Whenever an article is published about Sunshine Heart (SSH), the comments include questions on what the share price might be, in both the short term and longer term. That is an almost impossible question to answer in any meaningful and useful way. In any case, in respect of Sunshine Heart, it is the wrong question to ask.
The right questions are:
- How much am I prepared to lose, and how much can I afford to lose in an investment in Sunshine Heart? and
- What level of possible reward would entice me to make an investment in Sunshine Heart, knowing there is always a possibility of losing all of one's investment, in an early stage micro-cap company?
The likely answer to that question is, "Tell me what the possible rewards are, and I will tell you how much I am prepared to invest." And, I will respond to that in my concluding remarks.
An example scenario, described below, suggests that if one is prepared to wait, say 10 or more years, the return from an investment in Sunshine Heart could be some hundreds of times the initial investment. There could also be ample opportunities to exit in the medium-term, and to still achieve ten or more times the initial investment.
A scenario, from my most recent article (Sunshine Heart: Risk & Reward) looked at the potential Revenue and Operating profits of Sunshine Heart if it were able to achieve market penetration of 6% of its target market, at some future time. Those calculations suggested, at 6% market penetration, Sunshine Heart profitability would be close to matching Medtronic's 2012 results.
The scenario below assumes Sunshine Heart achieves 6% market share in 2027 (15 years from end of 2012).
Based on Medtronic's (MDT) current market cap of $45 billion, as a proxy, a market cap of $40 billion is assumed for Sunshine Heart at end of 2027. It is further assumed, to achieve 6% market penetration, Sunshine Heart will need to raise $3 billion in additional equity capital, and re-invest any and all operating cash flows, through 2027.
Before going further with that scenario, it is useful to have a discussion about the current and historical prices of Sunshine Heart shares, as determined by "Mr. Market." Over the last twelve months, the share price has ranged, on Nasdaq, between $2.50 and $22.90, and on ASX, between $4.00 and $11.60.
"Mr. Market," in the case of a micro-cap like Sunshine Heart, is obviously subject to extreme, and totally unpredictable, emotional highs and lows. That makes it near to impossible to predict what "Mr. Market" might do with the share price.
But, going forward, the assumption of a market cap of $40 billion in 15 years can be used as a benchmark outcome possibility, to determine the implied, risk adjusted, discount rate, arising from the price Mr. Market is currently placing on Sunshine Heart shares. Sunshine Heart currently has ~9.510 million shares on issue, and at ~$6.00 per share a market cap of ~ $57 million.
Using an exit, at $40 billion market cap in 15 years time, the present market cap suggests an implied discount rate of ~54.8% per year. (40bn/(1+.548)^15) equals ~$57 million. Table 1 below, calculates what the current share price might be, at varying assumed discount rates, assuming an exit at $40 billion in 15 years:
The current implied discount rate of 54.8% is calculated by working backwards, from the assumed exit value of $40 billion, to the current actual market cap of ~$57 million (the implied discount rate inherently allows for all risks going forward, including dilution from future equity capital raisings).
Adoption of higher or lower discount rates is a reflection of the degree of actual/perceived risk in the investment. Potential investors will likely have a range of views on the degree of risk involved in any investment. That can cause large disparities in the price various investors are prepared to pay for shares in an early stage, and perceived high risk company, like Sunshine Heart.
In Table 1 above, a divergence of just 5 percentage points up or down, from the implied ~55% discount rate, results in either a decrease or an increase in the share price of over 60% (a divergence of 10 percentage points can cause swings almost 200% either way).
Time and Risk
The formula for calculation of the present value of an investment includes both an element for "time to realization" (a dollar tomorrow is worth less than a dollar today) and an element for "other risks and factors" (a bird in the hand is worth two in the bush).
So, in a year from now, assuming there was no change in "other risks," and the discount rate was unchanged from 54.8%, the market cap would be expected to increase by 54.8%, from ~$57M to ~$88M, calculated as follows - (40bn/(1+.548)^14) equals ~$88M. But there will always be actual or perceived changes in "other risks and factors" and potentially new risks identified going forward.
In a year from now, good confirming results from the Pivotal Trial could result in a perceived lessening of risk for Sunshine Heart and thus a lower implied discount rate of say 50%. Market cap would be expected to increase to ~$137M, 2.4 times the current market cap. That's market cap and not the share price, which would have a lower increase if there have been any dilutive equity capital raisings.
A scenario of a high initial discount rate and diminishing risk as time to exit elapses is the investor's friend and ally. It can result in huge increases in market cap and share price as shown in Table 2 below:
Table 2 - Projected Share Prices by Year to 2027
It can be seen from Table 2 that Sunshine Heart share price is projected to increase by over ten (10) times in the 4 years to 2016 and by over one hundred (100) times in the ten years to 2022.
Table 2 above allows for the dilutive effect of raising total additional equity capital of $3 billion (per Table 3 below). The scenario target, of 6% market share by 2027, will obviously entail the ramping up of production, sales and marketing, and take Sunshine Heart from small start-up to a large cap company addressing markets around the world. A scenario assumption is the $3 billion in capital raised plus indicative operating income, per Table 4 below, will be sufficient to execute such plans and also cover capital equipment costs and working capital increases. It should be understood that these assumptions related to capital needs are purely arbitrary estimates for the purpose of making some allowance for the dilutive effect of additional equity capital on share price.
Table 3 - Projected Capital Requirements by Year to 2027
Note - Other than fixed price warrants, capital raised per Table 3 is assumed to be at a share price equal to the average of projected beginning and end of year share price.
Table 4 - Selected Projected Earnings Before Tax 2020 to 2027
Table 4 above is a pro-forma financial statement depicting arbitrary estimates of what sales and operating income C-pulse systems might generate at various levels of penetration of the U.S. and EU Congestive Heart Failure (CHF) market addressed by the system.
It should be understood the scenario of share price growth depicted in Table 2 above is merely a quantitative assessment, based in part on some very arbitrary estimates. Notwithstanding that, the key assumptions affecting share price growth in Table 2, can be narrowed down to:
- Market cap, today - ~$57M;
- Market cap, in 2027 - $40 billion (based on 6% target market share);
- Capital Raised - $3 billion; and
- Share prices at which capital is raised.
Accept these as reasonable and the projected share prices in Table 2 should be found to be reasonable.
In addition to the foregoing quantitative assessment, any meaningful analysis of whether a share is a potential "ten bagger," or a "hundred bagger," also requires a qualitative assessment, which is provided below.
Prerequisites For a "Ten Bagger" or a "Hundred Bagger"
1. Size - At a current market cap of $57 million and share price of ~$6, a ten-fold increase in share price (per Table 2), would move Sunshine Heart from micro cap to small cap status. A one hundred fold increase, would still only move it from micro cap to the lower end of the large cap range. Starting off with an insanely low valuation, gives Sunshine Heart plenty of room to grow, so give size a tick.
2. Growth potential - A recent Sunshine Heart corporate presentation, estimates an untapped target market for C-pulse, of 5,200,000 persons with CHF in the USA and EU alone. A less than ten percent share of that market will result in phenomenal growth in revenues and profit. Sunshine Heart could potentially match or exceed Medtronic's 2012 results, so give growth potential a tick.
3. Access to markets - The C-pulse device is already approved for sale in Europe. A 50 person Post Market Trial is being conducted in the EU, to generate data for reimbursement coverage. Expected completion is Q3 2014 (refer above corporate presentation ).
Enrollment, in the current Pivotal Trial in the USA, is expected to be completed by mid 2015. A one year safety follow up is required, so marketing approval in the USA could be as soon as 2017. In the meantime, C-pulse has Investigational Device Exemption in the USA, and trial sites will be reimbursed by CMS and most private insurers (refer above Corporate presentation).
The ability of C-pulse to substantially reduce hospital re-admission rates should result in active promotion from hospitals and health insurers. Give access to markets a tick.
4. Mass Appeal - This is the area where a great deal of time and effort is required for significant market penetration. Key issues:
4.1 Fully Implantable
Fully implantable has already been proven in animal trials. As envisaged in the original design stage, human implantation of a fully implantable system will undoubtedly follow.
All of the additional components such as TET, required for a fully implantable C-pulse system, are existing established technology. So an FDA approved, fully implantable C-pulse system, could be available and in use by 2017 or 2018. Give fully implantable a tick.
4.2 Education of Clinicians, Surgeons and CHF Patients
Thoratec (THOR) is already doing some heavy lifting here, with various trials and awareness campaigns, such as REVIVE-IT and ROADMAP, which target sections of the NYHA Class III CHF population. The REVIVE-IT study is co-sponsored by the National Institutes of Health's National Heart, Lung, and Blood Institute (NHLBI).
There could be no better organization than the NHLBI to have on board, to promote the switch from drugs to mechanical devices, if the trial is successful (NHLBI Mission Statement here). Its promotion would extend to both clinicians and patients and also the wider community.
The education of clinicians that Thoratec [and Heartware (HTWR)] are investing in, will ultimately result in a "paradigm shift" in CHF treatment from failed drug therapy to use of mechanical devices. This will benefit all players in the mechanical heart assist device space, including Sunshine Heart.
Give education, etc. a tick.
4.3 Ramping Up Production, and Marketing and Selling Infrastructure
A Medtronics or a Johnson & Johnson (JNJ), with all their promotion, marketing, and distribution capabilities, coupled with their branding, would be infinitely more capable than Sunshine Heart in achieving high sales growth.
For Sunshine Heart, the task will be immense. For that reason, $3 billion plus has been allowed for financing these tasks
Give ramping up production, marketing, etc. a tick.
From both a quantitative and a qualitative point of view, it would appear that an investment in Sunshine Heart, at this point in its development could quite easily turn into a "Ten Bagger," and a "Hundred Bagger" in the longer term is not beyond the realm of possibility. The main obstacle to that is the distinct likelihood of earlier takeover by Thoratec, Medtronics or Johnson & Johnson .
Now that the potential rewards have been covered, a response is also required to, "Tell me what the possible rewards are, and I will tell you how much I am prepared to invest."
Doug Carey, of Wealthrace, in his excellent article, "How A Company Like Johnson & Johnson Can Rescue Your Retirement," provided an example of a couple investing $400,000 in blue chip stocks with a consistent record of dividend growth. He projected the $400,000 initial investment to grow, over a period of 20 years, to an ending value (in nominal $'s) of $940,703, giving the couple a 70% chance of never running out of money in retirement.
Assume that $5,000 (1.25%) of the $400,000 was taken out and invested in Sunshine Heart. The projected ending value at retirement of the remaining $395,000 would reduce by $11,759 to $928,944 (in nominal $'s). If that $5,000, invested in a high risk, micro cap stock like Sunshine Heart, was completely lost, savings at retirement would be permanently reduced by the $11,759.
But if Sunshine Heart does turn out to be a multi-bagger, as per projections at Table 2 above, the $5,000 could grow to $65,000 after 4 years, or $560,000 after 10 years. Any proceeds from exit could then be invested back into blue chip stocks (might even receive MDT or JNJ scrip in a takeover).
For the couple in the example, chances of running out of money at retirement might be greatly reduced or eliminated, just by diverting a small amount of their investment to Sunshine Heart. That could be a very appealing prospect. Any decision by the couple or anyone else would still be dependent on their view of whether they could afford to lose, or would be prepared to lose, any amount diverted from more secure investments.
Investing in micro cap companies is not suitable for all investors and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risks. Due to illiquidity, share prices can fall despite strong fundamentals and possible inability to raise sufficient additional cash to continue to fund ongoing operations is always a serious concern. Fuller details of risks associated with Sunshine Heart as identified by the company may be found with their form 10-12B/A registration filing with the SEC and their other SEC filings.
Disclosure: I am long SSH.