PhotoMedex (PHMD) presents a timely and compelling short opportunity. The current PHMD is a "cosmeceuticals" company that was created out of a reverse merger with Radiancy, Inc., in December 2011. As a result, the market cap increased from $32 million to its present $260 million. More than 75% of PHMD's pro forma sales and all of its earnings come from a questionable hair removal device known as the "no!no!." The product is sold through late night TV ads and infomercials. The legacy PhotoMedex business is a perennial money loser that enabled Radiancy to gain access to the public markets through the backdoor.
The technology associated with the no!no!, known as Thermicon, literally removes hair by burning it off the skin. Online customer reviews of the product are not good, to say the least. Consumer reviews report burned skin, rashes and even scars from the product. Burns and a low efficacy were even discussed on a Good Morning America review. There are also a number of complaints on the BBB website, formal false advertisement allegations from consumer advocacy groups, and an unresolved lawsuit that has been costing $1 million a quarter to defend. The no!no! is not regulated by the FDA but has attracted their attention in a recent quality violation. Return practices at PHMD have also been criticized. Beyond those cited here, a simple Internet search will generate many examples and reviews.
The ASP for the base no!no! 8800 unit is $260 and according to some users, additional tips costing $39 each may be required every two weeks, so the total cost can exceed $500 for a few months of use. These units generate 80%-plus gross margins. Over 2.5 million have been sold since its launch five years ago, most of which have come from direct-to-consumer marketing efforts over the last two years. Based on the numbers last quarter, it appears as if PHMD has tapped out the direct channel and now needs to spend considerably more ad dollars to generate incremental sales. Total selling expense (half of which is advertising) increased to 51% of sales in Q1 2012 vs. 43% in the same quarter last year. As a result, adjusted EBITDA margins declined from 34% in Q1 2011 to 18% in Q1 2012. PHMD now spends $1 million per week and growing on ads.
PHMD generated pro forma EBITDA of $34 million in 2011 and LTM EBITDA of $32 million (this adds back all merger expenses and stock-based comp, but not $3 million in ongoing litigation expenses). With an EV of $247 million, the implied LTM multiple is 7.7 times. If ad expenses continue to grow at the current rate, consolidated EBITDA would get cut in half in two quarters. Any margin contraction in the no!no! segment is compounded by the ongoing losses from the other areas of the business.
The life cycle of cosmeceutical products like the no!no! are typically short. Examples include IPLs and chemical hair removal products. Management touts the opportunity in new markets and channels, but the no!no! is already sold in 55 countries. Regardless, selling a hair removal product with questionable efficacy to insomniacs is not a sustainable business, particularly at such a high ASP.
Following the merger, the stock ran up on management promotion. Based on the stock's subsequent decline, it appears as if skepticism of the story is growing. Only 3.8% of float is sold short and the current cost of borrow is less than 1%.