Eargo: I Am Slowly Starting To Listen

Summary

• Eargo ended 2020 on a solid note after it guided cautiously.
• The 2021 guidance looks soft, equal to the annualized fourth quarter sales numbers.
• I think part of this is certainly caution which together with a big pullback makes that appeal is slowly emerging.
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Eargo (NASDAQ:EAR) has been an interesting name which I followed since it went public in October of last year. In December, I concluded that I was leaning a bit cautious after shares doubled on their first day of trading and ever since continued to move higher.

This momentum surprised me to some extent as I was not too impressed with the operational achievements and traction of the company. In the meantime, the company reported very strong fourth quarter sales numbers and shares have seen a big pullback which is compelling, yet the 2021 guidance is underwhelming, even if it is likely cautious.

The Thesis

Eargo has a goal to disrupt the market for hearing devices with its quality and customized solutions, including a direct-to-consumer business model. The hearing aid aims to tackle the stigmas and disadvantages of traditional hearing aids, including a social stigma, accessibility and costs.

Eargo claims to have advantages as it is invisible, rechargeable, and completely in-canal. This focus on innovation, comfort, and expertise makes that 42,000 systems were sold through June 2020, a very small number given that more than 40 million adults suffer from hearing loss, let alone the international market opportunity.

This market continues to grow as aging is the most common cause of hearing loss, as the impact on the quality of life is substantial. Given the demographic trends and higher life expectancy of the population, it seems safe to say that this is a growth market. As the company targets a higher end segment of the market, it targets 14 million potential patients with a market size of $30 billion, at revenues per device of roughly $2,000 each. Greater adoption and more insurance coverage should drive potential.

The company went public at $18 per share, as 37 million shares represented a $660 million valuation at the time, although that number included $200 million in net cash. The $460 million operating asset valuation looked high for a business with less than $7 million in sales in 2017, on which it lost $18 million. Sales more than tripled to $23 million in 2018 as losses rose to $31 million and change. Revenue growth slowed down to 41% in 2019 as sales nearly hit $33 million, while losses rose to $44 million.

While growth is impressive, the lack of operating leverage is not too compelling. That being said, I liked the operating momentum in the first half of 2020. Revenues essentially doubled to $28 million and change for the six-month period, marking an acceleration in growth as operating losses were down to $17 million.

With sales trending at $64 million a year based on the second quarter results, shares were valued at 7 times annualized sales. This moved down to 6 times sales based on the third quarter sales guidance of $18 million.

While that looked relatively compelling, shares doubled to $36 on the first day of trading, pushing up the operating asset valuation to 15 times. Valuations only rose further to 23 times sales as shares traded at $50 late in December, as that prompted me to get cautious.

What Happened?

In November, the company reported third quarter sales of $18.2 million, a 135% increase on an annual basis as operating losses of $7.6 million were in line with the guidance. The guidance for the year revealed an expected $17.7 million in fourth quarter sales, which was a bit concerning as it marked a small sequential decrease in sales. This is disappointing given the pace of growth. With sequential sales essentially flat, the 23 times annualized sales multiple made me a bit cautious given the huge run in the share price. Based on this dynamic, I decided to cut my small position as the risk-reward did not strike me as very compelling at that point in time.

In January, the company reported preliminary revenues of $22.2 million which was way ahead of guidance, as it seems that the company was guiding conservatively. The $22.2 million revenue number reveals a $89 million annualized sales number. This growth and momentum in the market made the shares hit a high in the low $70s per share, but they fell to the $60 mark later that month when the company reported its definitive fourth quarter results.

Despite the accelerating growth, the company reported an operating loss of $9.9 million as the 2021 guidance was not too convincing in my eyes. The $90 million revenue guidance (at the midpoint of the range) was exactly in line with the annualized fourth quarter revenues being reported, suggesting no real growth although this likely has a conservative angle to it.

In the meantime, shares have now fallen back to $43, which has reduced the equity valuation to $1.59 billion as the company operates with a net cash position of around $200 million, for a $1.39 billion enterprise valuation. This reduces the sales multiple to 15 times sales, yet the outlook is very worrisome given that there is no pick-up seen in the annual results vs. the run rate reported in the final quarter of 2021.

The move lower has de-risked the thesis a bit already. While I found the risk-reward not compelling at $50 in December, we of course have seen a rally to the low-seventies, and now back to the low-forties. Despite this sizable move, I am leaning cautious here as I am not too convinced with the 2021 guidance, yet the fourth quarter numbers reveals that management is likely conservative in its guidance.

That alone is not enough of a reason to be compelled as I see no reason why sales should not hit or exceed the $100 mark. While the sales multiples have contracted a great deal, I am not seeing great risk-reward just yet, although dips to the thirties might be used to initiate a small position again.

Analyst’s 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.