Mad2,
I think that you have severely underestimated the value of Gum Tech's gum business. Yes, the gum business has lost money for the past several years, but I think that this will come to an abrupt halt one or two quarters after they begin production of nicotine gum. Gum Tech has also said that they are in negotiations with a toothpaste company to produce a new dental gum. The production of this gum should improve capacity utilization and push the company over their break even point even without nicotine gum.
Let's try to agree on some conservative estimates for gum sales in 2001. Combined sales of Smith-Kline Beecham's Nicorette gum and Nicoderm patch were $183 million (+68% YTY), $122 million (+11% YTY), and $120 million (+9% YTY) in the first three quarters of 1999. To be conservative, let's assume that sales in Q4 will be flat with Q3 at $120 million. This would bring SKB's annual sales to $545 million. SKB said that their share of the US market for smoking cessation products is over 95%. They didn't say what their share of the world-wide market is, but let's assume that most of their sales are in the US. Dividing $545 million by 0.95 brings us to estimate that the smoking cessation market was valued at approximately $575 million in 1999. If we assume a modest 10% increase for 2000 and 2001, sales of smoking cessation products would approximate $632 million in 2000 and $695 million in 2001. According to one research report, the smoking cessation market is expected to grow to about $1.5 billion by 2007. This theory is supported by the increased public disdain for smoking and the emphasis by world-wide governments and private organizations to encourage people to quit smoking. SKB doesn't say how their sales are divided among gum and patch, but it is my belief that sales of nicotine gum will eventually overtake the patch. This is based on my belief that the patch is on the downward slope of its life cycle and nicotine gum is in the relatively early stages of its life cycle. If there is an even split between gum and patch, we would estimate that sales of nicotine gum were approximately $285 million in 1999, and would grow to $315 million and $345 million in 2000 and 2001 respectively.
One of the complaints that consumers have with market leader Nicorette is that it doesn't taste very good. If you know Gary Kehoe like many of us, you would have confidence that Gum Tech will produce a nicotine gum that beats Nicorette on taste, flavor variety, texture, and price. Swedish Match is highly experienced in the distribution and marketing of nicotine products and has established channels in 140 countries. Based on this micro and macro market analysis, what is a fair estimate for sales of nicotine gum in 2001? If they only get 10% of the market, the joint venture would have sales of about $35 million in 2001. If you believe like me that the Gum Tech/Swedish Match joint venture can capture 25% of the market, their sales would approximate $86 million in 2001. Gum Tech owns 49% of the joint venture. Since the agreement with Swedish Match is structured as a joint venture, the sales from the joint venture will not be consolidated in Gum Tech's income statement. Rather, they will probably just include a line item on their income statement for "minority interest in joint ventures". Still, for the sake of trying to value Gum Tech, let's assume that they book 49% of the joint venture's sales on their income statement. What is a fair value for this enterprise? Is 4 times sales fair? I think that this is very conservative, and that the stock will actually trade at a higher valuation (6 to 8 times sales) to discount growth in other areas, such as pharmaceutical drugs delivered through chewing gum.
At any rate, with 10% of the market and a P/S of 4, the value of Gum Tech's nicotine gum business would be about $68 million. If they capture 25% of the market, the value of the nicotine gum business would be about $168 million. Keep in mind that this is the value of the nicotine gum cessation business only. Their other gum business has some value as well as they should turn a profit soon after beginning production of the new dental gum. I also believe that the Swedish Match/Gum Tech joint venture will market nicotine gum as a substitute for smoking (rather than cessation). Sales of tobacco products in the US alone were approximately $46 billion in 1999. Even if the joint venture convinces only 0.1% of the people who smoke to use nicotine gum as a substitute for smoking, the joint venture would have sales of $46 million. This would add about $20 million to Gum Tech's sales and an additional market capitalization of about $80 million based on a P/S of 4. A 1% penetration would equate to a staggering $460 million in sales to the joint venture, $230 million to Gum Tech, and additional market capitalization of $920 million based on a P/S of 4. If the market assigns a P/S greater than 4, the value will obviously be higher. I'm NOT attempting to hype GUMM, but when you compare the size of this company to the size of the markets that it is entering, you can get some pretty staggering predictions. Even with more modest predictions, the value of the gum business is significantly higher than $50 million, IMO.
I think that you have also underestimated sales of Zicam in the first quarter. For the record, my estimate is currently between $15 million and $20 million. I don't think that sales will drop off in Q3 and Q4 as you have suggested due to international channel filling and restocking in Q4 for next cold season. In addition, if Zicam is clinically proven to reduce allergy symptoms, sales should be fairly stable year-round. There may be a time to short GUMM, but I honestly think that you guys are way too early. It would be ideal if we both make money, but I think that this will require you to take quick profits from the short side when you get them.
Best of luck with your position.
Dan |
