- Outset Medical has seen continued commercial traction and provides a comforting guidance for 2021.
- While the guidance is strong, I still believe it might be conservative given the recent commercial traction and potential of the home market.
- Outset has everything going for itself to create a long-term multi-bagger and I am a happy holder here around the $50 mark.
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When Outset Medical (NASDAQ:OM) went public in September of last year, the stock attracted my interest. In November of last year, when the company released its first quarterly results as a publicly-traded company, I believed that the prospects for this medical firm looked good from the outset.
This medtech firm ticks all the boxes including spectacular growth, a real runway for growth, an approved product with good costs and quality improvements versus competition, and potential for further approval to only increase its addressable market.
Outset is known as the developer of the Tablo Hemodialysis Systems, with the benefit to reduce cost and complexity of dialysis in so-called acute and home settings. Basically, the system allows for dialysis anytime, anywhere, and to anyone. The machine only requires tap water and electricity to work, releasing patients and caregivers from frequent hospital and clinic visits.
The FDA-approved solution can be used in hospitals and clinics, but the real benefits are that this can be delivered in a home setting as well. This does not just result in greater cost savings but provides much greater convenience as well.
The potential market is huge as 800,000 people suffer from kidney failure, with spending on dialysis running at $70 billion a year. While Tablo was already approved by the FDA in 2014, this was for acute and chronic care in a controlled setting, with the home market segment being cleared in spring of 2020. That is very important, as the home setting is 4 times as large in terms of the market potential than the acute care market.
Valuation & Commercial Traction
Outset Medical went public at $27 in September, yet shares ended their first day of trading at $60, which worked down to a $2.2 billion operating asset valuation. That was a huge number for a business with just $2.0 million sales in 2018. While growth was spectacular, with sales increasing to $15 million in 2019, associated losses were huge as well, with an operating loss of $70 million reported that year.
Growth continued to be very spectacular as $10 million for the $15 million revenue number for 2019 was achieved in the second half of the year, and revenues for the first six months of 2020 alone already totaled $19 million.
With me estimating the run rate at $50 million in sales at the time of the IPO based on these numbers, I assumed that operating assets traded at 40 times sales, yet I observed that the spectacular growth was almost entirely driven by the acute care setting. This meant that the approval for the home setting was a huge driver, certainly as it did not show up yet in the numbers.
Accounting for that, I pegged a realistic sales run rate at $200-$300 million in a few years time for a sales multiple at less than 10 times which looked reasonable. With shares having fallen from $60 on the first day of trading to levels in the forties just weeks after the public offering, I was happy to initiate a small speculative position, which I have doubled down on ever since.
Third quarter sales were reported in November. Sales of $13.8 million revealed not just a 400% growth rate, they furthermore confirm a $55 million run rate, in line with my estimates, as again the revenue number does not yet include the potential for the home market. More good news arrived in January as the company announced the appointment of Karen Drexler to its board, a board member of ResMed (RMD) which has played a role in creating a big player of that firm.
Moreover, fourth quarter results are comforting by all means. Fourth quarter revenues of $17.2 million were up 143% on an annual basis and run at approximately $69 million a year. With the first production taking place in a new facility in Mexico, the company reported a positive gross profit for the first time, as despite this achievement there was still a big $31 million operating loss reported. That said, the worst of the losses seems behind as the run rate is largely in line with the $117 million loss reported for the year. Furthermore, operating losses are down substantially from a reported operating loss of $40 million in the third quarter.
With 42.7 million shares now trading at $56 per share, the current market value of $2.39 billion includes just over $300 million in net cash, for an operating asset valuation just below $2.1 billion. Based on the current sales run rate, operating asset valuation has fallen to 30 times sales. Furthermore, continued momentum is seen in 2021 with first quarter sales seen at $21-$22 million and full year revenues seen at $89-$94 million, although I would not be surprised to learn that this guidance would be conservative. This is certainly the case as this year will see some home revenues be recognized as well, and the backlog of 550 systems is rather large.
The results and outlook confirm my belief that the company is a real disrupter in its field, a huge field with large repetitive form of care which results in better outcomes for payers (in terms of the bills) and that of the patients (more convenience, at-home solutions). If there is something to win for all stakeholders, there are few limiting (or restrictive) factors in this success as we see great operational momentum at the moment.
Firmly believing that sales likely come in around or even above $100 million, even as it contradicts to the official 2021 guidance, I peg forward for current sales multiples at just over 20 times. While this is a big multiple for a still money-losing firm, I think that the market might still underappreciate the potential of the solution and thus the firm here, which led me to increase my stake recently in the high forties (again).
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This article was written by
The Value Investor has a Master of Science with specialization in financial markets and a decade of experience tracking companies via catalytic company events.As the leader of the investing group Value In Corporate Events they provide members with opportunities to capitalize on IPOs, mergers & acquisitions, earnings reports and changes in corporate capital allocation. Coverage includes 10 major events a month with an eye towards finding the best opportunities. Learn more.
Analyst’s Disclosure: I am/we are long OM. 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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