Why Conceptus Could Be A Value Trap

Feb.15.12 | About: Conceptus, Inc. (CPTS)

At the time of writing, Conceptus (NASDAQ:CPTS) appears to be one of the cheapest medical device stocks out there, trading at at 5x p/e on 2010 earnings. However, these earnings are substantially boosted by provisions and, as such, aren't reflective of the true cash generative ability of the company. In addition, despite a recent favorable legal outcome, Conceptus is still facing slow growth in its core markets, and the recent replacement of the CEO and downward revision of guidance in December 2011 do not inspire confidence.

Earnings not reflective of cash
In 2010, CPTS reported net income of $82M, but a deferred tax provision was 82% of this total. This deferred tax item was non-cash. If it is backed out earnings, the effective p/e ratio is 40x, and not 5x.

Looking forward to 2011 results
CPTS will report earnings later this month, and the $19M positive legal settlement should substantially help earnings, and OB/GYN visits are increasing. Nonetheless, guidance was for -$1M of net income and $21M of EBITDA, but this guidance has been reduced by the incoming CEO. This represents a significant decline, even from the underlying 2010 net income.

Cash on the balance sheet representing 25% of market cap
CPTS does have a strong cash position, as of Q3, cash and short term investments represented $100M against a current market cap of $400M.

Market conditions improving
CPTS offers a product that basically prevents women from getting pregnant, and is non-surgical. This is not always a critical procedure, and OB/GYN procedures are improving. Broadly speaking, moving from quarterly volume of ~20 million, to a higher level of ~25 million, would boost earnings 25%.

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Legal settlement favorable
CPTS recently received a favorable legal judgment against Hologic (NASDAQ:HOLX), resulting in compensation to CPTS of $19M. This blunts a competitive threat to CPTS in their core market, where competitive products were achieving ~15% share (of the US hystereoscopic sterilization market). However, the court verdict only provided compensation for infringement and has not blocked those products entirely.

A rosy scenario for CPTS
Assuming we see a 25% uplift in volumes, and CPTS gains back share from HOLX, which could be another 18% on volume. The ~$120M of sales this year implies a maximum +$55M sales uplift. The 82% gross margin and a 25% tax rate could be $34M in incremental net income. Given the company is likely to lose $1M this year, that would be $33M in net income, in the best case. We should be clear that is the most positive outcome for the business, both in terms of regaining share, market growth and all the incremental gross margin benefit falling to the bottom line.

Valuation scenarios
With $408M in market cap, if we back out $100M in cash/securities and add the $19M from the legal settlement, we have a resulting market cap of $289M. Net income this year should be roughly -$1M, and in the best case scenario, earnings would be $33M, though that assumes substantial execution risk. Averaging the current and best case outcomes, we have net income of $16M, which would put the stock at 18x earnings. Overall, CPTS is not as cheap as it seems, and the 2011 results could be a shock.

CPTS is not as cheap as it appears, and even on optimistic assumptions, it is hard to see value in the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.