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The first installment of this five part analysis covered Syneron Medical (NASDAQ:ELOS). Part II covered Candela Corp. (CLZR). Part III was all about Cutera, Inc. (NASDAQ:CUTR). In this, the fourth installment, I cover Laserscope (LSCP).

First, here's a quick synopsis of the series in its entirety:

1) Syneron Medical (ELOS) – designs, develops and markets aesthetic medical products currently relying heavily on FotoFacial RF skin treatment and developing a dental laser line of products.

2) Candela Corp. (CLZR) – designs, develops and manufactures aesthetic laser systems currently replacing the VBeam system with the more advanced Pulsed Dye Laser (PDL) Platform.

3) Cutera (CUTR) - designs, develops and manufactures aesthetic laser systems and other light-based equipment.

4) Laserscope (LSCP) – designs, develops and manufactures surgical and aesthetic laser systems and related surgical equipment.

5) Palomar Medical Technologies (NASDAQ:PMTI) – researches and develops laser systems primarily for hair removal and to a lesser extent other cosmetic applications.

Our (CrossProfit) outlook on the medical equipment sector is for the most part neutral with the notable exception being the cosmetic surgery stocks. Contrary to the over supply situation that prevails in the cardiology, orthopedics and drug-eluting coronary stents categories, robust demand for cosmetic surgery – primarily facial aesthetics and breast enhancement – should yield excellent returns well into 2007.

And now for the feature presentation...

Laserscope (LSCP) is no longer listed. American Medical Systems Holding Inc. (AMDD) completed its acquisition of Laserscope on July 19, 2006. The reason that American Medical found Laserscope to be so attractive and was willing to shell out $31 cash per share is what this entire series of articles is all about. There are two distinctively separate markets; aesthetic lasers and medical lasers. A smart company knows its marketplace.

Laserscope initially wanted to be a player in both the medical and aesthetic markets. Already back in December 2000, Laserscope had taken a strategic decision that it would concentrate on the medical laser market and that aesthetics would be secondary revenue filler. Hindsight shows us that this was the true nature behind signing an exclusive distributorship agreement with McKessonHBOC Medical Group (NYSE:MCK) for the aesthetics division while retaining medical laser sales within the company.

In a BusinessWeek article from 2005, there is no mention of the aesthetic line! In fact the article reads like a smorgasbord teaser inviting a company like American Medical to taste and devour. Note the “razor/razor blade” analogy:

“Laserscope's solution lit up a sorely underserved market. The standard treatment for enlarged prostates has been surgery that can cause dangerous bleeding and loss of sexual function. The operation is so dreaded that urologists jokingly refer to it as the Roto-Rooter. Now many of them are using Laserscope's device instead. It fires a green laser directly at the blood vessels in the enlarged prostate gland, which vaporizes the abnormal tissue, causing few side effects. "It's like a blowtorch on a snow bank," Reuter explains. Laserscope earns about $600 per procedure by selling a disposable fiber-optic catheter that must be replaced each time the GreenLight machine is used -- a classic razor/razor-blade business model. In the three years since it introduced GreenLight, Laserscope has seen its sales jump an average 38% a year. Profits in the first quarter of this year rose 124%, to $5 million, on sales of $28.2 million.”

American Medical Systems (AMDD) has no interest in aesthetic lasers. Its sole interest is in medical lasers. AMDD obtains 60% of its revenue from surgical implants. AMDD stated that it was likely to divest the aesthetic segment of Laserscope’s business which accounted for 30% of revenue in 2005. The crown jewel is Laserscope’s 70% revenue in medical laser equipment used to remove non cancerous prostate growth.

In May 2006 AMDD acquired Solarant. Solarant develops minimally invasive therapies for women who suffer from stress urinary incontinence. Once again American Medical has demonstrated its long term strategy. AMDD is on a buying spree to expand its primary - medical business.

AMDD was more specific about its intentions for the aesthetic business. Commenting on the recent purchase of Laserscope it stated “It will account for that segment as discontinued operations”, a dead giveaway, pun intended.

Aesthetics or Medical Surgery, which is more profitable?

Laserscope's business comprises products for both urology and aesthetic specialties. The company reported in its most recent 10-K that it expects faster revenue growth from urological sales in 2006, the company is especially strong in that area and aesthetic lasers have relatively low barriers of entry and stiff competition.

An entirely opposite statement was released by Mentor (MNT) rationalizing the sale of its urology business to focus on its higher-margin aesthetics products. To make matters worse the industry and analysts combine the two segments together as one (Motley Fool & Medical Laser Report).

A quick look at the industry report (April 2006) reveals that the faster growing segment is aesthetics. So which one is it? The answer is revealed in a recent article by Carl Howe at Seeking Alpha addressing similar traits shared by IBM in the 80’s and Microsoft today. Huh?

Carl wrote:

The IBM PC was the fastest-selling product IBM ever had, and it was the gold standard for desktop machines. But even so, MIS departments (Management Information Systems organizations, what IT was called in those days) still called PCs "toys" and snidely thought that they would never be able to handle "real" work like their IBM mainframes and minicomputers.

To which Blu vg wrote in this comment:

Where is IBM today, anyhow? They are still huge and very relevant. However, the desktop market is a commodity market, and IBM is simply not good at that; they aren't even willing to play that game. It's not that IBM lost the PC business. They tried to turn it into something it's not, and when they realized that, they gave up.

The same applies to the laser market.

Medical lasers are the mainframes. Their market is hospitals and medical clinics. There is tremendous potential for these products as the technology improves. Just like IBM viewed computers as a professional product to be used by professionals only, so do the medical laser manufacturers.

The aesthetic laser manufacturers are the PC industry in its infancy. They are still trying to put their PCs – lasers – into clinics. Once they reach economy of scale and are able to turn the aesthetic laser into a commodity for every home, it’s a whole different ball game. Hence, the title of this series “No Place Like Home.” For American Medical Systems, the mainframe is more profitable. For Mentor, Syneron, Candela and Cutera, the PC is the future.

One last thought, if the aesthetic industry can come up with an acceptable razor/razor blade scheme, then you have your new ten bagger stock.

LSCP 1-yr chart:

LSCP 1-yr chart

Notice: This article is the consensus of the CrossProfit - IL analysis team. Proprietary analysis published with permission of CrossProfit.com.

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

Authors note: Part V of this series is temporarily postponed until certain information pertaining to Palomar is confirmed/refuted.

Source: 'No Place Like Home' in Biotech Stocks, Part IV: Laserscope