Cynosure: The Stock Is Cheap, The Story Is Compelling

| About: Cynosure, Inc. (CYNO)
This article is now exclusive for PRO subscribers.

The aesthetic devices market is seeing various technological advancements leading to high functionality, lower costs, and ease of operation. The emergence of minimally invasive and non-invasive aesthetic procedures is fueling the growth of this market. Cynosure (NASDAQ:CYNO), a leading player in this market, hasn't seen much activity in its stock in 2013. The stock has traded between a 52-week low of $21.09 and a 52-week high of $30.20. Currently it is trading around $26. The company's EPS is expected to rise more than 50% next year. Its recent acquisition of Palomar Medical Technologies is expected to result in $8 million to $10 million cost synergies in 2014. I feel that the stock is a good bargain at the current level with meaningful upside potential over the medium-term.

The Business

Cynosure sells its aesthetic treatment systems to dermatologists, plastic and cosmetic surgeons, and aestheticians under the Cynosure, Palomar and ConBio brand names. Its products enable medical practitioners to perform non-invasive and minimally invasive procedures to remove hair, treat vascular and benign pigmented lesions, remove multi-colored tattoos, revitalize the skin, liquefy and remove unwanted fat through laser lipolysis, reduce cellulite, and ablate sweat glands.

Cynosure generates revenues primarily from sales of its products and parts and accessories and from services, including product warranty revenues. Its products are sold through the company's direct sales force in the United States, Canada, Mexico, France, Germany, Spain, the United Kingdom, Australia, China, Japan and Korea, and through international distributors in approximately 100 other countries.

Industry Outlook

The aesthetic medicine industry is moving towards completely non-invasive procedures with permanent results. In the future, the growth of this market will be driven by improving treatment results with decreasing side effects. Increasing patent awareness and growing acceptance of cosmetic procedures are also expected to boost growth. Furthermore, high demand from wealthy and middle class baby boomers coupled with social media and celebrity culture would support the growth engine in the industry.

The industry is experiencing cost reduction due to increasing competition among core and non-core practitioners, mergers and acquisition among companies and new FDA approvals of novel devices. This is also attracting a growing number of people in adopting aesthetic treatments every year.

Opportunities

Laser based technologies with minimally invasive procedures are fast replacing cosmetic surgeries. Cynosure has begun to incorporate more than one technology into each of its laser-based devices. The company has expertise in the following areas:

  • Laser Skin Resurfacing
  • Cellulite Reduction
  • Laser Hair Removal
  • Laser Body Contouring
  • Tattoo Removal
  • Vascular Treatment

Laser skin resurfacing procedures are growing at 13% CAGR. Cynosure's Affirm anti-aging workstations provide almost painless skin revitalization. Laser hair removal is the fastest growing non-surgical aesthetic laser application, with a projected annual growth rate of 18%. Laser hair removal for men is an ever-increasing group, as men seek hair removal treatment for areas other than their faces, such as their chests and backs. Cynosure's Elite aesthetic workstation is one of the most comprehensive laser hair removal systems available in the market. However, Cynosure's chief competitor Syneron's (NASDAQ:ELOS) Motif Hair Removal powered by its elōs technology is equally competitive.

Cellulite affects 85% of women, making the treatment of cellulite a multi-million dollar business each year. The company's Cellulaze is a minimally invasive surgical procedure for cellulite. Apart from cellulite, the global body contouring market is growing at 16% CAGR. Cynosure's SmartLook and Smartlipo, the latest in anti-aging laser technology, help aesthetic surgeons to provide patients perfect anti-aging solutions with less risk and recovery time. Smartlipo provides aesthetic surgeons with a less invasive technique, when compared to conventional body shaping methods. Syneron's VelaShape is an all-in-one tool that contours, shapes and slims the body by improving cellulite and body contouring. However, in the field of body shaping, Cynosure provides more specialized devices targeted for specific needs than any other company.

The vascular treatment procedures are projected to see an annual growth rate of 25%. Cynosure's Cynergy vascular workstations can treat all types of vascular and pigmented lesions more effectively than conventional single wavelength technology. The company's Accolade workstation is a high-powered Q-switched Alexandrite laser that treats a full spectrum of medical and aesthetic skin conditions, including multicolor tattoos and benign pigmented lesions. To measure the efficacy of the Alexandrite 755-nm-wavelength laser in the treatment of superficial pigmented lesions, a study was conducted by Trafeli et al., in which eighteen patients underwent a single treatment session using a variable pulse-width Alexandrite laser. The study concluded that a long-pulse Alexandrite laser is effective in clearing solar lentigines in a single pass with minimal adverse effects.

Competitive Landscape

Cynosure enjoys a clear competitive advantage over its peers in removal of tattoos and benign pigmented lesions with its new PicoSure device. Furthermore, its PrecisionTx laser treatment is more competitive than Allergan's (NYSE:AGN) Botox in one-time treatments for enhancing the look of the face. These two devices are expected to drive significant revenue for the company in near future.

PicoSure

Cynosure recently launched PicoSure in the US, the world's first and only picosecond aesthetic laser. The company also received approval from Health Canada to market and sell PicoSure there. It is used to remove tattoos and benign pigmented lesions safely and effectively. Approximately 1 in 5 adults in the US now has a tattoo. The primary reason for tattoo removal is employment concern. The size of the tattoo removal market is approximately $50 million. The market for removal of pigmented lesions is about double the size of the market for removal of tattoos. PicoSure's PressureWave technology shatters the target without injury to the surrounding skin. Even dark, stubborn blue and green inks, as well as previously-treated, recalcitrant tattoos can be removed. Syneron's AlexTriVantage is also an effective tool for removal of tattoos and pigmented lesions. It is PicoSure's chief competitor. However, Cynosure's PicoSure is picosecond-oriented, and hence more effective than nanosecond-based devices.

Very recently the company launched Focus, its new disposable lens array technology for PicoSure. Focus is a high density disposable lens array that redistributes laser energy in a combination of high and low level treatment sounds, stimulating collagen production and remodeling the treatment area thoroughly. The Focus technology has benefits not only for pigment related indications, but also new potential indications for which the company is pursuing regulatory clearances, such as acne scaring, skin rejuvenation and skin toning.

PrecisionTx

Cynosure's PrecisionTx, an Nd:YAG 1440nm wavelength laser treatment, has huge potential in sweat gland ablation, the need of which is growing among women everyday. In addition, PrecisionTx enables minimally invasive treatment of smaller areas, such as the jowls and jaw line. It is used in one-time laser treatment for an enhanced look of the face, which is more effective than repetitive Botox treatment. The jowls refer to the lower part of a person's cheek. With aging it becomes fleshier and droopier due to reduced level of elastin and collagen. As the jowls start to droop, it results in the loss of the defined jaw line, which is associated with youth and beauty. Although Botox can lift the jowls, its effectiveness depends on the extent of sagging. In large drooping jowls, the use of Botox is unlikely to give positive results. In such cases surgical procedure tends to be more effective. However, with PrecisionTx's heat stimulated treatment, new collagen can be produced locally for defining the jaw line again. Moreover, it does not need repetitive treatment, unlike Botox.

Palomar Acquisition

The company acquired Palomar Medical Technologies, a company that designs, produces and sells the most advanced cosmetic lasers and intense pulsed light ("IPL") systems for skin rejuvenation, in June for a cash and stock transaction valued at approximately $287 million.

The acquisition is expected to be accretive to Cynosure in calendar 2014 with the implementation of $8 million to $10 million in projected cost synergies. I really feel excited about the acquisition because I expect that apart from the cost synergies, the following factors would drive growth for the combined entity:

  • A more compelling product portfolio and expanded customer base
  • New product and service revenues
  • Robust global distribution network
  • New cross-selling opportunities
  • Enhanced intellectual property position

CYNO: Upside Potential

Cynosure primarily competes with Syneron Medical, Cutera (NASDAQ:CUTR), ZELTIQ Aesthetics (NASDAQ:ZLTQ) and Solta Medical (NASDAQ:SLTM) in the aesthetic devices market. For the third quarter of 2013, Cynosure reported a net loss of $1.3 million, or 6 cents per share. It includes acquisition costs for Palomar, which it purchased in June. Excluding those costs, earnings per share were 23 cents. Revenue of $60.7 million was up 64% year-over-year. The third quarter was the first full quarter for the combined entity. Cynosure is a debt-free company with cash and cash equivalents of $70.10 million. It has authorized to repurchase of up to $25 million of its common stock. The repurchase program will be funded using the company's working capital.

Based on 2014 expected earnings of $1.31, the company is trading at 19.8x, which implies the stock is attractively valued. Its prime competitor Syneron is trading at a forward P/E of 38.5x. For its other competitors, the expected 2014 earnings are non-positive. The average P/E for the medical devices industry is 27.6x. Applying the overall industry average P/E of 27.6x on CYNO's one-year forward EPS, I have arrived at $36.16 as the company's one-year projected price. That's a whopping 40% upside from the current level around $26.

Company

2014 EPS Forecast

P/E (2014 EPS)

CYNO

1.31

19.8

ELOS

0.30

38.5

Summary: Reasons to Buy

  • Cynosure has tremendous opportunities in laser skin resurfacing, laser hair and tattoo removal and laser body contouring.
  • The company recently launched PicoSure in the US, the world's first and only picosecond aesthetic laser. PicoSure has huge growth potential in multiple conditions. The company also received approval from Health Canada to market and sell PicoSure.
  • Cynosure's PrecisionTx has vast potential in sweat gland ablation and minimally invasive treatment of smaller areas, such as the jowls and jaw line.
  • Cynosure's Palomar acquisition is expected to be accretive to Cynosure in calendar 2014 with the implementation of $8 million to $10 million in projected cost synergies.
  • The company has authorized to repurchase of up to $25 million of its common stock. The repurchase program will be funded using the company's working capital.
  • Based on 2014 expected earnings, the company is trading at 19.8x. I feel the valuation is cheap, given its exceptional growth prospects.

Risks

  • The company operates in a high-growth sector. But the lack of reimbursements for aesthetic devices and social stigmas among the middle class can restrain its growth.
  • Acquisition of Palomar is expected to be EPS accretive since 2014. However, the anticipated cost synergies could be far less due to any delay in integration of the two entities.
  • Competition is intensifying everyday in the aesthetic medicine market, which is responsible for the drop in general price level in this market. This would hurt Cynosure's profitability going ahead.
  • Cynosure's business is capital intensive, in which returns are driven by focused investments, product innovation and selective acquisitions that go depth and breadth in the product portfolio. If the company fails to innovate and engages in faulty acquisitions, the business could face serious trouble.
  • In the third quarter of 2013, the company's selling and marketing expenses increased by approximately $5.7 million to $17.2 million from $11.4 million in the third quarter of 2012, due to higher sales and marketing expenses to support the Palomar products, as well as the roll out of PicoSure. Excessive promotional costs, which are generally the trend in this industry, could negatively affect the company's bottom-line.

Bottom Line

Apart from its growth initiatives, I am impressed by Cynosure's cost-cutting efforts. Outside the US, the company has streamlined its international direct salesforces. It has reduced the number of offices in Europe and the Asia Pacific region. Worldwide headcount was approximately 600 at the end of the third quarter, down approximately 8% from the end of the second quarter. I feel this is a great company in the making, and I consider it tomorrow's Allergan.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.