Comments:
LVCI: More competive environment ahead; downgrade to Market Perform
Market Risk HIGH
September 29, 1999 Target Price NA
Earnings per Share Cal LT Shares 52
------------------------ P/E Growth O/S Week
04/99 04/00E 04/01E 2000E Rate Yield (Mil.) Range
------ ------- ------- ------- ------ ----- ------ -------
New: $0.12 $0.34 $0.47 38.2x 40% 0.0% 28.8
Old: $0.20 $0.53 $0.73
Q1/Jul Q2/Oct Q3/Jan Q4/Apr Total
------ ------ ------ ------ ------
1998 (0.19) (0.07) (0.05) 0.01 (0.30)
1999 0.01 0.03 0.04 0.05 0.12
2000E 0.07A 0.08 0.09 0.10 0.34
2001E 0.11 0.11 0.12 0.13 0.47
2002E 0.14 0.15 0.16 0.17 0.62
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o More competitive environment ahead for laser center operators
o Contraction in laser center stock multiples should be sustained
o Focus on fully taxed earnings to value LVCI; Advest now reporting fully
taxed EPS to First Call
o LVCI is fully valued at current price levels
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Increasing laser placements and competition for patients and quality surgeons has led to a contraction in laser center multiples. The success of industry leaders LVCI and TLC The Laser Center (NASD/TLCV $24) has brought new competition into the laser center market much quicker than we had previously projected. Our model now calls for 303 net new excimer lasers to be placed in the U.S. during 1999. This estimate is 52% higher than the 198 new lasers we had projected when launching coverage on LVCI in June 1999. Our estimate for capacity expansion will more likely be increased than decreased based on the second half 1999 results that we expect from suppliers of excimer lasers. Our current model calls for 791 excimer lasers installed in the U.S. by year-end 1999, a 62% increase over the 1998 year-end installed base.
New competition is coming from all quarters: independent surgeons as well as existing and new corporate laser center operators. In the last two months, three new players have announced their intentions to enter this business. Combined with the significant private and public capital being raised and the ophthalmic PPM companies focusing on this market, the field is becoming increasingly crowded. This increased competition is seen in battles for patients, affiliations with quality surgeons and contracts with entities that can help direct patients to laser centers (e.g. vision insurance plans and
retail optical chains). We believe investors are paying sharply lower multiples for laser center stocks because of this increased competition.
While we have confidence in LVCI's model and execution abilities, its sources of growth are substantially changing to fixed-site lasers and to its "Market Development Model" (partnership with surgeons where LVCI takes on more margin and more risk). We applaud this direction for LVCI and believe it to be an essential part of its future growth. But the shift in its model also represents a higher degree of risk for investors. LVCI's ability to effectively direct patients to its centers was less important in its traditional mobile model, and
its capabilities here require investment and development. LVCI's level of investment and results from efforts to sign agreements that direct patients to its centers appear to lag those of TLC.
We expect multiple contraction to be sustained. Laser center bulls and bears typically differ on the issue of barriers to entry. In a sense, both are right. While barriers to buying a laser and opening a center are very low, building patient volume and a profitable business in today's refractive surgery market is increasingly difficult. Barriers to entry are rising quickly as the industry
leaders occupy key positions (leading surgeon affiliations and corporate contracts). We believe marketing and patient contracting activities are the keys to laser centers' value-added and margins. LVCI adds value beyond this with its patented "Roll on Roll off" mobile technology and operational capabilities. That said, we believe many investors will require continued reassurance that growth and margins are sustainable for the industry leaders.
Focus on fully taxed earnings to value LVCI: We are changing the EPS figures we report to First Call from the 6% "cash tax" estimates reported by other sell-side firms to a fully taxed (38%) EPS estimate. At 7/31/99, LVCI had $48 million in U.S. federal tax shelter from prior exercises of stock options and another 5.1 million options with an average strike price of $9.60 that will provide additional tax shelter. With the recent halving of LVCI's stock price, the estimated value of these future tax credits (equal to strike price minus exercise price) is significantly reduced. At current prices, these additional options, combined with LVCI's NOLs, have the potential to offer federal tax shelter through the end of calendar 2002 (mid fiscal 2003). By the April 2000 quarter, LVCI will be booking tax at the 38% rate but will only pay taxes at the
6% rate until the end of calendar 2002.
Assuming an increased focus on quality of earnings as this industry matures, we believe investors will value LVCI tax credits as an asset going forward and apply a reasonable multiple to LVCI's taxed earnings. Using generous assumptions, the present value of this future tax benefit is $1.50 per share.
LVCI is fully valued at current price levels. At $16.44, excluding $3 per share in tax credits and cash, LVCI is trading at 31 times estimated fully taxed calendar 2000 EPS of $0.43 and 36 times next four quarters projected EPS of $0.37. These multiples represent a modest discount to the 40% five-year EPS growth rate we believe LVCI can attain. We believe this modest discount to growth is appropriate given the industry factors noted above.
LVCI's multiple represent a significant premium to LVCI's piers. TLC the Laser Center trades at 19x the consensus First Call estimate for 2000 and LCA Vision (NASD/LCAV $5.34), trades at 14x 2000 EPS. We believe that LVCI does warrant a premium to its peers owing to its lower risk business model and better earnings visibility. We believe, however, that a multiple approaching 2x its peers is inappropriate. |
