Given Imaging: Slightly Undervalued - Strong Upside Potential But Also Some Risks
Aug 5 2013, 11:59 | about: GIVN (Given Imaging Ltd.)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Given Imaging, Ltd. (GIVN) is an Israeli high-tech, small-cap medical company offering innovative products primarily for the gastrointestinal medical treatment, with the flagship, breakthrough product being its camera-in-a-pill called PillCam COLON, which offers ingestible pill containing a camera as a minimally-invasive alternative to a traditional colonoscopy.
source: company materials
The company has been capitalizing on partnership with a company called RDC, which has first rights to commercially exploit defense technologies developed within Rafael Advanced Defense Systems, Ltd., a leading Israeli defense systems developer. This partnership facilitates finding innovative civil applications for breakthrough military technology advancements and provides Given Imaging with access to cutting-edge, patented technology to establish and maintain a competitive advantage.
The recent July 2013 Japanese approval for the PillCam product greatly changes the future company's outlook to the upside. Japan is the world's second-largest market after the U.S., with a sizeable and growing elderly population, ensuring growing future demand for colonoscopic medical treatments many years or even decades into the future. In the U.S., Given Imaging filed for an FDA approval, and the company expects to receive a positive regulatory sign-off by the start of the fourth quarter of 2013, following detailed European studies and Japanese regulatory clearance. The Japanese sign-off and the pending U.S. clearance are the two main and very strong catalysts for Given Imaging's strong future growth of EPS and stock price.
At the current price of $15.50, the company trades at a 17.63 forward P/E ratio, which is not cheap by itself. However, coupled with the great growth prospects after the substantial increase of the total addressable market due to the Japanese approval and pending U.S. approval, the company is expected to grow 25% per year. For many companies, I would be very suspicious if somebody promised me a 25% CAGR for five years. Indeed, there are risks. I think the 25% growth is achievable and provides a 50% upside by valuing a stock at $23.25.
Nevertheless, I am using a more conservative 15% EPS growth, which provides room for errors and setbacks in the company's future strategy execution. Even at my lower 15% EPS growth, the company's fair value is $16 and the stock is currently approximately 3% undervalued, trading at $15.50. Given Imaging is long-term buy, but with major downside risks and volatility ahead.
Primarily, there are two major recent developments that potentially could have a strong impact on the short-term stock performance:
1. The company no longer explores its sale or merger and plans to focus on its growth strategy
In 2012, the company explored options of a potential sale or merger to realize and maximize shareholder value, but ended these intends in January 2013. After a thorough exploration, the executive committee of the Board of Directors appointed to oversee this process unanimously concluded that the "continued execution of the company's operating plan, supplemented by additional acquisitions and alliances," provides the best opportunity at this time to enhance value for all of the company's shareholders. This is a potentially positive development as the stock will start attracting long-term small-cap growth stock investors. Short-term speculators betting on a takeover price spike had enough time since January to dispose of their speculative long positions.
2. Majority stakeholders seeking to sell their stake as the company emerges from its early stage
The company has one major beneficial owner of a 45.2% stake, the Discount Investment Corporation, Ltd. (TASE: DISI), which directly owns 15% of ordinary shares and indirectly the remainder of its total stake by having a 50.3% ownership in Elron Electronic Industries Ltd. (ELRNF.PK). Elron is a technology holding company focused on financing early-stage startups and usually seeking an exit after successful development of the company. It directly holds a 21.6% stake according to the latest SEC form 13D/A, as of March 25, 2013.
This majority stakeholder announced in January 2013 that it intends to seek and consider a sale of its 45.2% stake of Given Imaging's outstanding shares it owns, directly or indirectly, in one block. This is a major factor for potential investors to consider.
DIC is also in a strategic partnership with the aforementioned Rafael Advanced Defense Systems through a jointly owned subsidiary RDC, ensuring the access to the cutting-edge military R&D and patents.
Until this large 45.2% stake is sold, the company's stock could be under pressure and volatile. There have been some large volume spikes in the number of shares traded, but based on my analysis of the total and daily volume, the 45.2% stake could not have been entirely offloaded through the open market transactions yet, not even a majority of it, and this large stake is unlikely to be sold in the open market. And the majority owner indeed expressed its intentions to sell the stake in one block and didn't rule out a transaction outside of the public market.
Savvy investors should look out for any future dips below the $15 area, as in May to June 2013 period, which was primarily caused by the risk associated with the pending Japanese PillCam regulatory approval, and view them as a great buying opportunity in the long run, as the company is very likely to continue receiving positive approvals in further markets.
Company background
Since pioneering the field of capsule endoscopy in 2001, Given Imaging has become a world leader in GI medical devices, offering health care providers a range of innovative options for visualizing, diagnosing and monitoring the digestive system. The company offers a broad product portfolio including its flagship product, the PillCam capsule endoscope, a disposable, miniature video camera contained in an ingestible pill, for visualizing the small bowel, esophagus and colon. More than 1.9 million patients worldwide to date have benefited from the use of PillCam. The company also offers industry-leading GI functional diagnostic solutions, including ManoScan high-resolution manometry, Bravo capsule-based pH monitoring, Digitrapper pH-Z impedance and the SmartPill GI monitoring system.
The company's headquarters, research and development laboratories and manufacturing facilities are located in Yoqneam, Israel. Operating subsidiaries are located in the United States, Germany, France, Japan, Australia, Brazil, Vietnam and Hong Kong. Given Imaging's technology currently is marketed in the United States and more than 70 other countries.
Sales breakdown
A substantial portion of the company's revenues to date have resulted from sales of the PillCam SB capsule and, to a lesser extent, the Bravo system and the high resolution manometry products. For the future, the majority of its revenues will continue to come from sales of the PillCam SB capsule. Sales of the PillCam SB capsule contributed $116.6M, or 65% of the total 2012 revenue. Sales in the U.S. accounted for $109.5M, or 61%, of 2012 revenues. In 2012, $42.4M, or 23.4%, of total revenues came from sales to distributors, with the rest being direct sales through the company's sales force.
Competitors
Olympus Corporation has a competing capsule endoscopy system for the small bowel, which it is selling in the United States, Europe, Japan, Australia and other countries. In addition, other companies are selling capsule endoscopy systems for the small bowel in Europe, Asia and Australia and possibly other countries. The company also has a number of competitors in and outside the U.S. in the field of manometry and pH measurement.
Indirect competitors also include large and well-established manufacturers of traditional technologies for detecting gastrointestinal disorders (gastrointestinal endoscopes), mainly Olympus, Hoya, and Fuji Film. The principal manufacturers of equipment for radiological imaging are GE Healthcare Systems (GE), Siemens Medical Solutions (SI), Philips Medical Systems Ltd. and Toshiba Corporation.
Sources of growth
PillCam products are core to the company and a strong driver of future sales rise. The company sold its first capsule in 2001 and eight years later it reached 1M capsules sold. It took Given Imaging just four years to sell an additional 1M capsules. However, acquisitions provided most of the past company's growth, putting a big risk and question mark over long-term ability to continue acquiring new businesses to achieve growth.
a) Organic growth
Given Imaging's revenues from sales of capsule endoscopy equipment have not grown in the expected manner. If the company is unable to complete additional acquisitions or grow acquired businesses, its revenue growth could slow down.
b) Regional growth
At the moment, the Asia/Pacific region is the source of the fastest growth with 20% YoY increase. And this positive trend is likely to continue, with Japan and Australia driving the growth at the moment and China expected to add in the future to its current so-so performance for the company. Nevertheless, China enjoys much lower prices than Japan and Australia, so profitability will definitely stem from Japanese and Australian sales, with an average price per capsule of $800 in Japan.
c) Expansion of use cases for existing products
To date, the PillCam SB capsule, which accounts for a significant majority of the company's revenues, has been used primarily for detection of obscure gastrointestinal bleeding. The company strives to expand the use and increase utilization of the PillCam SB capsule for the detection and monitoring of additional small bowel abnormalities, such as Crohn's disease.
d) Acquisitions
In the last few years, the company's revenue growth has been largely due to acquisitions, primarily the April 2010 acquisition of Sierra Scientific Instruments LLC and the 2008 acquisition of the Bravo business. In October 2012, the company acquired virtually all of the assets of The Smart Pill Corporation, and expect such these assets to generate several million additional dollars in revenue in 2013, accounting for roughly 1 to 2%.
e) No share buybacks and dividends
Being in a relatively early growth stage of its lifecycle, the company doesn't pay any dividends and doesn't perform share buybacks. It reinvests all profits back into the business or performs acquisitions.
Financial results
In the first quarter of 2013, the company returned to solid sales growth in both the EMEA and APAC regions, which demonstrate record Q1 revenue growth of 5% and 20%, respectively. However, the total revenue growth in the quarter was below our expectations due mainly to a shortfall in sales execution in the America regions where sales fell 11% YoY. However, the company believes that the Americas region will be back on track in the second quarter and later in the year.
Profitability
On a GAAP basis, net loss for the first quarter of 2013 was $200M, or $0.01 per share, compared to net income of $200M, or $0.01 per share in the same quarter of last year. On a non-GAAP basis, net income for Q1 2013 was $1.5M, or $0.05 per share on a fully diluted basis compared to $1.8M or $0.06 per share on a fully diluted basis in the first quarter of 2012. Japan's yen had a negative impact of $400M on the company's profits this quarter and the trend is expected to continue in Q2.
Financial outlook
The company will hold its second quarter results conference call on August 8. However, during its first quarter conference call, it reassured investors that it will meet its previously given 2013 full year guidance as the current Q2 sales until May 1 are above the year-ago levels and outlook is strong. The company has zero debt and almost $3 cash per share, or 20% of its share price.
Valuation
a) Upside scenario
If the company manages to grow at the 25% annual EPS growth rate in the next five years as the analysts estimate, the fair valuation using a FDCF method would be approximately $23.25 per share, 50% above the current price.
b) My realistic scenario
As mentioned in the opening paragraphs, I expect a much lower 15% annual EPS growth than what the average analysts. Therefore, my fair value comes at $16, 3% above the current share price.
c) Downside scenario
At zero growth following the meeting of the next year's expected average EPS guidance of $0.88 per share would value the company at $8.80 per share. The investment has a substantial downside risk at current price levels.
d) Liquidation value
Incidentally, the rough liquidation value is also very close to a $7.20 price at which the stock would trade at a price-to-book ratio of 1, which can be viewed as a range at which the stock would liquidate. This represents a 50% worst-case scenario downside risk, though, assuming that all assets could be disposed of at full book prices, which is an optimistic assumption. Realistically, the liquidation value would offer a 60 to 70% downside from the current stock price.
Risks
a) Reimbursement coverage
Demand for Given Imaging products depends largely on the eligibility of the procedures performed using the products for reimbursement through government-sponsored healthcare payment systems and private third-party payers. Reimbursement practices vary significantly from country to country and in general, the process of securing reimbursement coverage takes longer outside of the U.S.
b) Management communication style
During the latest conference call, management refused to give any details regarding the reasons for its U.S. sales fall or what specific actions it took to remedy the situation. For me, this is not enough for me as an investor, and it gives me a feeling that the company doesn't really want me as an investor.
c) Return to investors
In the past decade, the return to investors was dismal. The stock gained less than 3% per year annually, underperforming its benchmark S&P 600 small cap index by roughly 130% as well as the broad large-cap S&P 500 by some 50% in total for the 10-year trailing period. The stock had a huge run-up in 2004 though, so traders who timed the exit well made a windfall.
Conclusion/Recommendation
Given Imaging is a company with excellent growth potential. However, with many downside risks, offering a symmetric risk/reward scenario of substantial upside and downside. The stock is fairly valued (3% undervalued) based on my growth outlook, which is much more conservative than what average analysts expect. Nevertheless, there are many risks and challenges that could get in the way of the company's growth efforts, as Given Imaging relies primarily on acquisitions-driven growth and faces tough, larger competitors.
