After much time and effort, Implant Sciences (IMSC.PK) has successfully procured the most significant milestone in the company's existence. Shareholders and management have long anticipated a favorable outcome, but the Transportation Security Administration's (TSA) stamp of approval brings certitude to the use of Implant's explosive trace detection (ETD) technology in air cargo screening applications - and gives legs to a paramount market. Since jettisoning its semiconductor and medical businesses in 2007 and 2008, Implant has shifted its full focus to the development and commercialization of explosive trace detection, devices designed to pick up and alert security personnel to minute amounts of explosives or narcotics; think bomb-sniffing dogs but without the extensive oversight required by a K-9 unit. It's 2nd-generation technology, and Implant, with its small market capitalization and advanced, integrate-able technology, makes for a compelling play in the security space.
Last month, the company announced that the Department of Homeland Security's TSA approved the Quantum Sniffer B220, Implant's benchtop explosives and narcotics detection device, for use in U.S. air cargo screening. Considering that every piece of freight on passenger aircraft flying through U.S. airspace need to be screened for explosives - a requirement that only just went into effect - the approval lends more than just confidence; it's a significant opportunity for Implant as one of only three providers to make the list.
But more importantly, Implant is the only domestic ETD developer, which among other reasons, makes it both a compelling supplier for American customers and an ideal takeover target for other high-technology developers. And self-admittedly, Implant Sciences has already been approached about the technology. CEO Glenn D. Bolduc even alluded to licensing or buyout inquisitions on the company's recent earnings call: "We've actually been contacted by some very large companies in that regard. They recognize us as an independent company with a sole mission in explosive trace."
Translation: We want your technology.
Ripe for a Buyout
Before shifting gears, lets take a look at the company's fiscal 2Q13 financials, which Implant reported on the 31st of January. Largely a result of a lucrative deal with the Indian Ministry of Defense, Implant generated revenue of $8.4M in the first six months of fiscal 2013, a 285.3% increase over the prior year's period. Shareholders can't expect this kind of explosive growth consistently, but it demonstrates existing demand for the Quantum Sniffer technology given that the order occurred prior to TSA approval. It's also important to note that while Implant reported a net loss of $16.5M compared to a net loss of $6.4M in 1H12, the increase stemmed from stock-based compensation of $9.3M recorded last September; pull that and you're looking at much more consistent expenses. Cash, equivalents, and restricted investments of $1.5M are clearly a mark against the balance sheet and raise some concerns about Implant's ability to meet near-term obligations. Expectations are for Implant to draw on the remaining portion of its $23M line of credit with primary lender DMRJ Group, and if necessary, it wouldn't come as a surprise to see DMRJ extend the loan's due date beyond March; DMRJ has been a long-time supporter of the company.
A fellow Seeking Alpha contributor did an excellent job of breaking down the long-term expectations for Implant Sciences' growth trajectory. With TSA approval in the rear-view, management and shareholders are shifting focus to execution and sales figure, and rightly so in the interim. Nevertheless, there's a strong case to be made for another swift and profitable resolution, business execution aside. With interested parties already contacting Implant Sciences, a buyout may be a realistic opportunity for a number of reasons:
An inexpensive way for large SS&D (Safety, Security and Defence) firms to fold in the next generation of ETD technology. First, a look at the R&D spending of some large defence and security suppliers. Pulling from Raytheon's (NYSE:RTN) 3Q12 earnings, the company's annualized R&D spending should top $700M, while Northrop Grumman (NYSE:NOC) spent $520M on research and development in 2012. L-3 Communications (NYSE:LLL) spent $756M in 2010 on acquisitions, and General Dynamics (NYSE:GD) deployed $426M in the first nine months of 2012 on business acquisitions. That's not to imply that any of these companies are pursuing Implant, but since its latest pull-back, IMSC trades at a market capitalization of just $55M and an E/V of approx. $90M. For any large security company, bringing IMSC's technology into its own business - at a comparatively low valuation - would be a very reasonable use of cash, even with the premium necessary for a buyout. For the same reason, investors should look at Implant as a relatively inexpensive security play with significant upside as the business takes off or potentially gets folded into a larger company.
The Quantum Sniffer line unequivocally improves on the current generation of ETD devices. Most explosive trace detection devices use a radioactive ion source, which are demanding in maintenance situations, bear obvious health and safety concerns, and may require licensing and testing per the requirements of regulatory bodies worldwide, an obvious burden for utilizers. But the Quantum Sniffer lines, the B220 and H150, use photonic non-radioactive ionization for sample analysis, reducing the long-term complexities associated with a radioactive element; with comparable effectiveness, customers prefer the non-radioactive option. A major contributor to the high cost of ownership associated with current ETD technology is the requirement of a wiped sample or "trap." The QS lines require no contact with the subject and no disposable aspect, reducing long-term cost of ownership. And, note that the devices calibrate internally and automatically with fast analysis and clear-down; post-analysis wait time is a detriment to competing products. Overall, the Quantum Sniffer devices are safer and cheaper to own in the long-term than competing first-generation products, making the new technology preferable to customers worldwide.
Implant's technology is a sensible integration. Acquirers aren't necessarily pursuing the existing business - the technology behind the business is what's exciting. While IMSC's sales are gaining traction, an acquirer or licensee will be interested in integrating Implant's technology and expanding into their own applications - walk-through portals for airport security, for instance. An acquisition will be more technology-driven than business, and buyers may be looking to apply IMSC's photonic ionization to their own existing devices or simply incorporate the line as another product offering. As announced on February 7th, the company added another patent to their extensive lineup of intellectual property and brought the total number of patents to 16. The company has a robust patent estate, and it's in this proprietary technology that outside firms are registering value.
Lead debtor is a lead shareholder. The DMRJ Group has been a major player in Implant Science's growth for years, important to recognize as the large investor has much at stake and will likely push for a profitable exit if the opportunity arises. Both a debtor and ultimately a shareholder of Implant, DMRJ holds approximately $15.1M in convertible notes and backs another $17M in debt through Implant's line of credit. DMRJ has consistently demonstrated confidence in IMSC by increasing its credit line, rolling a considerable portion of Implant's debt into a convertible loan, and extending the maturity of its indebtedness. An inability to meet near-term obligations is a real concern for IMSC as it progresses along the launch ramp in 2013. Nevertheless, DMRJ has much to gain with Implant's success, and should IMSC be unable to meet immediate obligations in 2013 I highly doubt that DMRJ will let the business grind to a halt. If anything, as interested parties approach Implant, DMRJ will likely be a primary supporter of a buyout - if the price is right.
Simply put, Implant's Quantum Sniffer line is the next-generation of ETD technology. It's proprietary tech and well-protected, and as such makes for a compelling acquisition target. Running with Lauchheimer's revenue and EBIT estimations, fair value for IMSC is closer to $150M as a growth story. And as a takeover candidate, a similarly priced deal is pocket change to the large-cap defense players. Whether investors get involved for long-term growth or the potential for an all-out sale of the company, IMSC's latest pull-back has made for a great entrance point.
Disclosure: I am long IMSC.PK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.