Outset Medical (OM) has attracted my interest when the company went public mid-September. At the time, I called it a very interesting MedTech growth play in this article. This conclusion was based on the fact that the company ticks all the right boxes in this environment, including being a medtech play which has seen spectacular growth, has an approved product with both qualitative and quantitative improvements for multiple stakeholders, real commercial traction and further widened approval has just increased its addressable market in a huge way.
Outset has created the Tablo Hemodialysis System, also called Tablo which aims to reduce the cost and complexity of dialysis, to be used in both acute and home setting, in essence performing dialysis anytime, anywhere and by anyone.
The Tablo only requires tap water and electricity to work, releasing both patients and caregivers from traditional dialysis machines and frequent hospital and clinic visits. With integrated water purification integration, dialysis production and connected reporting, the solution provides both cost savings compared to hospital treatment and much more convenience. Being FDA approved, the machine can be used both in hospitals, clinics or home settings.
With more than 800,000 people suffering from kidney failure in the US, and this number only being on the increase, spending on dialysis surpasses the $70 billion mark! Tablo was already cleared by the FDA in 2014 for acute or chronic care, with approval for the home market cleared in March of this year. With the home setting being 4 times as large as the acute care market, there is huge potential for Tablo to further expand its operations.
The company went public at $27 per share which translated into an $800 million operating asset valuation, although this jumped to $2.2 billion after shares jumped to $60 on their first day of trading. This was a sizable valuation for a business with just $2.0 million in sales in 2018, on which an operating loss of $46 million was reported. Sales rose to $15 million in 2019, although accompanied by losses increasing to $70 million.
Revenues are growing very fast and came in at nearly $10 million in the second half of 2019, with revenues coming in at $19 million in the first six months of the year, although losses rose to $45 million. Increasing losses could be financed with net cash holdings of around $300 million at the time of the offering, as leverage should be seen on the back of increasing sales and insourced manufacturing.
I estimated the run rate at $50 million per annum in sales at the time of the offering, translating into about a 40 times sales multiple, being quite high, yet revenues are nearly tripling on an annual basis, and this is before the addressable market jumped a great deal!
This current revenue number, based on similar market penetration, means that sales could increase a factor of 4 times as well, resulting in potential sales of $200-$300 million not too long from now, as a <10 times sales multiple seems reasonable given the potential, anticipated sales leverage and great solution of the company.
The risks relate to the valuation, losses, reliance on a single product and reliance on FDA standing,. The theoretical appeal of the solution and potential of the market made that I was quite happy to initiate a small speculative position, which I ended up initiating at $48 per share in the weeks after the offering.
After a dip to the mid-forties share rallied to $50 in early November when the company reported its third quarter results. Third quarter sales of $13.8 million rose more than 400%, revealing a $55 million run rate in sales which is more or less largely in line with the estimates at the time of the public offering.
Furthermore, the run rate does not include the huge potential from the home market yet, as only the first patient was sent home with the Tablo since FDA approval came in at March. With shares having recovered to $63 at the moment the operating asset valuation has jumped up to $2.3 billion, yet operating losses rose to $40 million, in part due to stock-based compensation related to the offering.
The great observation is that the company is disrupting the field in a repetitive form of care which is helping in cutting costs and improves patients convenience, as spending on dialysis is very elevated compared to the patient population. With the company claiming a leading and innovative proposition in an $11 billion US market alone the potential is obvious. The fact that benefits are seen for patients, caregivers, payers and basically all stakeholders other than competitors, there is real potential for a gradual breakthrough.
So far the lights remain on green based on the third quarter trends, yet with shares up 30% from the levels when I recently initiated a small position, valuations have risen quite substantially. After this move, valuation multiples have risen quite a bit again, basically leading me to draw similar conclusions which I have held at the time of the public offering mid-September.
Hence, I am happy to hold onto a modest position, although I look forward to perhaps continued above average volatility, allowing for potential some in and out trading given the great volatility of the shares and intraday moves, albeit that I continue to operate with a net long position.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.