Syneron, A Compelling Vanity Story (ELOS)

Jun. 7.06 | About: Syneron Medical (ELOS)

These days no matter what gender, age or geographical location you find yourself, chances are you want to look your absolute best. Well, you’re in luck because Syneron Medical (NASDAQ:ELOS) wants to help you do exactly that. Syneron manufactures medical devices for cosmetic procedures such as hair removal, wrinkle reduction and treatment of visible veins.

The company markets its products to a wide range of treatment providers from dermatologists and plastic surgeons to primary care physicians, ophthalmologists and medical spas. The company’s products are based on a proprietary Electro-Optical Synergy [ELOS] technology that combines electrical energy and optical energy in the various aesthetic treatments. Currently, most similar products on the market use optical energy only.

Syneron sold their first product, the Aurora (for skin treatment, hair removal and acne treatment), in December 2001 and since then they have introduced a number of additional products including the Galaxy (for hair removal, skin treatment, acne treatment, wrinkle treatment and vein treatment), Pitanga (for hair removal and skin treatment) and VelaSmoot (for treatment of cellulite).

The company was founded in mid 2000 before launching the Aurora in late 2001, and they are based in Yokneam Illit, Israel.

THE STORY
When you’re talking about a medical device company that’s early in its lifecycle like Syneron, just as with any technology company, you’re invariably going to face some risk of adoption and execution. I.e., there is no guarantee that the company’s products are going to be accepted by a wide enough audience to get it labeled the “de facto” solution before some other company comes along. Along with that, there’s the question of whether the management team, no matter how good the products are, has the wherewithal to execute on a growth strategy and get the darn things sold.

As for adoption, I’m not the guy that’s going to be able to tell you whether the ELOS technology behind Syneron’s products is where it’s at. That’s just not my value add here. What I can point out, though, is that a) they are in an awesome market and b) the market is ready for some new solutions. No matter which way you cut it, vanity is good business. As Christian Troy said in the Nip/Tuck series “The line that divides the porn industry and the plastic surgery is a thin one. We're both selling fantasy, aren't we?” Well put.

People of all walks of life want the fantasy – whether it’s dropping hundreds of dollars on MAC cosmetics, a few hundred dollars on Citizens of Humanity jeans, putting out the monthly membership to the gym and the cost for the personal trainer, or heading over to the friendly neighborhood plastic surgeon, most people want to look like Tom Cruise, not Tom DeLay (sorry Tom). The fact that people are just so willing to pay for this makes it a great business to be in.

Now we circle around to doctors – in my opinion basically a charity business in this country these days. Most doctors have been so beat up between malpractice insurance coverage and measly insurance payouts on the other end that they might as well have just gone off with the Peace Corps. Be that as it may, many doctors are now looking for in-demand, high margin business to tack on to their practice that doesn’t have the insurance payment risk that the rest of their practice has. Enter vanity treatments. Syneron's products would allow someone like a primary care physician to bring a device into his office and offer vanity treatments that patients would pay for out of pocket (as opposed to through insurance).

As for the products, Syneron's products are designed to be one step better than the current generation of optical energy cosmetic treatments. The reason that the optical treatments are popular in the first place is because they do some of the work of other cosmetic treatments like microdermal abrasion and botox without the pain, risk or need for special skill to apply the procedures. Syneron thinks that its ELOS technology provides better treatment and a wide array of possible treatment options than the optical only technologies.

VALUATION
At first glance the numbers on Syneron may look very inviting. They have great margins, have put up good return on equity and are growing the top line nicely and steadily. They also have a pretty clean balance sheet with plenty of cash on hand, no debt and nothing that jumps out as growing out of proportion with the rest of the company. So the 9.7x forward P/E and 0.46x PEG ratio looks just outstanding.

Then you may notice that they have missed earnings estimates in their last two quarters – by $0.03 in December, and then by $0.10 in March (a 24% miss!). Basically, at this point investors have priced in a heavy dose of skepticism for Syneron’s 2006 estimates. On top of that, it seems that the biotech industry can’t buy a good day on the stock market lately.

What particularly bothers me here is the most recent miss. Though the revenue grew nicely, sales and marketing and R&D “investments” were more than expected. What I generally would like about the company is that both the CEO and CFO have a good finance pedigree. The CEO was the former CFO, so he should have a good eye for numbers and the CFO has been CFO for a number of public companies such as RADVISION Ltd. (NASDAQ:RVSN). So while I would fully stand behind strong expenditures on sales and marketing for Syneron (with a lot of competitors out there it’s important they get their name out), I would think that between the CEO and CFO they should have a pretty good grasp on what their spend is going to be – and be disciplined enough to stick to that.

Based on the numbers that are currently out there, I’d probably put a value of around $35 on Syneron’s stock. This would give it a 21.6x P/E multiple on trailing twelve months earnings and roughly a 1.0x PEG ratio. This gives you a potential 80% gain over the current stock price.

CONCLUSION

The bottom line here is that Syneron could be a good bet for someone with some risk tolerance. While there certainly is potential downside in the stock price if they miss analysts estimates in Q2, a lot of the downside has already been taken out of the stock through the relentless beating it’s taken the last two quarters. On the other hand, the potential upside is pretty nice.

The competitive dynamics of the industry could make it a tough road for Syneron, but the fact that they can differentiate themselves through their proprietary technology (and hopefully keep themselves safe from lawsuits like the one that Cutera Inc. (NASDAQ:CUTR) is facing) makes them one of the better bets.

ELOS 1-yr Chart