EnteroMedics: Lose Weight Or Lose Your Money?

| About: EnteroMedics Inc. (ETRM)

Summary

This is a company with a long history, but very little financial success.

Its medical approach has experienced major negative results with other companies.

The current elevated stock price is not sustainable without major issues being resolved.

Investment Thesis

The following information relates to a company that has been in existence for about 15 years. It has a product that is approved by the FDA for marketing in the United States, plus being approved in the EU countries. Based on my research and reviewing the history and background for its product, it is my opinion, current investors or potential investors should not consider this being a viable company for an investment. My opinion has no negative considerations for the management of this company, but merely relates to the history for this type product and the lack of marketing success that has been demonstrated to this point.

Background on Company

EnteroMedics, Inc. (NASDAQ:ETRM) is a Minnesota-based company that was formed in 2002. The original name of the corporation was Beta Medical, Inc. The name was changed to EnteroMedics in 2003. The founding member of this corporation was Dr. Mark Knudson. As a body of work in the healthcare industry, Dr. Knudson has been involved in starting or helping establish over 20 healthcare companies. However, if one follows my articles here on SA relating to MannKind (NASDAQ:MNKD), you would know that all endeavors by brilliant entrepreneurs don't always translate down to the retail investor - at least for making them money by investing in their stock. At this point, EnteroMedics has been on a direct parallel when compared with MannKind, but as with any company, there is hope! However, before you jump on the EnteroMedics roller-coaster, let me share some background information for this medical device company that has an FDA approved product that is also approved in the EU countries.

Medical Product

The EnteroMedics product is known as the vBloc Rechargeable System and was recommended for approval to the FDA in 2014. The product was launched into the US market in 2015, so right off we see a similar matching event with the MannKind's approval and launch timeline. However, it should be noted with EnteroMedics obtaining EU approval earlier, it had the first medical implant for its product in Kuwait.

A critical element for this product is it is designed to address one of the largest medical issues that impacts humans all over the world. That being the crisis brought on by obesity. The vBloc product consists of an implantable pacemaker-like device that is designed to intermittently block the vagus nerves using high-frequency, low-energy, electrical impulses. The vagus nerve is one of the most critical components of the human anatomy. Impacting and altering the function of this nerve by any external application could create major problems for how our body works in keeping us alive. Caution should always be the foremost concern when attempting to alter the normal function of this nerve.

The longest of the cranial nerves in the human body is the vagus nerve. The vagus nerve is so named because it "wanders" like a vagabond, sending out fibers from your brainstem to your visceral organs. The vagus nerve literally controls our inner nerve center - the "parasympathetic nervous system."

The action of the vagus nerve directly impacts the following in your body:

  • Inflammation warning.
  • One's memories.
  • Breathing.
  • Heart rate.
  • Body relaxation.
  • Gut and brain response (There truly is such a thing as a "gut feeling").
  • Fainting episodes (When one faints, this is the response when your vagus nerve is over-stimulated - the scientific name is a Vasovagal syncope).

In recent years, there has been much attention in the medical community dealing with manipulating the vagus nerve. Probably one of the more interesting areas of work was done in treating epileptic seizures. One of the more memorable companies was Cyberonics (NASDAQ:CYBX), and its very questionable history with its stock and ensuing scandals (Please note I'm not equating EnteroMedics to Cyberonics, just merely its work concerning developing a medical device that would manipulate the vagus nerve in resolving a medical condition). With this disclaimer, I would still suggest one re-read the things listed above and think about what aspect of our body the vagus nerve influences. I would highly recommend reading this in-depth report involving the Cyberonics product and the issues that arose as a result. I have no opinion on the merits of this report, but it reveals some very troubling potential issues when applying an electrical implanted device that impacts the normal and critical function of the vagus nerve.

Chronology of Events

ETRM was formed in 2002, and in each year since it has incurred losses as reflected in its financial reporting. Since its initial IPO in November 2007, its stock has fluctuated from a low of $1.75 to a high of $67,851.00, based on the reverse splits that I've cited. In April 2012, the company achieved its first commercial implant of its product; this occurred in Kuwait. April 7th, 2013, EnteroMedics announced clinical trial results that showed that the predefined efficacy measurement had not been met in patients. In June 2014, the FDA Advisory Committee voted to recommend the product to the FDA for final approval. January 15th, 2015, the FDA gave its final approval for the product. On April 7th, 2015, the company announced it had 15 medical centers on board with 19 surgeons trained to implant the medical device. On April 30th, 2015, ETRM announced it had a total of 21 centers signed up and 40 surgeons trained for implanting the product. Also, in April 2015, EnteroMedics announced it had signed a contract with American HealthCare Lending where potential patients wanting the device could borrow funds for what seem to be extremely high APR rates. From what I have found, it appears the cost for this procedure runs around $8,000.00. Based on the need to provide an outside finance source, I think it is safe to assume this procedure isn't nor will it ever be covered by third-party payers, in my opinion. In May 2015, the first US implant was completed at the Tufts Medical Center in Boston by Sajani Shah, MD.

Current Events Impacting the Stock

Over the last few weeks, EnteroMedics' stock has been on an astounding rocket ride. On December 28th, 2016, the stock closed at $2.48. In the interim, it has zoomed as high as $27.70, before closing last Friday, January 13th, 2017, at $13.70. An astounding 5x increase in value. Excellent, right? Before one faults themselves for missing out, if you had owned this stock on December 27th, 2016, you would have been holding a stock trading for $0.04. Let me repeat, $0.04. The price of $2.48 on December 28th was based on a 1-for-70 reverse split. I'm not taking the time to go back and review the complete history of the previous stock splits, but in 2010, the company had a 1-for-6 reverse split. In 2015, it had a 1-for-15 reverse split. So, over the recent years, the company had cumulative reverse splits totaling 1-for-91 shares. I haven't counted the number of secondary stock offers. There have been too many for me to count. However, note that with the latest reverse split, ETRM has filed for a new secondary offering that should conclude soon.

With a company history of 15 years, looking back at the above critical milestones and events, where does it stand today?

EnteroMedics Financials as of Third-Quarter 2016

Revenue:

Total Revenue

$296,760.00

Cost of Revenue

$146,631.00

Gross Profit

$150,129.00

Operating Expenses

R&D

$1,253,390.00

SG&A

$3,361,572.00

Operating Income or Loss

($4,464,833.00)

Retained Earnings

($296,506,929.00)

It's very clear, based on the above financial data, EnteroMedics has burned through nearly $300,000,000.00 of cash, generated by massive stock offerings, both IPO and secondary. Soon it will be five years since it generated its first commercial implant revenue. The product has been available on nearly a world-wide basis with the European and Middle East approval for several years. Now that it has been approved in the US since January 15, 2015, in two years, the company now has an YTD revenue run-rate as of the third-quarter 2016 of $296,760.00. Broken down further, ETRM had a monthly revenue capture rate of $32,966.00. Considering the company shared that it had 21 centers and 40 surgeons trained to conduct the implants in April 2015, if the 40 surgeons each conducted one implant in the last nine months, each would have generated $7,419.00 in revenue.

Based on the documents that reflect the latest 1-for-70 reverse split, the insider data reflects there are eight employees who could be beneficial owners of the stock. The largest holder has 4,781 shares. The next largest holder owns 4,384 shares. The third largest holder owns 1,037 shares. The fourth and fifth largest holders have 412 shares, respectively. The sixth holder has 111 shares, and the seventh, a whopping eight shares. And then we have what appears to be the smartest insider; #8 holding zero shares. The simple takeaway from this data - for those who should understand the future potential for this product - is they obviously have opted not to gamble with their money invested in the stock.

My Investing Opinion

If you've read some of my articles here on SA, you'll know that I personally don't invest any of my investment dollars in short positions, whether by shorting the common stock or having put options. In the past, I used the options market to take advantage when I perceived a stock being overpriced. However, now that I'm retired, and for others that are retired, having a margin account necessary for shorting is a foolish endeavor. For those where this personal position might not be a concern, in my opinion, EnteroMedics would offer the potential for making a nice return based on the stock being extremely overpriced. It appears there are options, but currently the pricing models are out of whack in relation to the strike prices and spread. One should be very cautious in making a trade for options in this stock.

It is further my opinion the recent spike in the stock price is related to the just announced addition of two more centers where the implants can be provided. However, if the current 40 or more surgeons aren't conducting any implants, why would two more centers change the history of such implants? It is my opinion that with the recent spike in the stock price to nearly $30.00, EnteroMedics has become a day trader's delight. Be cautious with any trades - long or short. With the now miniscule outstanding number of shares, the stock can and will be manipulated with elevated volatility.

You should do your own personal due diligence that incorporates the criteria you personally apply in making investing decisions. My comments are strictly my opinion, and investors should merely use my comments as a starting point for their review.

Good luck with your future investing decisions!

Disclosure: I/we 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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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