Soliton: Avoid This Company

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About: Soliton, Inc. (SOLY)
by: Innovative Investor
Summary

Soliton has spent $25 million in the past five years developing the RAP technology.

If accepted by the Food and Drug Administration (FDA), the device will help improve the tattoo removal industry by reducing the amount of time it takes to have one removed.

In addition to the tattoo removal industry, the company hopes that the technology will be helpful in the cellulite removal purposes.

Soliton (SOLY) is a small medical device company established in 2012. The company, which is pre-revenue, is developing the Rapid Acoustic Pulse (RAP) technology that is aimed at the tattoo industry. If accepted by the Food and Drug Administration (FDA), the device will help improve the tattoo removal industry by reducing the amount of time it takes to have one removed. In its website, the company says that the technology will help reduce the number of clinical visits from about 10 to 2-3. In addition to the tattoo removal industry, the company hopes that the technology will be helpful in the cellulite removal purposes.

Investment Thesis

After running out of cash in 2018, the company went to the public markets through an IPO, which raised more than $7.9 million. Since then, the company’s stock price has gained by more than 140% and its valuation has risen to more than $171 million. Investors have cheered the recent announcement that the FDA will start reviewing the RAP device. While the company has been relatively rewarding to early investors, this article explains why it should be avoided, especially by long-term investors. First, while the company’s technology makes sense, but it is still in its early stages and there is a likelihood that it will not get an approval by the FDA. Second, even if it is approved, the company will need to raise more money, which will lead to dilution of existing investors. It is riskier when you consider that SOLY has been in the industry for more than 7 years and has nothing to show for it in terms of revenue.

Financial Position

The table below provides a summary of the company’s performance in the past two years.

Financial Position

Source: Soliton

As shown, since the company does not have any revenue, its income statement is made up of its expenses. In 2018, its research and development expenses rose to more than $4.6 million while the sales and marketing expenses rose to $304K. According to the company, the jump in sales and marketing expenses was attributed to ‘social media development’. Obviously, this is a curious expense because the company did not have any need for social media at a time when it did not have a product. In fact, looking at the social media platforms raises more questions than answers. On Twitter, it has just 31 followers and has sent just 80 tweets. In Instagram, it has just 136 followers while in Facebook, it has tried by having more than 200K followers. From my perspective, I see no reason why a company without a product spent all that money on ‘social media development.’

The company’s balance sheet is not pleasing either. As of December 31st, the company had just $133K in cash. Factoring in the $9.7 million it raised in February, it means that the company has less than $10 million in cash. At the same time, its liabilities are increasing. At the end of 2018, its total liabilities were more than $21 million. This was double from where they were in the previous year. At the end of the year, the total current assets were $143K, while the total liabilities were $21 million, giving it a negative working capital of more than $20 million. Therefore, from an investment point of view, this means that the company will run out of cash soon. In the 10K, it says that the IPO funds will be depleted by February next year.

Early Stage of the Technology

Investing in a pre-revenue biotech company like Soliton is a risky thing for a number of reasons. First, there is no assurance that the FDA will accept the RAP device. In its 10K, the company highlights this as its biggest risk. If the FDA rejects the device, it could lead to a sharp decline in the stock as we have seen in other companies. For example, in the past one year, the stock price of Advaxis (ADXS) has declined by almost 90% after the FDA rejected its Axalimogene filolisbac. Obviously, the counter-argument is that the stock will soar if the FDA approves the device is right. However, the other risks highlighted in the article makes it difficult for me to recommend buying the stock.

Need for Capital Raises

As a follow-up to the previous point, if the FDA accepts the device, it will be the starting point of more challenges. This is because, the company will need more money to build, market, distribute, and educate the clinicians. To do all this, the company will need millions of dollars, which it won’t have. In its 10K, the company says that the current IPO funding will run out by February 2020. This means that it will need to raise more money from the investors, which will lead to more dilution of the original investors.

Small Company

As mentioned, Soliton is a small and unproven company that aims to break in the multibillion dollar industry that is dominated by large companies like Cutera (CUTR) and Hologic (HOLX). These companies have a distribution system, larger R&D teams, and a brand name. While it is possible to disrupt an industry, past experience of companies like Amazon (AMZN) and Tesla (TSLA) shows that a company needs to have really strong backers to succeed. In addition to this, investors should remember that SOLY is not a new company. It has been in the industry for more than 7 years and has nothing - in terms of revenue - to show for it.

Finally, while valuing a pre-revenue company is a bit difficult, I believe that investors are paying a very high premium on a company that does not have any revenues, that will be in need of more money soon, that is operating in a commoditized industry, that has an unproven management, and one that is likely to continue posting losses for the foreseeable future.

Conclusion

Investing in a company like this is usually a high-risk and high-reward exercise. This is because if the FDA accepts the device, the stock will soar and the company could be acquired by a bigger rival. Also, if the technology works, it can be applied in other industries like in cellulite removal. On the other hand, if the FDA rejects the device, the stock will tank and the company will go out of business because it does not have other products. Therefore, because of how the management is spending its money, its small size, and the need for a capital raise, I would recommend avoiding the company.

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.