Sell Watch: Zeltiq Has Become Over-Speculated

| About: ZELTIQ Aesthetics, (ZLTQ)

Written by Scott Matusow and Michael Kovar

We mainly focus on long-based trades and investments, preferring to stay away from what many would perceive as "bashing." However, from time to time, we see companies absurdly overvalued and not presenting investors with the entire story, leading to an inflated stock price.

Zeltiq Aesthetics (ZLTQ) is one such company we feel is being over-speculated, and at its current market cap around $800M, could potentially leave investors holding a large losing investment even over the long term.

Zeltiq engages in developing and commercializing non-invasive products for the selective reduction of fat. The company offers the CoolSculpting System, which utilizes proprietary controlled-cooling technology to selectively reduce stubborn fat bulges that may not respond to diet or exercise.

CoolSculpting is an interesting niche product for sure. Its procedure is said to freeze fat cells. It's claimed that over numerous costly treatments, the fat cells die and then simply disappear.

Zeltiq has done very well with its one single asset, at least according to its latest unaudited earnings report, seeing revenues of $38M or so for Q4 2013. However, the company is not yet profitable, and we do not believe it will be any time soon. If we look at the chart below, we can see a large price-to-sales discrepancy that currently exists for Zeltiq compared to its competitors. The company sits at about more than four times Cutera (NASDAQ:CUTR) and Syneron (NASDAQ:ELOS) for that metric and well over double Cynosure (NASDAQ:CYNO). This is a very high ratio for any company, let alone a virtually single revenue stream. Obviously, this is just one of many factors to consider when completing the due diligence on an investment. However, to justify a stock price relative to sales this much higher than typical, a company would need something unusually spectacular about it.

Significant Risk Factors

Any time a company with a lot of value is limited in its product lines, it presents numerous challenges compared to a company with more versatility to accomplish success and growth in many areas. For one, once a lot of revenue starts to flow in, it raises the eyebrows of the heavy hitters. This appears to be the case in the body contouring market.

Valeant's (VRX) recent acquisition of Solta Medical (SLTM) will most likely create a big problem for Zeltiq. We believe Zeltiq is at or close to peak sales with CoolSculpting, and could actually see a large decrease in sales of the product because of Valeant's buyout of Solta. We feel this was a huge missed opportunity for Zeltiq, as it could've figured out a share swap deal with Solta that potentially would've provided the company with much needed differentiation in the market versus being a one-trick pony.

When we did our due diligence related to Solta Medical in the past year, we asked skin care clinics what types of body contouring services they may offer. One that was common was called the Vanquish Laser. Many investors probably haven't heard much about this device since it was developed by a private company named BTL Industries based out of Framingham, MA.

Vanquish is a new procedure in fat reduction and removal, offering painless and surgery-free treatments that require no downtime. Vanquish is the fastest in terms of single treatment time (large and multiple areas in just 30 minutes), as well as with total results which are seen in weeks versus months for some competitors. Some clients have reported a permanent reduction of two to four inches in the abdomen after a series of four treatments over a four-week period.

Zeltiq's CoolSculpting is a first-generation device that freezes fat as a method to kill the fat cells. Although this appears to be an exciting breakthrough for now, it will have a tough time measuring up to the advanced technology of Vanquish and other new devices being currently developed.

Potential drawbacks of CoolSculpting are:

  • Takes an hour per small area, plus an hour thawing out time. If you wanted four areas, that would be four hours of treatment with four hours of thawing, totaling eight hours.
  • CoolSculpting is only pain-free when first done, but for 24 hours post treatment the patient will most likely experience pain.
  • Is limited in achieving a broad area of application, so a patient can't get a total even area.
  • Can only get up to 20% of the fat in one section at a time, which is up to one inch.
  • Takes three months to get the result.

We feel Vanquish is a more advanced system than CoolSculpting, which could hurt Zeltiq's ability to transition from a company losing money into a profitable one. When a company has only "one shot on goal", so to speak with, one product driving a great majority of investor speculation and revenue, there can be many threats. This is especially true for Zeltiq now that Valeant has purchased Solta Medical and is aggressively pursuing revenue in this space. With a virtually unlimited supply of resources, Valeant should make a significant dent in the body contouring market with Solta's assets.

Additionally, when reading through Zeltiq's recent 10-Q, we find the following;

We rely on a license relationship with Massachusetts General Hospital for much of our core intellectual property, and this arrangement could restrict the scope and enforcement of our intellectual property rights and limit our ability to successfully commercialize our products.

Although MGH cannot restrict our future product development efforts, the terms of our license agreement with MGH may require us to pay MGH a royalty of up to 7% of net sales of future products we develop or that may be developed by our strategic partners.

The above could substantially cut into Zeltiq's profit margins and leave the company dependent on an outside source to enforce any potential infringement on intellectual property rights now and in the future. It's extremely important for investors to read through a company's SEC filings before considering any investment. We ignore the hype and study company filings for full consideration of all factors in our due diligence.

Another substantial risk that we've found for a company specializing in this area is the lack of a residual revenue stream. This means once a machine is sold, the company receives revenue from the initial sale but no revenue coming through the door from that point forward.

Solta Medical was an especially nice acquisition bargain for Valeant, when also considering that tips for aesthetic devices account for over half of the revenue Solta was bringing in on its own. This creates a much more sustainable business model, as the sales force is always in contact with the customers and have virtually guaranteed sales coming in the door, making operating/earnings results easier to forecast.

Valeant, for some time now, has been looking to enter the aesthetics device market, and the perfect situation presented itself with Solta. Solta got itself into financial issues by overlevering itself to acquire too many assets, leaving it with little to no money to effectively market its two aesthetic devices, Liposonix and Vaser Shape. Both of these products are ultrasound-based and provide similar and potentially better results, depending on a client's point of view. This is really what aesthetic devices come down to, perceived effectiveness driving personal choice.

But is Zeltiq concerned with Solta's two products here? You bet they are, so much so that Zeltiq mentions Solta's products as a threat to its business in the last few 10-Qs - let's take a look.

In September 2011, the FDA cleared the marketing of an ultrasound energy-based product for body contouring offered by Solta Medical, Inc., a publicly traded company. This ultrasound energy-based product utilizes heat to non-invasively eliminate fat cells in a single procedure. We believe that the marketing of this product extended the sales cycle for CoolSculpting during 2012 and may continue to have an impact on our sales in the future.

Zeltiq believes Liposonix extended CoolSculpting sales (meaning many clients chose Solta's products and/or took extra time making a decision) in 2012, affecting its sales. The mention in Zeltiq's 10-Q doesn't refer to Vaser Shape, which should further extend CoolSculpting sales.

In 2012, Solta was doing much better financially, so it makes sense its Liposonix cut into Zeltiq's sales. However, in 2013 after Solta acquired the Vaser Shape asset, it became over-extended financially, while facing heavy activism from its shareholders who were demanding the company's sale. These factors left Solta in a weakened position.

Solta simply was not in a good position to market these products correctly in 2013, but was in a better position in 2012 before its problems developed. This is one key reason why in 2013, CoolSculpting saw a large increase in sales while no mention of 2013 sales are made in Zeltiq's latest 10-Qs.

Valeant, for lack of a better term, is the "800 pound gorilla." In fact, it is the largest aesthetics device company in the world, known to have the biggest and best sales force in the business.

Now that Valeant has Solta, we think it's likely that CoolSculpting will revert to 2012 level sales, which were negatively affected by Solta, resulting in Zeltiq's "warning" under the risks section in its 10-Qs becoming realized. In fact, we believe this is why it chose to release unaudited earnings over a full month in advance - to attempt to keep investors focused on the rosy picture before Valeant closes its deal to acquire Solta and begins to throw its weight behind Solta's products.

We also feel that it's not a coincidence that the early earnings report was released while the company is engaged in an open share offering. Since the offering began in early November 2013, Zeltiq's share price has doubled.

I do not blame the company, as it certainly wants to keep the stock price momentum up. The higher the stock price, the more money it can make, especially for those who bought the offering at $13. I saw Molycorp (MCP) engage in similar tactics in 2011, and even wrote an article and tweeted about it, suggesting investors think carefully before buying into the hype there. Molycorp's executives, starting in 2011, appeared on various media outlets touting its stock on a regular basis. At the time, the share price of the company was near $70 a share, and $30 a share when I wrote the article predicting it would go to $5 a share in a few months. I was correct, as Molycorp's share price has been trading around $5 for some time now.

In my Molycorp article, I mentioned,

I feel bad for those who bought into the hype without any fundamental backing to warrant such a high run up. I feel even worse for anyone attempting to buy now for a long-term investment.

Investors were over-speculating Molycorp on its potential to mine rare earth metals, thinking they were going to strike it rich and failing to understand the rare earth segment with its fluctuating prices and Chinese competition. We list Molycorp as an example for investors to learn from - do the due diligence on business modeling and potential revenue and profit to gauge stock price, and ignore the "hype."

This is the number one mistake investors engage in - buying into the "hype" and not the actual business model in terms of monetary potential, or lack thereof. Investors still need to be careful in consideration of a Molycorp investment and not once again, buy into the hype.

We collectively feel the same about Zeltiq as I felt about Molycorp then and even before my article on it. From time to time, we see these overvalued high flyers that do not have the potential to justify absurdly high valuations, and every one of them eventually comes crashing down to reality.

Zeltiq, in our opinion, is worth no more than $500M at this time, which equates to a stock price around $14 a share. This is assigning it a best-case scenario when considering each and every business risk and current business model.

In our opinion, at Zeltiq's current valuation over $800M, it's being dangerously over-speculated at this time.

Dendreon (DNDN) might be the most epic example of reckless over-speculation the market has ever seen. Starting in 2009, speculation was hot and heavy on the perceived potential of its cancer vaccine drug Provenge. The hype was incredibly over-done, as the stock hit an all-time high of $57.67 in April of 2010. Many misinformed investors believed that Provenge was a cure for prostate cancer, when in reality the drug is a decent treatment at best, and at worst, a barely effective overpriced drug. It was also alleged that the company management failed to accurately define the large upfront costs to physicians with the drug, and were not properly educated about these costs. In addition, it was alleged the company failed to inform the investing public of this problem with market acceptance of Provenge in addition to drug reimbursement costs. While Zeltiq does warn potential investors of the threat that Solta products present to CoolSculpting, investors have to dig through the 10-Qs to find this warning.

Needless to say, Provenge did not meet investor expectation and Dendreon found itself in serious financial trouble that has carried over to this day. After hitting its all-time high of over $57, the stock has been spiraling downhill ever since, hitting a low of $2.23 in October of last year.

Currently, Dendreon has racked up over $500M in debt and its enterprise value has ballooned to over $885M. Unless a suitor is found to acquire it soon, we feel there's a good chance that Dendreon files for bankruptcy protection.

While Zeltiq is not likely to flounder as Dendreon has, the above situation serves as an example of investor over-speculation on hype and lack of proper evaluation of current and future fundamentals.

Celldex's (CLDX) hot speculation is an example of a company whose valuation is justified at this time. For one, it's a developmental biotech with the potential to make billions if its cancer vaccine Rindopepimut is eventually FDA-approved. Zeltiq simply does not have this type of potential, although its current market cap and stock price would have investors believing it does.

Rindopepimut is an investigational immunotherapy that targets the tumor-specific oncogene EGFRv3 (also known as EGFRvIII), a functional and permanently activated mutation of the epidermal growth factor receptor (EGFR), a protein that has been well-validated as a target for cancer therapy.

Rindopepimut has seen several positive data releases over the last year that has justified its hot speculation, notwithstanding that the treatment will be targeting an unmet need if eventually approved. Companies that possess unmet need drugs that have orphan status can basically charge what they wish, so the monetary potential for Celldex is astronomical. However, Rindopepimut would need to be FDA-approved to accomplish this, which will not be easy.

We first covered Celldex back in 2012, and have been generally bullish on its chances since that time.

Halozyme (HALO) is another company we cover that we believe has earned its hot speculation. This is one of our best speculative picks moving forward, mainly because of PEGPH20.

According to the company:

Halozyme's FDA-approved HYLENEX® recombinant human hyaluronidase is administered subcutaneously and temporarily and reversibly degrades HA to facilitate the absorption and dispersion of other injected drugs or fluids and for subcutaneous fluid administration. However, rHuPH20 acts only locally at the injection site, is rapidly inactivated in the body, and does not survive in the blood. An investigational PEGylated form of rHuPH20 has been developed by Halozyme which dramatically increases the half-life of the compound in the blood and allows for intravenous administration.

In pre-clinical models, treatment of mice bearing tumors with PEGPH20 alone was found to significantly reduce the growth of tumors that accumulate HA. Experiments with other tumor types suggest that PEGPH20 is selectively active against tumors that contain high levels of HA. Multiple preclinical studies have demonstrated that PEGPH20 degrades tumor-associated HA and reduces interstitial fluid pressure in tumors with elevated HA. An estimated 20% to 30% of solid tumors are thought to contain high levels of HA.

Essentially, if PEGPH20 is eventually FDA-approved, it can revolutionize the way cancer is treated. Again, this is a big "if", as the treatment is in early stages of clinical testing. If the treatment is eventually approved, Halozyme's valuation could balloon to a price similar to Intercept Pharma's (NASDAQ:ICPT) recent epic price appreciation.

Zeltiq's CoolSculpting does not possess the monetary potential of these developmental biotechs, not even in the best-case scenario. People are focusing on how "cool" freezing fat sounds, but not on the actual results, which are subjective with no actual data to back it up. Furthermore, the factors we have mentioned here are not being properly considered, which could lead to yet more investors holding the proverbial "bag" and the stock's current price.

As mentioned, with Valeant's large-cap weight now in control of Solta's assets, we believe CoolSculpting will begin to see its sales chewed into as Valeant will put its top sales force and marketing money into Liposonix and Vaser Shape - something Solta could not do on its own because of financial issues.

Zeltiq has also enjoyed strong CoolSculpting sales by purchasing billboard space in targeted affluent neighborhoods, mainly in the Southern California area. No question, this is smart marketing by Zeltiq, and for the time-being it has paid off in increased revenues as mentioned earlier. Solta on its own could not afford to engage in this kind of marketing because of the prior reasons mentioned and because of a diverse product line to market. Zeltiq only has the CoolSculpting asset, so it allocates 100% of its marketing effort to one product.


Valeant has vast resources far beyond Zeltiq to correctly market Liposonix and Vaser Shape, which spells certain trouble for Zeltiq.

CoolSculpting is at or very close to peak sales. If Solta were still on its own, then we could see its current revenues somewhat sustaining. When we refer to Zeltiq's 10-Qs, Solta's product (Liposonix) was a factor in 2012 in cutting into CoolSculpting sales, when Solta was in a much better position as a company.

In 2013, Solta was a wreck and CoolSculpting took advantage of this, producing increased (but unprofitable) revenues. Now that Solta is in the hands of the aesthetics giant Valeant, we feel Zeltiq should be "reverse-speculated."

Zeltiq basically has a single asset that produces revenue for the company at this time, and is certainly not a developmental biotech worthy of its current hot speculation like Celldex and Halozyme. There is no justification of a market cap over $800M, and the case is made that it's not even worth $500M. Strong speculation is always based on forward-looking earnings, and we simply do not see the potential to match the speculation at this time.

Additionally, BTL Industry's Vanquish product offers a cheaper and better solution, which should substantially cut into Zeltiq's future revenue stream. With Zeltiq lacking any significant residual income, investors buying and holding at these prices now are taking an incredible risk, in our opinion.

Almost all aesthetic body contouring devices are "niche" products that rely on heavy marketing campaigns, which Zeltiq has engaged in here, taking advantage of Solta's weak position as a company. Think of it this way; I can label four bottled waters with fancy names, claim some "flow over lava," while others are "taken from a high spring on Mt. Everest." With these four bottles, I engage in a "taste test" with various bottled water enthusiasts.

Everyone will have a preference which one is better, tastes fresher, etc. Now for the catch - all the bottles were filled with regular tap water. We as humans are programmed in certain ways. Marketing departments know this, and there is no question Zeltiq has done an excellent job marketing CoolSculpting. However, with Valeant now in the game, we believe things will change for Zeltiq in a drastically negative way.

Additionally, there is no data to support any real fat loss associated with these products, so insurance companies will never support the procedures. While the idea of freezing fat might seem "cool" to some investors, it offers next to no benefit over other body contouring devices.

Regardless of this, there is a large market of affluent people willing to pay to have these procedures done. Valeant knows this, and has for some time now stated its desire to enter into the space, which it has by acquiring Solta.

Valeant can produce Solta's products cheaper, meaning it can sell them cheaper. Valeant can market way more effectively than Zeltiq, with cash and sales resources on hand to crush the latter's forward momentum dead in its tracks. As already mentioned, Zeltiq has enjoyed increased revenues because of Solta's poor financial position as an independent operator.

Zeltiq's stock is up nearly 400% over the last year on frenzied speculation. We feel investors buying the stock for the long term at these prices might have to wait years for long-term returns, but will most likely rather see stable-to-negative returns. Investors who bought at or near the 52-week low are in some serious profit at this time. We feel many of these investors will soon take a good amount of this profit off the table.

Solid aesthetics companies have a diverse product line, and the best of these companies do not warrant the kind of speculation Zeltiq has been receiving. We feel Cutera, with an undervalued market cap of around $135M, is a much better value.

Don't buy Zeltiq simply on the "freezing fat is cool" chatter. In the end, it comes down to the ability not only to produce strong enough revenue to justify a certain market cap, but profit as well. Zeltiq has neither of these, and will likely begin to see a dent in its revenue stream for the reasons mentioned in this article.

We believe investments should be made on a company's longer-term chances at solid and sustainable earnings and growth. We have made our case for why we feel Zeltiq's earnings are not sustainable, and will likely begin to see negative growth.

It's our opinion that Zeltiq is a sell, with a target of $14 as a more reasonable entry point. This is assuming the company can either produce more products faster via research and development for better diversification, or engages in a strategic acquisition of other assets. This would give the company a chance to give itself the needed diversification to act as a safety net in the case CoolSculpting revenue has or will soon hit a peak, and we believe it has.

Disclosure: Short ZLTQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are short via option chain puts, and not the stock.

Disclaimer: This article is intended for informational and entertainment use only, and should not be construed as professional investment advice. They are my opinions only. Trading stocks is risky - always be sure to know and understand your risk tolerance. You can incur substantial financial losses in any trade or investment. Always do your own due diligence before buying and selling any stock, and/or consult with a licensed financial adviser.

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