I've been getting quite a few emails about BriteSmile's (BSML) prospects, following the extreme volatility in the stock last week, after the company rejected a $4 acquisition offer from Futuredontics. The following post details my thoughts on BriteSmile's prospects in the year ahead.
Overall, while I can't predict short-term stock prices, it seems obvious to me that when considering BriteSmile's underlying business, BriteSmile's stock is still incredibly cheap even after the recent run, and still offers investors a very attractive risk/reward scenario over the next twelve months.
Specifically, as I will detail later in the post, it appears to me that BriteSmile will most likely earn $0.55 per share in 2007 from continuing operations, as compared to about $0.20 per share from continuing operation in 2006. As such, with 10.6 million shares outstanding, $9 million in projected cash, $150 million in tax loss carryforwards, and strong potential for future growth, it seems to me that as investors recognize the profit situation here, the stock could trade to $9.50 in the next year, which would still be a mere 15X Enterprise Value to 2007 Earnings (untaxed, since BriteSmile will not pay taxes for many years).
As I detailed in my first post, there are still some remaining legal risks for BriteSmile, as well as the more obvious execution, market and economic risks, but at its current price of about $3.30, the stock adequately reflects all these risks given the valuation of about 4X Enterprise Value to 2007 Earnings and about an 11X multiple of Enterprise Value to 2006 Earnings.
In fact, it's extremely rare to find a company with BriteSmile's growth potential trading at these types of multiples, which are usually reserved for cyclical businesses and/or companies in severe financial trouble, of which BriteSmile is neither. BriteSmile is merely a company undergoing significant and positive changes following the divestiture of the money-losing and inherently unattractive part of its operations earlier this year.
How do I arrive at the financial projections detailed above?
This filing states that:
At the beginning of April 2006, the Company reduced the price of its whitening procedure from $600 to $399 and as a result of this price reduction, the Company has approximately doubled its weekly volume of paid procedures and increased average weekly revenues in the Center business by about 60 percent.
More importantly the financial projections provided in this filing clearly show that excluding stock option expense (incidentally BriteSmile has very few in-the-money stock options remaining) and unusual Impacts of Costs and Gains Related to the Sale of the Associated Center Business (these one-time costs will be gone after 2006, 2nd quarter results), BriteSmile is looking to report revenues of at least $8 million in both the 3rd and 4th quarter of 2006, and EBITDA from continuing operations of at least $1.4 million per quarter.
Since BriteSmile has no debt and will pay no taxes for quite a long time, EBITDA is in this rare case, a perfect measure of the company's earnings. As such for 2006, the company is projecting in this SEC filing about $0.22 per share in earnings.
Of course projections for 2007 are NOT included in this SEC filing, but it is fairly simple to see that 2007 will be the first full year when BriteSmile will be operating under the current new business structure (2006 has two quarters of downsizing and realignments of both strategy and costs). Since there is no inherent cyclicality to BriteSmile's business, and making the conservative assumption of no revenue growth in 2007, it seems obvious that it is fair to annualize BriteSmile's projections for the third and fourth quarter of 2006, to a full year estimate for 2007. That implies about $33 million in sales in 2007, and $6 million in EBITDA/Earnings or about $0.55 per share.
Furthermore, the company has very good growth prospects (20%+ per year) post 2007, via the opening of new whitening spas (there are only 17 at this time), the continued growth of whitening product sales to consumers, and selective acquisitions.
How can the market be mispricing this equity by such a wide margin?
Whenever I find stocks like BriteSmile, whose earnings prospects seem so out of whack with the current stock price and valuation, I become a bit suspicious given what I believe is the basic efficiency of the stock market. However, in the case of BriteSmile, I think that this is truly one of those rare "free" lunches that the market doles out every once in awhile to those patient enough to wait for the perfect opportunity.
The basic reason why BriteSmile is still so cheap is because most investors are still confused by the the company, as there is still very little "clean" data on continuing operations. In fact, many investors I have spoken to are immediately negative towards BriteSmile on the assumption that the company is still selling their tooth whitening system to dentists, a business that consumed a huge amount of BriteSmile's resources in years past.
However, this competitive business was sold to Discus Dental earlier this year. Currently, BriteSmile is solely in the business of selling high-end tooth whitening procedures and products directly to consumers via 17 whitening spas and via direct-to-consumer marketing channels like QVC. This business is growing and is profitable, as evidenced by several SEC filings, the most important of which I have referenced above.
Another reason for the undervaluation of BriteSmile is due to the fact that with a market cap of only $35 million or so, the stock is not followed by many people on Wall Street and is shunned by others who refuse to look at these types of low-priced stocks, despite proof of profitability and in the case of BriteSmile a simple way to verify the health of the business: Visit the stores! This lack of coverage provides thoughtful investors with the opportunity to invest at an attractive valuation.
Overall, the combination of a major divesiture, uncertainty related to continuing operations, and little Wall Street sponsorship, has created the rare situation where a business has been significantly mispriced by the market.
What are the risks in investing in BriteSmile?
Overall, it is my opinion that the company has set aside more than enough cash to settle these lawsuits and as such, I do not see any significant financial risks associated with BriteSmile's remaining legal issues. Of course, the company may have to recognize large one-time expenses when these legal cases are settled, but since these costs are non-recurring, it is doubtful that the market will penalize the company for a one-time hit to earnings.
Aside from standard market and economic risks, it is also possible, as mentioned in my original write up, that the largest shareholders may try to take BriteSmile private at a discount to the company's fair value. However, as mentioned in the past, I do not believe that these shareholders will take the company private, assuming the share price continues to rise and begins to reflect the positive prospects of the company.
Furthermore, there are other large shareholders of BriteSmile, who are sitting on major paper losses, and who in my opinion will never allow a private takeover at current prices. I am sure that these shareholders would rather see the company report strong earnings growth in the remainder of 2006 and into 2007, and allow the market to fairly capitalize these earnings via a much higher share price.
BSML 1-yr chart:
I, Yehuda Fruchter, own shares in the stock mentioned in this report. I first alerted subscribers to BriteSmile at an average share price of $1.75, as detailed in this post. In addition, this report includes market analysis. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets or in any particular stock. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. Yehuda Fruchter maintains no legal responsibility to update this report or his holdings in the stock mentioned in this report.