Syneron Medical: Update and Corrections To This Promising Story (ELOS)

After submitting the Seeking Alpha article Syneron Medical: Falling Revenue Should Only Be Temporary, I had an interesting telephone conversation with Judith Kleinman, VP Investors Relations at Syneron (ELOS). As that Syneron gives top line guidance and just recently started giving bottom line guidance, Kleinman was impressed with our (CrossProfit) analysis pegging 2006 EPS at $1.89. “Definitely in the ball park” was the response. The rest of the conversation was about the current stock price, Q3 2005 sales and earnings highs, Q4 2005 analysts’ speculation, Europe Asia & China and insider selling.

With YOY EPS growth exceeding 25% a forward PE of 14 is cheap. No let’s correct that, it’s an outright give away. In my previous article I mentioned that ELOS is trading at 14 x trailing PE, not forward PE. Taking the worst case ball park scenario, 2006 EPS coming in at 1.85 would indicate a $25.90 valuation. The stock is currently at $20. Compounding this undervalue phenomena is that the competition is priced at 20 x forward EPS and above.

Mindboggling is that some competitors are showing a lower growth rate for both top (revenue) and bottom [EPS]! The industry as a whole is experiencing tremendous growth and the consensus outlook is that this trend should continue regardless of U.S. economic activity.

Though Syneron doesn’t officially comment on its stock price, I got the distinct feeling that the stock is terribly undervalued. This was our own conclusion based on our proprietary fundamental analysis prior to this call.

A self correction is in the cards once the Q2 2006 figures are published in August. Kleinman was careful not to disclose figures.

Corrections

According to Kleinman, Q3 2005 sales and earnings spikes were misread by the market. At the end of Q2 2005 Syneron received FDA approval for its VelaSmooth medical device, designed to temporarily reduce the appearance of cellulite. Q3 2005 spiked due to the backlog of orders awaiting the FDA action. The market missed out on the significance of the timing of this (sixth) addition to the product line. Analysts started upgrading their sales and EPS estimates contrary to the company’s official guidance.

One might temporarily excuse the analyst blight as Q3 is usually the weakest quarter while Syneron reported a performance light years ahead of its best quarter.

I surmise that when Q4 figures were in line with guidance, instead of punishing themselves, analysts deserted the stock. Well, not exactly. The drop to the 30/33 range was justified because the 40 range was largely due to the frenzy created by analysts. Without mentioning names, some analysts hyping the stock didn’t and do not officially cover the stock! (There are 9 certified analysts covering Syneron.) The drop from 30 to 20 could be these same pundits trying to recoup losses generated by their own sins by shorting the stock. Who knows, but if that’s the case they deserve to get burned twice. I should have titled this article ‘Sins and Virtues of Laser Blinded Self Guidance’.

Upon discussing China, Kleinman was not in her office and could not confirm any trends regarding Asia or China in particular. Reading in between the lines, I conclude that our source regarding China (“We expect to see positive results from the Chinese market already in Q3”) may be more speculation than reality. Kleinman’s tone on Europe was very upbeat. I have made a note of this and I am looking forward to dissecting Q2 results.

Kleinman also mentioned that R&D is projected at 7% for 2006 – interesting! We think it might come in a tad above. Still the numbers are good.

Update

We both agreed that Syneron has to do a better PR job on the insider selling issue. As a general rule young companies tend to compensate their senior executives with a combination of (lower) salary and stock. The insider sales have been primarily compensation oriented.

Syneron being a three year old filly is no different. Updated insider selling statistics is a complicated topic that requires further research and a separate article comparing Candela, Cutera, Palomar and Syneron.

Disclosure: Author is long shares of ELOS as of 7/13/06.

Comments

[Retail Inve...:]

Saul, welcome aboard onto the ELOS bandwagon. Was feeling rather lonely until June being the only one with financial blogs on ELOS - there are plenty of medical blogs on the same. AverageJoe and GroovyStocks posted in June and then you did too - encouraged :-) See that you finally picked up some shares of ELOS today. I continue to be very long on ELOS and may post by 3rd blog on ELOS later this month. Judith is defly. very pleasant to talk to, though I agree that both their IR and PR department needs an uplift. Watching this stock like a hawk :-) Regards, Subbu

2006 Jul 13 12:31 PM

[Saul Sterman:]

Just read your posts on Retail Investor & SeekingAlpha. You may be blessed with too much foresight, that is to say your right but way ahead of time.

What puzzles me is that you mentioned in one of your blogs that Syneron needs to come out with smack on earnings or better in order to regain the Street’s confidence. I agree – so why didn’t you wait until it was obvious that they would hit Q2 expectations? The report is due out in the beginning of August and the Street usually gets around to noticing these things two weeks beforehand. Timing is important. I bought today simply because next week might be a bit into the upswing.

If you would be kind enough to compile a list of the Medical Blogs mentioned in your comment and post them either in a nested comment here or on your site, it would be much appreciated. Kindly, Saul

2006 Jul 13 01:31 PM

[Retail Inve...:]

I initiated a position and build one long before the downturn in ELOS and so the question of waiting until Q2 did not exist. I do have a full position now and so am not adding any more. If I were buying only recently, then I would try and time like yourself, but my positions were build a while ago.

Any comments on the recent Isreali war situation and its impact on ELOS?

When I get some time, I will try to compile a list of the medical blogs, but a simple approach would be the obvious - a Google Blog Search on ELOS - blogsearch.google.com

Best! Subbu

2006 Jul 13 04:31 PM

[Retail Inve...:]

ok, you know I meant "built" :-)

2006 Jul 13 04:32 PM

[Saul Sterman:]

Retail Investor-

The tense situation in Israel has no effect on ELOS. Manufacturing is done globally. Supply lines are secure.

In the odd chance of an all out ground offensive into Lebanon, the IDF would call up only a small portion of the reserves. A few younger scientists in R&D might miss a month or two at work but that would be the extent of a worst case scenario. General Management is accustomed to doubling up whenever an employee goes off to do their annual reserve duty. A war situation is no different.

Currently action is limited to sending a clear message that Israel will not tolerate the abduction of civilians or soldiers from its sovereignty. Neither would anyone else tolerate such madness.

It is a shame that the language that is most understood in the Middle East is not English, Hebrew or Arabic. Firepower is.

2006 Jul 13 05:26 PM

[Retail Inve...:]

Saul, I do not believe you are right in your statement on "manufacturing is done globally" though I am not as sure any more after reading your confident statement. Per what I know, all 3 manufacturing plants of Syneron are in Isreal. And so if a political unrest results in everyone being called to duty, then the operations will be affected. Yeah, very rare possibility but it exists. Where are you getting your data that manufacturing is done globally from? Regards, Subbu

2006 Jul 13 05:47 PM

[Faisal Laljee:]

I do believe this conflict and rising tensions will affect Syneron. At the very minimum, market perception of this potential affect will keep the stock low unless they really blow away earnings.

-- Faisal Laljee

2006 Jul 14 03:12 AM

[Saul Sterman:]

Retail Investor-

I see you have done your homework! I didn’t want to get into the knotty details but after your last comment it would be a disservice to SA readers not to explain.

At CrossProfit when compiling data on nearly 1000 U.S. listed companies we analyze their BCP – Business Continuity Program. Truth be told, with most Israeli companies we don’t bother.

Willy-nilly most Israeli companies had a BCP in place long before 9/11. Syneron is no exception. Syneron subcontracts all manufacturing. This is one of its strengths on an ongoing basis and provides the basic structure of its BCP.

The way Syneron has structured its BCP is typical Israeli style i.e. a three prong approach.

1) Primary protocol: Manufacturing is outsourced to three Israeli companies.

2) Secondary protocol: The three sites are located in three different geographical locations within Israel. Any two out of the three have the ability to manufacture the complete product line. Syneron will confirm this.

3) Backup protocol: Syneron maintains all production files at a location other than the three Primary sites. At the drop of a hat production can be transferred to several other predetermined locations/subcontracto... (in or) out of Israel. Syneron will confirm the existence of the production files but will not disclose details of its backup protocol.

In the case of a general call up of all reserves (unlikely) Syneron could activate its Secondary protocol and combine manufacturing to two sites. There are other options as well.

In the case of: nuclear (Iran?)/chemical (Syria)/biological (?) attack (not on the table now) Syneron could turnkey its Backup protocol.

Sorry for the doomsday prognosis but you did want to know if there was any added risk due to the Middle East situation. The answer is none.

Very few Fortune 500 companies have this type of a global production capability. The Primary/Secondary/Back... structure is the best known/cost effective BCP method available. The backup protocol is confidential. Hence, we do not know where the production lines would popup should the occasion arise.

It is beyond the scope of this comment to go into the numerous BCP categories and how different sectors/companies test and update their protocols.

I should have said ‘can be done globally’ and not ‘done globally’. Thank you for noticing.

2006 Jul 14 06:16 AM

[Retail Inve...:]

Thanks for the detailed response - though I am the biggest bull for ELOS (I am going to claim bigger than CrossProfit and CGI - the two other major "retail" bulls), I do want to recognize the negatives and I am glad that you have thrown enough cold water on one. What are your comments on the major risk of ELOS... the effect of discretionary spending in a recession.

ELOS targets baby boomer vanity and folks may not be spending on discretionary items like cellulose when they are facing a recession. I believe this is a fundamental risk of investing in Syneron Medical. So what is your response to the argument that this is a "good economy" stock, the market conditions may not always be favorable for ELOS and we need for that to be good and hope baby boomers will live up to the vanity we expect them to demonstrate.

Also, have you done any research in terms of talking to individual doctors for their opinions on how much demand they are seeing for cellulose and if the stories of "doctors prefer to do these procedures thanks to the higher margin and lack of insurance hassles" - given these procedures are paid for directly by patients and insurance companies do not cover such pure cosmetic procedures?

2006 Jul 14 08:07 AM

[Saul Sterman:]

Retail Investor-

I must confess that when writing this article I had no idea that there was such interest in Syneron. E-mails received for the most part are about all three issues being raised by Retail Investor – Subbu. I have written beforehand but have never received e-mails! I hope to answer all by the end of this weekend. (Please use faq-at-crossprofit.com and not the other e-mail addresses on the site.)

The vast majority queried the security issue which I have addressed.

Subbu raises two additional distinctively separate issues. The first pertains to demand from the consumer (in your terminology ‘retail’). The second deals with point of sale (‘wholesale’?).

As a side note I take issue with the notion that ‘baby boomer vanity’ is the prime market for Syneron’s products. I also do not care much for the phrase itself. We are all vain, baby boomer or not. Do you not shave in the morning? Do you not enjoy putting on a nice clean pressed shirt? Do you not fix your hair or look in the mirror?

For now I will say that there are several categories of discretionary spending. If I can not find a site/article that explains this I will try to find the time to write a comprehensive article covering discretionary spending. Keep in mind that during the great depression beauty salons did very well while the haberdasheries were closing one after another. There is a reason for this…too long for a comment, will have to wait for site/article.

Point of sale is short and sweet. Money is money in all cultures and throughout the history of mankind. Yes, if a Doctor can pick up an extra buck especially in a respectable professional manner you better believe that he/she will do so. Why not?

2006 Jul 14 12:05 PM

[Retail Inve...:]

Haha.. Actually, it is really not "such interest" - it is all just me - RetailInvestor/Subbu S - fellow blogger whose posts are syndicated at SeekingAlpha and MustFeed

In terms of the brief responses here, I think the prime market is indeed baby boomer vanity, I do not see anything wrong in someone going after that as a target market.

In terms of the doctors, there is a huge difference between "why not" and "are they"?!

Looks like ELOS is taking another beating today thanks to the Isreali tension. Here's to hoping that you and I are right and this is an overreaction and this one will bounce back!

2006 Jul 14 12:29 PM