Our investment in cord blood banking company, CRYO-CELL International, Inc. (CCEL.ob), now close to a year old, continues to dissappoint us. When a company's share price underperforms our expectations for more than a year, we think it is prudent to try to understand what the market may be telling us about the long-term prospects of a company and the proper valuation for its shares. Our perspective is that the market is very efficient over longer time periods (3 years+), so if an invesment is not showing profits after over a year (we could lengthen this reassesment time, but once a year is probably about right), it is time to reevaluate the position and question our investment assumptions.
So what could be bugging the market about Cryo-Cell (CCEL.ob)? By all accounts the company operates in an attractive growth industry, cord blood banking, and has strong prospects for growth. In addition, the company has a solid balance sheet, a recurring revenue model, is cash flow positive and has little need for capital expenditures in the years to come. What is wrong with the picture?
How Attractive Really is the Cord Blood Banking Business?
In looking for some answers, the obvious first place to look is at the industry as a whole. Perhaps, the cord blood banking business is not as good as it seems.
On that note, in the company's recent 10K we found this relevant quote:
Despite the potential benefits of U-Cord® stem cell preservation, the number of parents of newborns participating in stem cell preservation is still relatively small compared to the number of births (four million per annum) in the United States. Some reasons for this low level of market penetration are the misperception of the high cost of stem cell storage and a general lack of awareness of the benefits of stem cell preservation programs. However, evolving medical technology could significantly increase the utilization of the U-Cord® blood for transplantation and/or other types of treatments.
We would add to the above, that many doctors are still completely skeptical as to the true medical benefits of stem cell preservation.
The bottom-line appears to be that the adoption rate of stem cell preservation has been slow and as such companies in the industry have not been growing as quickly as one would expect given the huge potential market for their products. In addition, the whole business of stem cell preservation is becoming somewhat commodotized, and it is difficult to understand how the various companies will differentiate themselves in order to sustain prices well above costs.
Can one still remain bullish on Cryo-Cell (CCEL.ob) considering seemingly negative current industry conditions? We think the answer is yes. As regards to slow market penetration of stem cell preservation, we think that this will change dramatically in the coming 5 to 10 years. Despite the skepticism of the medical profession, increased marketing on the part of stem cell preservation companies, and continued favorable news regarding stem cell based treatments will convince more and more parents to bank their child's cord blood in the coming decade. In addition, with the passage by the Senate last year of HR 2520, which authorizes $79 million in federal funding for the collection and storage of umbilical cord blood for stem cell research and the treatment of diseases, cord blood banking companies now have a powerful ally in their marketing assault. We would note that Cryo-Cell's largest competitor and closest comp, ViaCell, Inc. (VIAC) is forecasting 20% revenue growth in 2006, implying that industry dynamics remain quite strong.
Of course, the key question really is if cord blood banking will really prove beneficial for people in the longer-term, but we think the obvious reply is: Does it really matter? The US Consumer pays for so many clearly unproven and most likely ineffective health treatments, that it seems inevitable that cord blood banking, which in reality does have alot of real evidence in its favor, will over time be added to the list of required health care expenditures. If everyone you know is banking their child's cord blood, can you as a parent deny your child the potential benefits, to save only $125 per year? We think not.
The commodization of the cord blood banking industry is probably a more serious issue facing companies in the industry including Cryo-Cell. However, this is simply a marketing issue and a good marketing team should be able to devise a strategy so as to differentiate a particular company and retain premium pricing. Cryo-Cell, in particular, seems to be taking the lead in this area. For instance, this year the company is adding a new Plureon Stem Cell preservation program, to complement the U-Cord service. This new Plureon program will clearly differentiate the company and allow for some pricing power long term. It is also instructive to read Cryo-Cell's cord blood comparison chart to see the various marketing lingo available to the company to support premium pricing in the years ahead. The chart can be found by clicking here. Interestingly, Cryo-Cell's prices are still lower than competitors, which implies that the company is not generating as much revenue as it could.
The bottom-line is that the cord blood banking industry is attractive longer-term and there are clearly ample opportunities for Cryo-Cell to compete effectively and grow revenues and profits significantly over the coming years. If industry conditions do not provide us with a reason to consider selling the stock, what else can be wrong here?
Cryo-Cell's Dirty Laundry: Revenue Sharing Agreements
Without delving into Cryo-Cell's storied and corrupt history, since that is already in the past, current investors still need to be aware that past management and the current CEO retain one ludicrous and unethical relic: Revenue Sharing Agreements.
From the company's 10-K:
The Company has entered into Revenue Sharing Agreements (“RSAs