CHF Solutions, Inc (CHFS)

[Tommy]

$SSH - Sunshine Heart: Potential '10 To 100 Bagger' Re-Visited - Part I

http://seekingalpha.com/article/1777172-sunshine-heart-potential-10-to-100-bagger-re-visited-part-i?source=email_portfolio&ifp=0

Reason to re-visit

Back in early March this year, I wrote an article, "Sunshine Heart: Potential '10 Bagger' In 4 Years, '100 Bagger' In 10 Years" as a follow up to my article, "Sunshine Heart: Risk and Reward".

I have been receiving requests for an update of the above mentioned "10 Bagger" article. A lot has happened with Sunshine Heart (SSH) in the intervening period, including a near doubling of the share price, so it is an appropriate time for an update.

Effect of share price increase on "10 to 100 Bagger" status

I wrote in my March 2013 article that a significant contribution to Sunshine Heart's potential multi-bagger status was what others had referred to as the "insanely low valuation of Sunshine Heart" (share price $5.99 at the time of my article).

At that time, Sunshine Heart shares had to increase to $59.90 by March 2017 and $599 by March 2023 to achieve the projection of 10 times increase in 4 years and 100 times increase in ten years.

At the current share price of ~$11 per share, the above projected future prices would represent only a 5.5 times increase through March 2017, and a 55 times increase through March 2023. A further near-term increase in share price, to say $15, would bring the original 100 times increase by March 2023 down to a 40 times increase. So back in March, a $5,000 investment at $5.99 per share that was projected to grow to $500,000 in 10 years' time would now only be projected to grow to $200,000, by the same time in the future, at a price per share of $15.

When the market gets it wrong

"Mr. Market" sets the price of a share in a listed entity on a daily basis. Particularly for a micro cap such as Sunshine Heart, Mr. Market is not always well informed.

An "Alpha Rich" investment opportunity presents itself when a "High Reward" investment opportunity has, in fact, a relatively much "Lower Risk" than the market has implicitly assigned to it.

I believe Sunshine Heart is one of those "Alpha Rich" investment opportunities. This could be due to the market underestimating the "High Reward" prospects and overestimating the "Risk" aspect. Or more likely, it could be the market has not made any meaningful attempt to quantify the risks and the rewards.

One reader of my most recent article, "Sunshine Heart: Profitability And A 'Light Bulb' Moment", was highly critical of the current value I placed on Sunshine Heart shares. The reader went on to indicate in comments that they believed Sunshine Heart could achieve a value of $3bn to $4b in the future (say an average $3.5bn).

Another reader suggested, based on HeartWare's (HTWR) market cap at a similar stage, that a market cap of $1.25bn in 5 years should be achievable.

Quite obviously those readers certainly believe there is a potential "High Reward" on offer in the future -- though nowhere near as high as I believe can be achieved based on detailed projections, supported by comprehensive high level assumptions (see my most recent article referred to above).

But despite this view of market caps in the billions in the future, the current market cap of Sunshine Heart is just $185M.

Table 1 below gives an indication of the levels of risk adjusted discount rates required to be applied to those future values nominated by readers ($1.25bn in 5 years, and $3.5bn for various future periods) to arrive at the current market cap.

Table 1 -Implied risk adjusted discount rates to arrive at Sunshine Heart current market cap from projections of future market caps in future years

Very high risk adjusted discount rates can be the source of very great opportunity

High risk adjusted discount rates, such as those in Table 1 above, are a two-edged sword.

They are on one hand an indication that an investment is perceived by the market to be very "High Risk".

On the other hand, if I believe the market perception is wrong and the actual risks are not that high, then the high discount rate provides a high growth investment opportunity. If the perceived level of risk does not eventuate, then the high discount rate effectively becomes a high compound growth rate for the initial investment.

Table 2 below shows the way an investment will grow at selected discount rates/compound growth rates.

Table 2 - What $1 will grow to at selected yearly compound growth rates for various numbers of years

It will be seen from Table 2 above that an investment with a compound growth rate of 10.41% will increase to 4 times the original investment after 14 years.

But at a 41.42% compound growth rate, an investment would increase to 128 times the original investment after 14 years.

What is relevant here is all but one of the implied discount rates in Table 1 are above 41.42%. So the potential for "100 Bagger" status is still there, despite the current share price nearly doubling since my previous article on this subject in March.

Assessing the risks of an investment in Sunshine Heart

I have researched and written a number of articles on Sunshine Heart over the last 9 months and have received many comments from readers with a similar interest in its very promising C-Pulse opportunity.

Together with readers, I have explored the many issues that have been raised as potential risks. There have been discussions and debates, and for every perceived risk, there has been an answer that either eliminated that risk or greatly reduced the concern about that potential risk.

The recent PropThink interview with Mr. Dave Rosa, CEO of Sunshine Heart, gave an opportunity for questions to be asked directly to the company on concerns about potential risks for Sunshine Heart and its C-Pulse system. Not only were answers given that eliminated or reduced concerns on various risks, but a new potential market opportunity was revealed.

Nevertheless, Sunshine Heart is a micro cap with the usual risks associated with a micro cap. It is still in the early stages of a pivotal trial for marketing approval in the US. It has CE Mark in the EU, but is still in the process of seeking approval of reimbursement, which involves a post approval trial in the EU. And its fully implantable model is still in pre-clinical stage with animal trials expected to be completed by end of 2013.

Appropriate discount rates to reflect the risk in an investment in Sunshine Heart

Taking into account the foregoing, I believe the following risk adjusted discount rate ranges would be appropriate for determining present values of Sunshine Heart from projected future values -

For projected future values out to 8 years, a range of 15% to 25%; and
For projected future values out 9 to 14 years, a range of 20% to 30%.

The higher rates shown for the longer period are to take account of the longer elapsed time being an added risk.

As Sunshine Heart progresses with its development, and as announcements are made that are positive, I would expect a reduction in risk. This could result in a downward review of the above proposed risk adjusted discount rates.

Applying the above proposed discount rates to the projected values per Table 1

In Table 1, there are projected future values of Sunshine Heart at various future year ends, and the current market cap of Sunshine Heart as given data. From this data, implied risk adjusted discount rates have been calculated.

In Table 3 below, the implied rates have been replaced with selected discount rates from the above proposed ranges.

Table 3

I believe the above future values will, in time, prove far too low. But even the lowest projected market cap in the range is $254M. That is 37% above the current market cap and equivalent to a share price of ~$15 per share.

As described above, the projected future value of $1.25bn is based on using HeartWare's current market cap as a proxy for value of Sunshine Heart in 5 years time.

This would seem to be a reasonable approach to valuation, even if I would say it is likely on the low side and too far out. The resulting current valuation range of ~$400M to $500M is equivalent to a share price of ~$24 to $30 as compared to the current price of ~$11 per share.

Conclusions:

The current Sunshine Heart share price of ~$11 and market cap of ~$185 appear to be an undervaluation by a largely poorly informed market. A higher current share price of $24 to $30 is justified.

The greatest risk to long-term shareholders from such a situation is the adverse dilution effect if a new stock offering is made.

In Part II, I will address how shareholders might take steps to avoid dilution. I will also expand on the scenario included in my last article for future value and current value of Sunshine Heart. These scenarios will include a "Worst Case" and a "Likely Case".

I will await the information on the TCT Conference being held Monday, October 28, and any resulting impact on the share price before completing Part II.

This way I should be in a position to provide estimates on future share value and "multi-bagger" potential from a solid starting point.

Caution: As always, please do your own research before any buy or sell decisions. Use of information and research in the article above is at your own risk.

Investing in micro cap companies is not suitable for all investors and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risks. Due to illiquidity, share prices can fall despite strong fundamentals and possible inability to raise sufficient additional cash to continue to fund ongoing operations is always a serious concern. Fuller details of risks associated with Sunshine Heart as identified by the company may be found with their form 10-12B/A registration filing with the SEC and their other SEC filings.