | No |
| During the last 12 months, has Echelon Wealth Partners Inc. provided financial advice to and/or, either on its own or as a syndicate member, participated in a public offering, or private placement of securities of this issuer? | No |
| During the last 12 months, has Echelon Wealth Partners Inc. received compensation for having provided investment banking or related services to this Issuer? | No |
| Has the Analyst had an onsite visit with the Issuer within the last 12 months? | No |
| Has the Analyst been compensated for travel expenses incurred as a result of an onsite visit with the Issuer within the last 12 months? | No |
| Has the Analyst received any compensation from the subject company in the past 12 months? | No |
| Is Echelon Wealth Partners Inc. a market maker in the issuer’s securities at the date of this report? | No |