Inspire Medical Systems (INSP) has gone public and its shares have seen a great opening day return. The medical device company has great prospects as shares jumped 50% on their opening day. The still limited valuation and the potential of its therapy make that I am still happy to buy a few shares, which I regard as a long-term call option on the potential success of the business.
Minimally Invasive Solutions
Inspire Medical is a medical tech company which focuses on development and commercialisation of minimally invasive solutions for patients which are diagnosed with obstructive sleep apnea. The company has developed its proprietary Inspire system, as the company claims that this is the only FDA approved neurostimulation technology which offers an effective treatment for obstructive sleep apnea.
The Inspire therapy essentially monitors breathing patterns and delivers nerve stimulation to maintain open airways. The company has been marketing this therapy in certain European countries from 2011 onward, as FDA approval was granted in April of 2014. Note that patients must have moderate to severe sleep apnea and must not have a complete concentric collapse of the airway before being considered for treatment. Patients, furthermore, need to be 22 years of age, or older, and not be tolerant to airway pressure treatments.
In essence, the Inspire system involves a remote control and 3 implantable components including a sensing lead, a neurostimulator, and stimulation lead.
To date, nearly 3,000 patients have been treated with the Inspire therapy in the US and Europe combined. The WHO estimates that 100 million people across the globe suffer from OSA (obstructive sleep apnea) as the most common therapy CPAP (continuous positive airway pressure) is not often very effective, nor comfortable.
Within the US, there are an estimated 17 million patients with OSA of which 2 million are on CPAP treatment. Of this group, 35% or more is not compliant with that treatment, of which, 70% would be eligible for treatment with the Inspire therapy, which works out to 500,000 eligible patients in the US alone. At $20,000 per implantation, the opportunity comes in at $10 billion in the US alone, at least according to the company.
The Offering & Valuation
Inspire sold 6.7 million shares at the high end of the preliminary offering range of $14-16 per share, indicating that it raised $107 million in gross proceeds in its IPO. The 20.2 million shares value the company at $323 million at the offer price, which includes existing cash holdings of $16 million, existing debt of $24 million, and net IPO proceeds just shy of $100 million. Pegging these three together, Inspire operates with a net cash position of $90 million, thereby valuing operating assets at $233 million.
That said, this valuation is already outdated as shares jumped to $24 on their opening day, boosting the valuation to $485 million or $395 million after accounting for the net cash holdings.
So, what has the company done to deserve such a valuation? Looking at the financial statements tells us that Inspire is a growth story with relative small revenues, narrowing losses, and a strong pace of total revenue growth.
The company generated revenues of $8.0 million in 2015 on which it reported an operating loss of $19.8 million. Sales more than doubled to $16.4 million in 2016 as losses fell slightly to $17.3 million. Revenues were up by 74% last year to $28.6 million, as losses narrowed a little further to $16.0 million. Based on the valuation of operating assets, the company is valued at 14 times sales for 2017, a steep multiple of course, not to mention the losses incurred along the way.
Good news is that growth accelerated in the final quarter of the year in which revenues were up by 88% to $10.0 million, suggesting the current run rate exceeds $40 million per annum, thereby reducing the sales multiple to 10 times or less. Furthermore, operating losses narrowed to $3.8 million in the final quarter, running at an annualised rate of $15 million.
The preliminary numbers for Q1 look a bit disappointing with sales seen at $9.9-10.0 million, as that suggests no growth on a sequential basis. That being said, first quarter sales for 2017 were just $0.1 million higher compared to Q4 of 2016, as the fourth quarter appears to be a seasonally stronger quarter. One disappointing fact is that operating losses are seen at $5.1-5.7 million, up quite a bit from the $4.1 million loss in the first quarter of 2017 and the loss reported in the most recent quarter.
A Call Option
It goes without saying that Inspire is a high-risk, potentially high-return story. The company has an interesting product and its solution are clearly in demand. Based on current revenue trends, the company has just about 2,000 patients a year, while its target group in the US alone amounts to half a million patients, with plenty overseas opportunities as well.
Growth is very impressive as operating leverage is healthy as well, although the preliminary loss numbers for Q1 of 2017 suggest that losses are on the increase again.
Besides the obvious risks of being a one-product pony and the fact that the company is currently posting losses, there are other risks mostly related to competition, efficiency of the therapy and closely related to that reimbursement coverage decisions.
On the bright side, the potential for the company is enormous. Pegging the potential target market in developed countries at about a million patients, this could become a multi-billion company. Even if Inspire would obtain just a 10% market share in this market, it could achieve sales of $2 billion, as a common 4-5 times sales multiple could easily justify a $10 billion valuation in that case. In comparison to the current valuation of operating assets around $400 million, this creates real potential for a multi-bagger over a longer period of time. If the chances are somewhat realistic of this occurring, shares are obviously way too cheap.
In that sense, shares should be regarded as a long-term call option in my opinion as the risks are very high, yet prospects look pretty solid based on an interesting technology and solid pace of growth.
For this reason, I am allocating a small allocation, with the focus on small and a speculative, as I essentially treat shares as a long-term call option.
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Disclosure: I am/we are long INSP.
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.