RBC Cap Market .80 target!! March 29, 2019
TSO3 Inc.
Q4/18: slow but steady progress
Our view: TSO3's Q4 results were in line to somewhat higher vs our
outlook, with revenues of $1.1MM consistent with our estimates but
EBITDA ~$0.6MM higher than we were expecting. Relatively speaking,
the company remains in the early stages of its new distribution approach
and we continue to believe the transition period that started in 2018 will
continue in 2019.
Key points:
• Q4/18 revenue of $1.1MM consistent with our $1.1MM forecast. TSO3
reported Q4/18 results that were in line to somewhat higher than our
estimates. Total revenues were $1.1MM versus our $1.1MM estimate
and consensus of $1.7MM. Gross profit was <$0.1MM compared to
our $0.6MM estimate. EBITDA was ($2.1MM) compared to RBCCM and
consensus at ($2.7MM). TSO3 ended 2018 with $13.0MM in cash and
cash equivalents.
• Device update. TSO3 indicated that it had 75 sterilizers installed in enduser
locations, compared to 59 as of Q3/18. The company received
PO's for 21 units in the quarter and actually shipped nine sterilizers to
customers (two of which were zero dollar purchases). Additionally, it
expects to receive purchase orders for more than 10 sterilizers in Q1/19.
TSO3 also recorded consumables revenues of $0.4MM.
• Purchase orders, sales remain lumpy. While the company generally
reiterated that it was making progress in its direct-to-consumer
approach, it also reaffirmed that purchase orders, shipments, and
installations remain lumpy. We do believe that the company is making
slow, but steady progress in improving and refining this approach (as
evident by the increasing shipments and installed base) but highlight
that TSO3 remains in the early days of this rollout.
• No changes to our view - transition period continues. We viewed 2018
as a transition period for the company as it moved away from the
Getinge relationship and note that this is likely to continue in 2019. We
have confidence in the company's ability to commercialize the VP4, but
again note the difficulty in gaining penetration without a large partner.
Furthermore, while we have seen device performance improve to a
degree, we still await a meaningful uptick in the metrics noted above
and choose to remain on the sidelines until this is observed.
• Maintain target, outlook remains intact. Following the quarter and
model adjustments, we maintain our $0.80 target for the shares.
Disseminated: Mar 29, 2019 01:02ET; Produced: Mar 29, 2019 01:02ET Priced as of prior trading day's market close, EST (unless otherwise noted).
Target/Upside/Downside Scenarios
Exhibit 1: TSO3 Inc.
15m
10m
5m
N D J F M A M J J A S O N
2017
D J F M A M J J A S O N
2018
D J F
2019
M
UPSIDE 1.25
TARGET 0.80
CURRENT 0.37
DOWNSIDE 0.25
Mar 2020
3.80
2.30
1.30
0.80
0.30
125 Weeks 05NOV16 - 28MAR19
TOS CN Rel. S&P/TSX COMP IDX MA 40 weeks
Source: Bloomberg and RBC Capital Markets estimates for Upside/Downside/Target
Price target/base case
Our $0.80 price target is based on a DCF valuation. Our base
case DCF valuation is $0.84/sh, rounded to $0.80. We apply
a 6.0x multiple to 2020E sales and discount back one year to
derive a $1.02/sh supporting valuation. The 6.0x multiple is
a premium to the group, which trades at ~4.0x 2020E sales,
but we believe a premium is warranted given the company's
growth profile relative to its peers. Our base case assumes that
VP4 placements capture ~2.0% of the U.S. and <1.0% of the
OUS annual replacement market by 2021.
Upside scenario
Our $1.25 upside scenario is based on a $1.20/sh DCF
valuation (11.25% discount rate, 1.0% terminal growth) and
is supported by a $1.33/sh EV/Sales valuation, derived using
a 7.0x multiple on 2020E sales. Our upside scenario assumes
incremental annual TSO3 VP4 placement/shipment growth
of ~5% relative to our base case. Additionally, our upside
scenario incorporates a 2020 80L launch.
Downside scenario
Our $0.25 (prev. $0.40) downside scenario is based on a $0.26/
sh DCF valuation (11.25% discount rate, 1.0% terminal growth)
and is supported by a $0.28/sh EV/Sales valuation, derived
using a 4.0x multiple on 2020E sales. Our downside scenario
assumes incremental annual TSO3 VP4 placement/shipment
declines of ~80% relative to our base case.
Investment summary
We view TSO3 as a highly differentiated player within the
reusable medical equipment sterilization space, offering a
value-added device and services. We believe TSO3 will
perform in line with peers over the next 12 to 24 months.
TSO3 focuses on the sterilization of reusable medical devices
and instrumentation. In late 2014, the company secured FDA
approval of its STERIZONE® VP4 Sterilizer, and in 2016 its
label was expanded to include the ability to terminally sterilize
flexible endoscopes with up to four channels.
Potential catalysts
• Continued successful commercialization of the Sterizone
VP4 across the globe.
• Approval and launch of the Sterizone 80L.
• Positive clinical data through its partnerships with academic
hospitals in the U.S.
Risks
• Lack of device placement relative to shipments due to
limited adoption of sterilization to reprocess medical
equipment and endoscopes.
• The company only generates meaningful cash flow starting
in 2022 according to our estimates and will burn cash prior
to this time. As such, the company may raise equity.
• Manufacturing risk associated with the company being
unable to secure additional capacity as it grows.
TSO3 Inc.
March 29, 2019 Douglas Miehm, (416) 842-7823; douglas.miehm@rbccm.com 2
Valuation
We value TSO3 using a DCF valuation but support our valuation with a 2020E EV/Sales multiple,
discounted back one year. Our base case DCF valuation (11.25% discount, 1.0% terminal
growth) is $0.84/sh, rounded to our base case target of $0.80/sh.
We apply a 6.0x multiple to 2020E sales and discount back one year to derive a $1.02/sh
supporting EV/Sales valuation. The 6.0x multiple is a premium to the group, which trades at
~4.0x 2020E sales, but we believe a premium is warranted given the company's growth profile
relative to its peers. Our base case assumes VP4 placements capture ~2.0% of the U.S. and
<1.0% of the OUS annual replacement markets by 2021.
We utilize an 11.25% weighted average cost of capital for TSO3’s sterilization business due to
the relatively de-risked nature of the company. TSO3 has successfully launched its Sterizone
VP4 in several key markets including the U.S. and Europe and has validated its technology
through both commercial and academic partnerships. We believe that the WACC should be
slightly higher than other de-risked medical device companies, as there are follow-on devices
that have yet to receive regulatory approval and are subject to a certain degree of regulatory
risk.
Our $0.80 price target supports our Sector Perform, Speculative Risk rating. We assign a
Speculative Risk rating due to the early nature of the company and note that although TSO3
has existing revenues, it has not generated positive EBITDA.