GOLDEN CAPITAL SECURITIES LTD. PT.3
Sales and Distribution Strategy
As Current Technology is a small Canadian company, it does not have the money or marketing expertise to penetrate distant markets, let alone develop them. The Company has elected to pursue a distribution strategy which relies on exclusive agreements with national distributors in each geographic region, thereby establishing a dealer network capable of providing localized marketing for the ETG machines, and opening the door for the distribution of additional products and services down the road.
The terms of the distribution agreements vary on a case by case basis, but contain some common features: a pre-specified number of units to be shipped over a pre-specified period (three to seven years, depending on the country), with the understanding that failure to meet these targets gives the Company the option to nullify the contract and find another exclusive distributor for that region. Initially, contracts were negotiated with annual sales targets; they are now being negotiated with quarterly sales targets, which affords the Company greater flexibility in monitoring its product sales. If the quarterly or annual targets are not met, the distributor has a fixed amount of time to pay a deposit on each device it has failed to purchase, the balance of which is payable upon delivery. Failure to make a deposit can result in the distrib-utor losing both his or her exclusive status and all subsequent royalties derived from annual use fees. Contracts with licensees and distributors include provisions whereby the Company reserves the right to review all marketing materials, and to inspect operations to ensure quality standards are being upheld. Thus, while distribution is carried out at arm's length, the Company has made an effort to ensure that it retains ultimate control over its brand name.
While distribution is decentralized, the Company does have the capability of providing some product support through its head office. Each unit is equipped with a modem and self-diagnostic program. By simply connecting the unit to a phone jack, all rele-vant information regarding the unit's operations - battery life, short circuits, loose connections, etc. - can be transmitted back to the Vancouver office for technical support. Parts which need to be replaced can usually be dispatched by overnight courier.
Revenue generated by ETG devices include an upfront compo-nent and an ongoing licensing component, or "technology use fee". The units retail for US$25,000, and the gross margin is split equally between the Company and the distributor. The tech-nology use fee is charged to the end user, and is equal to the greater of 10% of gross income per device or US$10,000. As with the gross margin, this fee is split equally between the Company and the distributor. End users are at liberty to set their own fees as local market conditions warrant - and could even provide the treat-ments for free if they so choose - provided they pay the minimum US$10,000 annual use fee. By incorporating an annual fee into the revenue model instead of charging a higher sales price, the Company can distribute its revenue stream from a single sale over several years. The Company has protected itself against non-payment by programming the ETG devices to administer a fixed number of treatments at a time. Users must contact their national distributor periodically in order to acquire additional treatment blocks, and distributors are empowered to refuse additional blocks to users with accounts outstanding.
Valuation
There are few comparables for Current Technology, since the Company's primary competitors are either privately-owned clinics and "hair clubs", or large pharmaceutical companies. There are three companies that we would consider to be comparables on a general level, but none that we consider to be a direct comparable. The three companies include two development-stage pharmaceu-tical companies and one development-stage cosmetics company specializing in non-drug hair and skin care products.
Life Medical Sciences is a development stage medical products company based in New Jersey. While its products are geared primarily towards skin repair, it currently has a topical hair regrowth product (Piliel) in Phase III clinical trials. For the six months ended June 30, Life Medical Sciences lost US$3.7 million (US$0.46 per share) on revenues of US$33,000.
ProCyte is a development stage healthcare company focusing on specialty wound care and dermatological applications, based in Washington. The Company recently started marketing GraftCyte, which is used in conjunction with hair transplants to reduce the period of shedding as scalp wounds heal, and currently has a hair loss treatment (Tricomin) in Phase II clinical trials. For the six months ended Jun 30, ProCyte lost US$3.6 million (US$0.27 per share) on revenues of US$1.6 million.
SBI Skin Biology is a skin and hair care products company based in Washington and founded by the former president of ProCyte. The Company has a range of cosmetic products, including anti-wrinkle creams, suntanning and anti-peeling products, skin repair creams, veterinary skin care products and a hair restoration product. Unlike the other comparables, SBI is marketing products for cosmetic rather than medical use, and therefore circumvents the rigorous regulatory screening processes. For the year ending December 31, SBI lost US$627,000 on revenues of US$20,000.
Price Shares Mkt 12M
Sep 2 O/S Cap EPS
Life Med Sci* (NQ-CHAI) 5.125 7.9 40.5 -0.74
ProCyte* (NQ-PRCY) 1.219 13.4 16.3 -0.72
SBI Skin Biol (V-SBI) 0.48 8.2 3.9 -0.07
Current Tech (V-ONE) 0.59 24.2 14.3 -0.12
*US Dollars
Market caps vary widely among this group of companies. The relatively low valuation placed on SBI suggests that the market places a significantly higher valuation on medical products than on cosmetic products, as this is the only company whose products are not being marketed as medical therapies.
Because Current Technology does not readily compare to any existing company, it is best viewed in relation to industry aggre-gates. Since the Company is expected to be profitable in 1998, it can be valued on the basis of forward-looking price-earnings multiples. At the low end, the PE for the S&P 500 is 25, while at the high end, the PE for medical devices is 35. The PE for personal care products is around 33. Based on these earnings multiples and our projected EPS of $0.088 for 1998, our target range for Current Technology is $2.20 to $3.00 for 1998.
Risk Factors
New Product.
ETG is a new treatment unlike any existing hair loss products on the market. Because it is a new product, there is little information upon which to forecast the product's market acceptance. While the initial response (as measured by the number of formal agreements being signed) has been favourable, there can be no assurance that this enthusiasm will be sustained over the longer term.
External Distribution Network.
The Company distributes the ETG device through exclusive agreements on a country-by-country basis. While the Company strives to make these agree-ments as comprehensive and binding as possible, sales revenue is ultimately driven by distributors' success in meeting their targets rather than by factors within the Company's direct control. Non-performance on the part of one or more of the larger distributors could significantly impact revenues.
Regulation.
Regulatory approval is perhaps the biggest hurdle facing the Company, as it cannot market its product as a medical device without the approval of health authorities in each jurisdic-tion. ETG devices are approved for sale by the Health Protection Branch in Canada, and by the regulatory authorities in New Zealand, Australia and Mexico. All European sales are contingent upon receiving regulatory approval in at least one jurisdiction within the European Economic Community. While the Company expects approval to be forthcoming from the UK authorities, bureaucratic delays are beyond the Company's control.
US Market.
The US is the dominant market for hair loss products, due to its demographics, income level and youth-oriented culture. The fact that the Company cannot market its product in the US as a medical device at this time will undoubtedly limit its earnings potential. The FDA has indicated that it requires data from long-term studies in order to evaluate the efficacy and safety of the ETG device for chronic use, but has not indicated how extensive these studies must be. The Company is confident that it will even-tually receive FDA approval in consideration of the fact that the ETG device has already been approved in four countries (including Canada and Mexico) and will likely be approved in Europe this fall. However, when or if the FDA approves ETG cannot be known with certainty.
Competition.
The primary competing product to ETG is Pharmacia & Upjohn's Rogaine, which is distributed worldwide at a price below the expected cost of ongoing ETG treatment. It is expected that Merck will introduce the second FDA-approved treatment in the near future, which will increase competition within the hair loss treatment market even further. Both Pharmacia & Upjohn and Merck have significantly greater marketing and distribution resources at their disposal. While the ETG device is covered by various patents, there can be no assur-ance that the device could be duplicated in jurisdictions which do not recognize external patent protection.
Consumer Confidence.
Hair loss treatments are generally met with extreme skepticism in the marketplace, as results tend to be highly inconsistent and often fall short of expectations. While the Company is careful to emphasize that ETG is not a cure and that the cessation of hair loss is the primary objective of the treatment, many consumers will still expect complete regrowth. Many users of hair loss products also have a tendency to expect instant results. Treatment results which fall short of consumer expectations even if consumer expectations are unrealistic could adversely affect the Company's perception in the marketplace.
Outlook
Current Technology is just starting to see significant sales revenues after a decade of product development. Because its distribution agreements are structured to deliver a fixed number of devices over several years, the Company expects sales growth to escalate over the coming years. At face value, all of the Company's signed agree-ments amount to a total of over US$28 million, allocated over seven years. Letters of intent amount to an additional US$19.4 million. While it is likely that at least some of these agreements may ultimately fall through, the Company's client base is broad enough that its revenue is not dependent upon the performance of a single distributor.
In the first two quarters of 1997, Current Technology has sold 48 of its ETG devices to twenty two clinics in seven countries. We are anticipating sales in 1997 to total around 100 units, rising to 270 units in 1998. In addition to these sales revenues, we are assuming a conservative US$10,000 technology use fee per unit the minimum contractual fee required to maintain exclusivity on the part of distributors. We have assumed that administrative expenses are fixed for the most part, such that the increase in unit sales in the rest of 1997 and in 1998 will not require additional overhead. Based on these assumptions, we arrive at an estimated net loss of $530,000 on revenue of $2.3 million for 1997, and an estimated net income of $3.0 million on revenues of $7.1 million in 1998. By the end of 1998, we expect a total of around 370 units to be installed worldwide.
Sales are not expected to rise substantially in the initial year, as distributors typically purchase a limited number of ETG devices on a trial basis before entering into larger contracts. In addition, we are allowing for bureaucratic delays in regulatory approval in certain key markets, which will undoubtedly restrain initial sales. By late 1997, we expect to see an acceleration in sales as regulatory hurdles are overcome and distributors complete their evaluation phases.
We are basing our investment thesis on the premise that the ETG device can deliver an effective treatment which prevents, and in some cases may reverse, androgenetic alopecia. Published articles from double blind clinical studies support this thesis.
Based on a PE multiple of 30 and an EPS of $0.088 for 1998, our share price target $2.70. We view this as a lower bound target based on conservative sales projections. Share price appreciation will derive primarily from earnings growth, as the Company's market capitalization does not appear to be undervalued relative to its peers.
SPECULATIVE BUY
Julian Marlowe (604) 844-3036
marlowe@istar.ca
GOLDEN CAPITAL SECURITIES LTD. 7 |
