Company Update
I love it when a plan comes together
Investment Recommendation
Earlier this month, the FDA announced its intention to require manufacturers of certain reusable medical devices (including endoscopes) to include validation data for cleaning, disinfection, and sterilization within all new 510(k) filings. While not a near-term impact, we believe this means that the FDA has recognized advancements in reprocessing technologies and will now require clear validation of reprocessing data in an effort to raise safety standards when using these devices. In light of recent deadly outbreaks
of antibiotic-resistant hospital-acquired infections, the sterilization of such devices is paramount, in our view, and could drive adoption for VP4 in the longer term. With the only technology proven to sterilize certain complex flexible endoscopes, we believe that hospitals will eventually need to adopt VP4, and TSO3 remains positioned to be a leader in the low-temperature sterilization market.
This action by the FDA fits with our thesis that, eventually, hospital customers can’t afford not to use TSO3’s sterilizer. For investors with a two to three-year time horizon, we believe that these regulatory changes will be a key driver of longer-term market share growth. We are therefore adding TSO3 as our Focus List pick.
Investment Highlights
• Potential for additional expanded claims in 2017. We believe that by seeking additional expanded claims for the sterilization of individual duodenoscopes, TSO3 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 need 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 to VP4’s larger capacity and ability to process mixed loads relative to competitors, in our view.
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 86.2% and continues to support our BUY recommendation. "