Intersect ENT (NASDAQ:XENT) is a commercial drug-device company that has developed a drug releasing bioabsorbable implant technology, which enables targeted and sustained release of therapeutic agents. This technology is designed to help ear, nose and throat or ENT physicians to improve patient care, specifically aiding in the treatment of chronic sinusitis. According to the company, there are an estimated 3.5 million U.S. patients who are managed by ENT physicians for chronic sinusitis.
Currently, the company derives all its revenues from the sales of the Propel and Propel Mini steroid releasing implants. These are the only steroid releasing implants that are approved by the U.S. Food and Drug Administration (FDA) for use in patients undergoing surgery for chronic sinusitis.
We arrive at a target price of $41.5, if we value Intersect's stock according to a relative valuation approach based on Price/Sales multiple. However, if we value the company according to discounted cash flow valuation, we arrive at a price estimate of $11.50.
Considering that the company is in its growth phase and its capital structure can vary significantly in the coming years, we have more faith in our price estimate derived according to the relative valuation approach. Furthermore, considering the size of the opportunity involved in the market of bioabsorbable implants for the treatment of chronic sinusitis and the fact that Intersect has been bearing operating losses in the last couple of years, the company can be an attractive buy target for a larger company in its industry going ahead. In such a scenario, Intersect's stock price can significantly jump depending on the premium being paid by the acquirer. Therefore, a target price of $41.50 seems reasonable. Given that the Intersect's current stock price is $13.35, the stock seems to be like a buy opportunity.
Price According To Relative Valuation Approach:
Price According to DCF Valuation Approach:
Rationale behind our valuation:
A) Strong revenue growth: We believe that Intersect will manage to increase its revenue at a CAGR of approximately 25% over the next ten years.
The company's future sales growth will be fueled by strong adoption of its products. The unit sales of PROPEL and PROPEL Mini increased from 59,300 units to 71,400 units, or 20% year-over-year, in the first nine months 2016. The company attributed the increase to the expansion in its sales, marketing and reimbursement organizations as well as the introduction of an expanded indication for PROPEL Mini following approval from the FDA to treat patients undergoing frontal sinus surgery.
Intersect seeks to further increase the frequency of use of its products among current physician customers and add new physician users. Further, the company is putting significant efforts to expand its sales channels by aggressively marketing, which should help increase the awareness of its products. Intersect's SG&A expense as a percentage of sales stood at 97% in the first nine months of 2016. Furthermore, Intersect is strengthening the reimbursement for its products. These factors combined have helped the company achieve higher sales growth in previous years and should continue to do so in future.
Moreover, approval of the products mentioned below should translate into higher sales growth for the company going ahead:
· RESOLVE - Intersect is in the process of completing clinical trials of RESOLVE, a steroid releasing implant designed to provide a cost-effective, less invasive solution for patients that have had ethmoid sinus surgery yet suffer from recurrent sinus obstruction due to polyps. The company plans to submit a New Drug Application in the first quarter of 2017 to seek regulatory approval from the FDA to market the RESOLVE product.
· PROPEL Contour - The company is also pursuing the approval of PROPEL Contour, formerly referred to as NOVA, a steroid releasing implant designed to fit the ostia, or openings, of the dependent sinuses following enlargement of the sinuses. In July 2016, Intersect submitted a PMA supplement to the FDA to seek approval of PROPEL Contour.
In our valuation, we assume that Intersect will manage to get the approval for the above products by 2018, and the revenues from the new products should translate into higher sales starting 2019. Hence, we project a higher revenue growth for the company in 2019 and 2020.
B ) Improvements in operating margins: We believe that Intersect will manage to reach an operating margin of 12% in the next 10 years.
Intersect's gross margins have hovered around 85% in the last couple of quarters. In the last quarter, the company managed to increase its gross margins by 5 percentage points on a year-over-year basis, due to growth in unit volume which helped in spreading the company's manufacturing overhead costs over more production units. In addition, Intersect claims that its average selling price of its products increased which has also contributed to margin improvements. Since there still remains ample scope of growth in the unit volumes, Intersect stands a chance to further increase its gross margins.
The company's primary operating expense other than the Research and Development cost, which we have capitalized, is its SG&A expense. Intersect's SG&A expense as a percentage of sales stood around 97% in the first nine months of 2016. This is primarily because the company is aggressively spending on marketing efforts to expand its sales channels and commercialize its products. However, we can expect higher sales growth to offset the company's SG&A expense in future. Considering that the industry average operating margin has been around 12%, we can expect Intersect to achieve this figure once it reaches the stable growth period (after 10 years).
Intersect's Economic Moat:
Propel and Propel Mini are the only steroid releasing implants that are approved by the U.S. Food and Drug Administration (FDA) for use by patients undergoing surgery for chronic sinusitis. Further, if we exclude the off-balance sheet arrangements, the company has zero debt, saving the company from interest burden.
Primary Risks Associated With Intersect:
Intersect started selling PROPEL in August 2011 and PROPEL Mini in November 2012. However, the company has yet to achieve operating profitability. This suggests that the company's efforts to market its products have not been very fruitful. It remains to be seen if Intersect's efforts will translate into profits for the company in future, failing which the company will continue to increase its cumulated deficit and burn cash. This can negatively impact our valuation for the company.
Furthermore, considering the high gross margins associated with this business and the size of the opportunity involved, the market for steroid releasing implants is likely to invite more competition. This can negatively impact Intersect's future growth. Nevertheless, the company has been aggressive in filing patents for its research, which should help thwart competition for some time. As of December 31, 2015, the company owned 59 patents globally.
Disclosure: I am/we are long XENT.
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.
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