American Shared Hospital Services - A Latent Bargain

| About: American Shared (AMS)
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Today Wealth-Ed features a provocative investment thesis, American Shared Hospital Services (NYSEMKT:AMS) as a cash machine: you get paid to own it. AMS has a relatively simple business model, leasing high cost equipment, in a very well defined niche: oncological radiation therapy systems.

AMS seeks to enter long-term (normally 10 year contracted) revenue-sharing or fee-based partnerships with hospitals and clinics and capitalizes the cost of the therapy equipment in partnership with the hospital. The hospital provides the facilities and the patients; AMS provides the equipment, financing, service and support.

The reason a hospital or clinic enters into agreements with companies like AMS, is that as with any business leasing agreement, capital requirements and associated operational risk are outsourced to a third party (AMS). This allows the hospital to allocate its capital resources to other more critical uses.

AMS has a non-exclusive distribution relationship with Swedish firm, Elekta. Elekta builds gamma radiation (higher energy than X-ray) therapy systems for eradicating cancerous tumors. It calls its system, the Leksell Gamma Knife and its newest version the Perfexion. Gamma ray machines have the benefit of providing very high energy to a very localized area in the patient. For this reason, gamma ray systems are used to “non-invasively" treat cancers in hard-to-reach areas such as the brain, spinal cord and eyes. No surgery is required, which lessens the chance of damaging healthy areas of the nervous system. The treatment is cost-effective because it can be done on an out-patient basis. This also promises to protect such treatment regimens from government and healthcare management cost cutting campaigns.

AMS has offered or developed additional and complementary technologies for radiation treatment centers. The “Image Guided Radiation Therapy“, IGRT as it is known, is a patient imaging system that allows a physician to locate the area for treatment in real-time (once each day). If the tumor moves or changes shape, the program that directs the radiation beams is adjusted, on-the-fly. This further improves efficacy by allowing higher doses focused exclusively on the area of treatment. AMS also has developed a turn-key procedure architecture that can be deployed during construction of the treatment facility: its "Operating Room for the 21st Century® " concept . This system includes all the networking, computer stations, software and other furnishings for a state-of-the-art cancer treatment center.

Another important development for AMS in the past few years is its partnership with startup Still River Systems in Cambridge, MA, which I will refer to as SRS (it is not a publically traded company). SRS, a spinoff of MIT research efforts in the area of high energy particle physics, is in the final stages of developing a compact and relatively low cost “Proton Beam Radiation Therapy” system, the "Monarch250". So called PBRTs have been in existence for more than 50 years. They rely on proton energy, rather than gamma ray (photon) energy. Protons have a great deal of mass, where gamma rays have virtually none (depending on your opinion on particle physics and the scientific debate whether or not photons have mass). The mass of a proton, directed at high speed toward the tumor by a particle accelerator, can more effectively destroy a tumor with minimal damage to the surrounding tissue.

Existing PBRTs required very large facilities for the particle accelerator. They were built at a time when electro-magnet technology was much more primitive. A larger number of magnets and longer distances to accelerate the particles were required. Now, with advances in electro magnet design through the use of superconducting materials, much more compact and powerful accelerators can be designed. SRS holds patents on its magnets providing a strong competitive advantage. SRS PBRT facilities can be developed in just a few thousand square feet of space at a treatment center with a single treatment room, where older technology required tens of thousands of square feet of space for the accelerator and multiple treatment rooms (to justify the cost of the accelerator). Old PBRTs cost up to $500M to build and equip where the new SRS design may only cost $50M to fully develop and staff.

AMS has worked with SRS to commercialize its technology. In so doing, it has committed to purchase three systems and has already contracted to place one of those systems at Barnes Jewish Hospital in St. Louis, followed by the second installation at Woods Johnson University Hospital in New Jersey.

In return for its commitments and progress payments, AMS was given the opportunity to invest in SRS and has done so, buying 4.9% of outstanding shares for $2.6M, in 2006. SRS, in March, received additional funding from venture capitalists, to pay for the cost of building its first run of equipment. FDA approval for the SRS PBRT is expected late this year, or early in 2010, at which time commercial treatments can begin.

Further diversifying itself, AMS has also entered into a relationship with Varian Medical Systems (NYSE:VAR), a global leader in radiation therapy for oncology. VMS has its own line of gamma radiation and the larger, costlier PBRT systems.

Together, AMS and Varian will build a stand-alone treatment center in the Bay Area. This opens another development avenue for AMS so that it does not have to rely on hospitals and clinics for development partnerships.

From a financial standpoint, AMS is a latent bargain. I say latent, because companies this small can stay under the radar of large institutional investors for many years. This is not a short term investment, but one to tuck away in a portfolio and add to as opportunities present themselves. As of today, AMS has cash and equivalents on its balance sheet of $10M. But, with 4.7M shares outstanding, and a current stock market price of $2, the market cap for AMS is only $9.4M as of April 17, 2009. This means AMS is selling for less than its cash on hand and with no apparent value given to its net assets (including the 4.9% stake in SRS) or its ongoing cash generating capabilities.

View the full AMS chart from Wikinvest.

AMS, as I said at the beginning, is a cash machine. It generates around $2.25M in operating cash flow (EBIT) every quarter. Some of that cash is reinvested in new equipment leases, some is used to pay interest on financing for existing machines (about 25%) and a smaller amount goes to income taxes. But since suspension of its dividend in 2007 (to raise funds for more partnerships and technology investments), AMS regularly grows its cash surplus by about 30-50% of its operating cash flow each year. In the future, this cash hoard will allow it to enter lease agreements on additional SRS PBRT systems, which require a much greater cash commitment than the Leksell Gamma Knife, which sells for less than $5M each installed, about 1/10th of a new PBRT. Neither is AMS required to front cash for progress payments on Gamma Knives as it is for the SRS PBRT. With excess cash, AMS will also be able to continue to invest in partnerships like the new Varian Medical relationship.

The cash machine aspect of AMS, its high tech status in the flourishing sector of medical care, and its super low stock price, is interesting enough to get me to invest (and did, as I first invested in 2007 before all of the recent developments). But equally of interest are future prospects. AMS has been revenue neutral for some time as it stuck with its gamma knife financing business model and the limited prospects of expansion due to a fixed market and the non-exclusive nature of its distribution deal with Elekta. Until recently, most of excess cash was distributed to stockholders as a dividend. But that model is now changing and AMS shows it is expanding its range. The semi-exclusive distribution deal with SRS is very interesting, but so too is this new arrangement with industry leader Varian Medical.

Where will all this lead? There is no indication from executive management the long term vision of AMS, but we can speculate based on its moves the past two years that the current financial base and its evident expansion strategy might allow AMS to grow to $100M revenue from the current $20M. As the revenue grows and the higher media profile relationships with SRS and Varian become publically known, the cash flow to price multiple could expand from its current 1:1 ratio, to maybe 10:1, still a conservative operating cash flow multiple for a company with long term contractual commitments in the health care sector and owning a stake in proprietary technologies (SRS). Put a 10 multiple on future operating cash flow (EBIT) that quintuples in the next 10 years to $10 / share annually, and a stock price of $100 is not impossible, as compared to today’s $2.

For your reading pleasure, here is the recently filed 2008 SEC 10-K for AMS. The Annual Meeting is in early May and can be joined by teleconference; go to the website to register.

Disclosure: No Positions