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Synopsis

Cynosure (NASDAQ:CYNO) has seen its stock price double since its launch of Cellulaze in February. But that's not the end - Cellulaze is just the beginning of the story.

Cellulite, it's a word that makes most women cringe. More than 80% of women have it and for decades they have been throwing money at everything from creams to ridiculous vibrating machines promising to treat it. The treatments didn't work or didn't last, leaving women feeling frustrated and self-conscious. Cynosure has provided women with a rare beacon of hope. In January the FDA approved its Cellulaze. The one-time procedure targets cellulite from under the skin and reveals smoothing results within six months. Eight months into its introduction the 57 trial members and now scores more have found a reduction in the appearance of cellulite. Those results are translating into huge revenue gains by Cynosure. Domestic laser revenue has increased 92% compared to the same time last year.

Cynosure's annual revenues grew 50% to $39.6 million. This marks the company's highest sales quarter in history. Also, its third straight quarter of GAAP profitability with an EPS of $.28. Cynosure has been developing and manufacturing light-based aesthetic and medical treatment devices for over twenty years. CYNO's applications include cellulite reduction, hair removal, anti-aging, vascular lesions, pigmentation, and more in the works.

Lasers make up 83% of total revenue. As I mentioned before U.S. laser revenue increased 92% to $16.4 million and international laser revenue was $16.5 million up 35% since the same period last year. Much of this increase can be attributed to the Cellulaze Cellulite Laser Workstation. The cellulite removal procedure is a three-step process costing patients an average of $2,000-$6,000. In an over simplified explanation, the first step of the process melts the fat under the skin that causes the bulges. The second step uses the laser to sever the connective tissue pulling down the skin. And the final step uses the laser to smooth out the skin.

The Cellulaze laser is sold as both a standalone unit and an upgradable solution for some existing Cynosure customers. New Cellulaze Laser Workstations cost practitioners $150K or for $225K it will include the Triplex Lypo feature. There are 250-300 Cynosure laser units currently being used that can be upgraded to include Cellulaze. These upgrades cost between $75K and $125K depending on the existing equipment. Once the company received the FDA approval it marketed the upgrades to its existing install base. With success, the company has upgraded just about 20% of the existing install base with anticipation of 30% more upgrading.

Service and parts revenue for the company has grown 19% to $6.5M since last Q2. Contributing to this increase is the disposable nature of the Cellulaze parts. The Cellulaze Workstation uses a one-time use fiber as well as a guide that can only be reused four to five times. The fibers are sold in a ten pack for $3,000 and the guides are sold for $1,250 each. This pricing schedule puts the practitioner's cost of a single procedure at $550 creating a significant recurring revenue source for CYNO.

Every year Google Insights shows a spike in the search term "cellulite" in the month of June, which is expected, given the warmer weather. Considering the procedure's six-month reveal time and initial local bruising, demand will come in the winter months. Cellulaze first launched at the beginning of this year and the results are just starting to pour in. Therefore major demand for this procedure has not yet vested.

Given the recent launch of Cellulaze it is hard to fully grasp the demand of this type of procedure. Insights can be drawn from the now 20% adoption rate (expected to reach 50%) of current practitioners. These are people in the field who feel strong enough about the demand that they are willing to spend at least $75,000 on the upgrade. Given the average profit margin on this procedure, they will need to perform 25 procedures each to break even on their investment. Those who are purchasing new units will need to perform twice as many. What does this mean for Cynosure? Using the practitioners ROI information and accepting the 50% adoption rate figure supports 3,425 procedures being performed before the practitioners break even on their investment. Using the cost per procedure of $550, Cynosure is set to rake in $1.8 million in parts revenue before practitioners start drawing a profit. Again, this confirms the significant recurring revenue source for CYNO.

Future Growth

I had mentioned that Cellulaze was just the beginning of the story. Cynosure is always on the lookout for opportunities to grow the business both organically and non-organically. On July 5, CYNO received 510(k) clearance from the U.S. Food and Drug Administration (FDA) to market a home-use over-the-counter device for the treatment of facial wrinkles. CYNO still has not registered the product with the FDA but it is expected to launch commercially by 2013. In partnership with Unilever (NYSE:UL), Cynosure is capitalizing on UL's expertise in distribution and marketing denoted by such major brands as Dove, VO5, Bertolli, TRESemmé, and Vaseline. The home skin care market is expected to grow at a compounded rate of 12.5% per year until 2016. This provides ample room for growth. Cynosure CEO Michael Davin put it this way: "Its world-class distribution, marketing and branding capabilities for home skin care products are second to none. With its global footprint, Unilever has the scale to successfully launch and distribute light-based products into the consumer market." Beyond wrinkle reduction, Cynosure is also expecting to launch the PicoSure (Picosecond Alexandrite Laser) in 2013. This laser will be exclusively used for tattoo removal.

CYNO has $80 million in cash and very little long-term debt. This is a good launching pad for non-organic growth. Not shy on acquisitions, Cynosure acquired ConBio in June expanding its already broad product portfolio. ConBio's PhotoAcoustic energy technology uses high-speed energy waves to penetrate the skin in nanoseconds, which minimizes the amount of heat in each procedure. Looking forward, Cynosure CEO Michael Davin explained that, "not needing that cash to drive P&L, we're certainly both encouraged by our board and also by our executive team to look at non-organic activities, which we are active, absolutely active, in looking at additional opportunities for Cynosure to invest."

Valuation

Using the current stock price of $28 and second quarter EPS of $.28 CYNO has a P/E multiple of 99. I would normally run from any such P/E. However, twelve month projected quarterly revenue of $60M and EPS of $1.06 brings the P/E multiple down to a more reasonable 26. So I'll continue...

Looking forward twelve months and excluding Cynosure's 2013 commercial product launches, current business will bring in $207 million. Adjusted net tangible assets (NTA) are $124M. Calculating back in a successful 2013 Unilever product launch and a moderate demand for Cellulaze would warrant a 2x multiple on forward twelve month revenue. This would yield an enterprise value of $538M or $39.60 per share.

With a current share price hovering around $28 there is a good deal of upside to owning CYNO shares. From a risk reward standpoint, it is important to consider a liquidation price. A break-up value on Cynosure is $9.14 given a NTA of $124M.

Conclusion

Cynosure is on the cutting edge of laser skin care treatment. As the technology changes the company has positioned itself to take full advantage of the growing demand for both at-home and in-office procedures. It does this not by just selling machines, but creating a recurring revenue source as well. Even though CYNO is approaching its 52-week high, there is still a good buying opportunity ahead of new product ramp-up and the full realization of Cellulaze demand.

Source: Cynosure: Pioneering Aesthetic Laser Applications