Syneron Medical - ELOS

Syneron Medical, Ltd. (ELOS) engages in the design, development, and marketing of aesthetic medical products to physicians and other practitioners worldwide. This is a medium risk play on the rapidly growing aesthetic surgery industry. The company’s products are based on its proprietary electro-optical synergy (elos) technology, which uses the synergy between electrical energy and optical energy. Most companies use only optical (light) energy in the various procedures, and Syneron argues that is dual-use (optical and bi-polar radio frequency) is both more effective and safer. Syneron Medical was incorporated in 2000 and headquartered in Yokneam Illit, Israel.

Syneron’s product line includes Aurora, Galaxy, Pitanga, and Comet, which are used in the treatment of hair removal, rejuvenating the skin’s appearance, and acne; Polaris, which is used in the treatment of wrinkles; and Vela, which is used in cellulite treatment. As technology continues to improve, the baby boomers age, and stigmas surrounding certain procedures dissipate, this industry is expected to grow rapidly. Most estimates are for 25% annual growth for the next five years. The company sells its products directly to users and through third-party distributors.

The Bull case for ELOS:
-The stock has been battered recently, due to Sharon’s stroke and a short-term revenue miss (at its last CC the company raised guidance for the year, but now will miss by $3-4M, which is the exact amount which the company announced it had sold but could not recognize because of shipping issues with the shortened holiday week at the end of the year). Having dropped from $45 to $27 recently, the company has a trailing PE of 20 and a forward PE of 12. With expected growth rates in the 20% range this is an attractive valuation. Note also that from a logistical viewpoint the recent drop makes little sense. In October the company increased its revenue guidance from $84-$85M to $91-$92M, and the stock jumped from $33 into the $40’s. Recently the company announced that it would actually have revenues of $88M, with $3-4M in unrealized sales. This news, coupled with an analyst downgrade and Sharon’s health issues, have sent the stock substantially lower than when the expectations were for only $84-$85M in revenue!

-The company has $114M in cash on hand (with a total market cap of $682M), and no debt, giving it many options in terms of organic development and or prudent acquisitions.

-The company has the highest profit margins in the industry, and has an excellent return on equity.

-Syneron has done an excellent job recently with bundling sales (selling units that can do several procedures), and also offers units that can easily handle add-ons (i.e. incremental sales).

-Future product introductions, particularly a non-invasive liposuction treatment (and a spin-off home-use version) could drive sales significantly higher.

-Analysts currently expect the company to earn $2.11 in 2006. If the company earns ~$2.00 this would be >20% growth, and could easily merit a PE of 25 (especially considering the company’s strong cash position). That would put the stock at $50, a near double from here.

The Bear case on ELOS:
- Syneron has many competitors, and there are risks that its margins could be pressured. That said, I think that as the boomers age and as Syneron enters a host of new markets, top line growth will more than make up for any margin concerns. The stock has been struggling recently and could drop further.

- Analyst estimates were predicated on that extra $3-4M in sales which will end up being recorded next Q because of timing issues around the holidays.

- I've also seen reports that the company's increased hiring will result in some incremental G&A expenses that may have not been fully modeled. Put the lower revenues and higher expenses together and you've got a recipe for earnings that may not meet the all important "analyst estimates." If this "miss" comes to pass, and the markets focus on it (I can just see the comments about "deteriorating margins") the stock could take another hit. Of course the argument can also be made that a miss has been more than accounted for in the stock price.

- The longer term bearish case is predicated on the argument that Syneron's industry leading margins are not sustainable, and that increasing competition will result in falling margins, muting the effect of sales increases. This is a plausible argument, as the natural progression of capitalistic markets is to erode abnormally high margins in the absence of barriers to entry or consistent innovation. The question is whether ELOS does have a sustainable competitive advantage. The company clearly has a differentiating factor in that its products use the dual optical/radio methodology. I'm not a doctor and do not really feel comfortable assessing the efficacy of this versus other methods, but I have no qualms with pointing out that from a selling standpoint, this is a major advantage for the company. The medical institutions performing these procedures are all fighting for the same pool of clients, and there's most certainly a benefit in being able to tout the fact that one's equipment uses a patented, dual-method technology that promises superior results.

Syneron’s product line includes Aurora, Galaxy, Pitanga, and Comet, which are used in the treatment of hair removal, rejuvenating the skin’s appearance, and acne; Polaris, which is used in the treatment of wrinkles; and Vela, which is used in cellulite treatment. The company sells its products directly to users and through third-party distributors. Here’s a link to more information: http://www.syneron.com/vela.html

I believe the company will earn $2.20 this year but let's be conservative and call it $2.00. If you attach a 25 multiple on that - also conservative relative to its peer group multiple of 27 times and its earnings growth rate - you get a $50 stock. Over $100mm in cash, no debt. Huge new product cycle - the VelaSmooth alone, for example, will do more sales in 2007 than the whole company did in 2004. Then there's non-invasive liposuction coming out next year. And a home solution in the works so people can zap their problem areas without leaving the house. Throw in the demographic shift and aging effects on the body.

2006 has been seen as something of a transition year, with Syneron expecting to bring a couple potential huge sellers (the non-invasive liposuction product being perhaps the most interesting), but I think that if the company can deliver adequate results the market will respond quite positively. Right now ELOS is being priced as if its business has hit a major roadblock, but there simply isn't any real indication yet that this is the case.

And on the patent infringement issue that is of concern on all the companies in this segment thanks to Palomar's patent attorneys who have been working overtime. Not only is the company going after Cutera (CUTR:Nasdaq), but Cynosure is also at risk. And other companies in the sector that use lasers or intense pulse light (IPL) -- which is almost all of them -- are also getting nasty legal notices from Palomar. In Cynosure's prospectus, it states: "On July 2, 2004, Palomar Medical Technologies, Inc. sent us a letter proposing to enter into negotiations with us regarding the grant of a nonexclusive license under specified United States and foreign patents owned or licensed by Palomar with respect to our Apogee Elite, Apogee 5500, PhotoLight and Acclaim 7000 products, and also with respect to our SmartEpil II product, which we no longer offer. In subsequent letters from Palomar dated September 14, 2004 and March 24, 2005, Palomar reiterated its willingness to negotiate a license under these patents and, in its March 24, 2005 letter, stated that it continues to believe that we need a license under these patents for each of the products listed in the July 2, 2004 letter, as well as for our PhotoSilk, PhotoSilk Plus, Cynergy, Cynergy PL and Cynergy III systems. We have not entered into negotiations with Palomar with respect to such a license."

Syneron is insolated from any of Palomar's patent disputes because its Electro-Optical Synergy technology, or ELOS, is unique. Other noninvasive aesthetic products rely solely on optical energy from lasers or IPL, limiting the safety and effectiveness of many procedures because optical energy alone isn't able to adequately penetrate the skin. Rather, it undesirably becomes absorbed in the outer layer of skin. High-power optical energy also requires relatively large and heavy equipment, which can be cumbersome and costly. Syneron's ELOS technology adds radiofrequency energy to the mix, and is the first approach to combine electrical and optical energy. So it looks like ELOS will steer clear of all patent infringement claims because its technology is so very different.

In a recent analyst report in December, investment bank CE Untenberg suggested that Syneron is trading at 31% discount to peers (prior to the huge drop in Syneron’s price). Its peer group, by the way, is small medical technology companies, mainly ones making products for laser and cosmetic therapies.

ELOS announced their results in February and there were really no surprises from the pre-announcement in December. ELOS now trades at PE ratios almost half of its major competitors.

From smallest to largest:
-- PMTI 2005 rev 76.2, 2006 rev estimate 93.5, increase +17.3, or 22.7%
-- CUTR 2005 rev 74, 2006 rev estimate 93, increase +19, or 25.7%
-- ELOS 2005 rev 87.4, 2006 estimate 116.5 (I used midpoint of their guidance), increase +29.1, or 33.3%
-- CLZR 2005 rev 124, 2006 estimate 148, increase +24, or 19.4%

So on revenue alone, ELOS is far and away the fastest projected grower. Peer group at 20-26% (CUTR is the highest of the peer group and it has serious patent fight on hand!), and ELOS is still in this "disappointing" #s expected to come in, in the low 30%s

Again, if ELOS was the highest valued in the group on PE, PS etc maybe some haircut in order, but before PMTI's recent fall, ELOS was valued at half the valuation measures of PMTI and still trades at a deep discount to the 3 named above. Yet now it is being punished further.

ELOS has announced an analyst day on March 6th in SF. Other comment on note from their earnings call in February:
- Net margin 45-47% for 2006 down from 51% in 2005, more expense in sales force (commissions, new sales avengues, etc) and R&D more spending
- Q3 2005 was very low in sales expenses which in retrospect in getting the word out about Syneron.
- Gross and operating margin will stay steady in 2006 vs 2005
- They plan to get into a lot of medical conferences in first half of 06 to get word out. "Doctors talking to doctors" is the best marketing. They anticipate the Vela product to be more popular after working through the medical conferences in 1st half of 2006.
- They have been working on the home use product internally for 18 months and the first cycle of clinical trials are already complete. ELOS May also enter into a PMTI and Johnson and Johnson type of distribution agreement with 3rd party big distributors – they are making sure safety is verified before moving forward. The home use product could be in the market by the end of 2006.

Disclosure:

Position: Very long and my largest position in the portfolio as of Feb 20^th 2006. Own both equity and have written Out of the Money Naked Puts with a June expiry.

Last Updated: February 22^nd 2006

GOL Linhas Aereas Inteligentes SA - GOL

I have responded to a few queries on what’s my approach to “research” as a retail investor and if I can share my research on the stocks I “track” or own. In response, I have decided to share my research on specific stocks in this blog as and when time permits. I will start with my largest holding ELOS and the international company that fascinates me the most, GOL (though arguably ELOS is international to – an Israeli company that I happen to “track” under a small-cap Medical Appliances and Equipment category.

GOL Linhas Aereas Inteligentes S.A., (GOL) provides airline services on routes between the cities of Brazil. It offers approximately 350 daily flights to 42 business and travel destinations in Brazil and Argentina. As of June 30, 2005, the company operated 34 single-class Boeing 737 aircraft serving 39 destinations in Brazil and 1 destination in Argentina. GOL Linhas Aereas Inteligentes is headquartered in Sao Paulo, Brazil.

GOL which is growing incredibly rapidly began life just a few years ago as the brainchild of a Brazilian bus company. They are copying the early moves of Southwest Airlines very closely - they fly all Boeing 737's so far to standardize training and maintenance and keep costs lower, they are doing a great job of cost containment, and they fly direct routes to where people want to go. It's smart to follow the lead of the most successful airline in the Western Hemisphere, and in doing so they have grown their traffic rates more than 50% in the last year.

GOL is basically an amalgam of JetBlue, Southwest Airlines, RyanAir and the other successful low cost airlines, but it's in Brazil. They are taking the best features of many of these budget airlines that have revolutionized western air travel and combining them into one service that is dramatically changing air travel in the largest country in South America and looking to expand to all of Latin America. But they have also moved beyond that SWA model quickly in one significant way. They are aiming to become not just the airline of choice for Brazil, but for international and domestic flights throughout South America. They have started nearby, with Bolivian and Argentinean flights, and they are even moving into Mexico with a franchise deal has caught some attention as well (though there's plenty of low-fare competition likely in that country, for sure).

GOL is still quite small and an upstart in its home country -- they operate about 400 daily flights and have a market share of around 30% at the moment, but it looks like a great story. The airline was founded by the Oliveira family, which owns and operates a large intercity bus system in Brazil, and this is clearly a family that understands how to build and run a business to move a large population.

The key for me is that GOL is growing quickly and, with the limited amount of research I've done so far on South American air travel, they've got the chance to really become a dominant force given the way they've hit the ground running. So what's keeping me? The stigma associated with investing in any airline given the way the US fliers have performed, and they've already grown and seen their stock appreciate very quickly - it's trading at a PE of about 30, which is not cheap for a Brazilian stock. Bu I do like their growth and their remarkably low cost structure, and the fact that they're not very well followed here in the US – well until recently. Of late they have definitely started to catch the world's attention with their excellent returns, and the number of US analysts on their earnings conference call has gotten significantly higher.

GOL is growing at well over 50% a year and still building out with massive plane orders in place, and they're just starting to tap into debt financing. Recent development suggests that GOL is partnering to bring its model to Mexico. They added routes to Bolivia several months ago ... then Paraguay, Uruguay, and Argentina were announced just in November.

The Bull case for GOL:

--They're following an established strategy, albeit one that hasn't been tried in many countries, in basically mimicking the successful low cost airlines with good service, low frills, and great prices.

-- They are changing the marketplace - not content to just operate a business to serve existing customers, which in Brazil might have been profitable given the significant amount of business travel, they're bringing in people who've never flown before, putting them on their first airplane, and building a big customer base. Like the "Southwest Effect" before them, they're calling this the "GOL Effect" - it's now cheap enough for lower and middle income Brazilians to fly when they never would have considered it before. One of the smart things they are doing is flying a lot of cheap overnight flights - using planes that would be otherwise sitting on a runway and selling much cheaper flights for those unfriendly hours, thereby bringing still more fliers into the market.

-- They have massive insider ownership. Regardless of their actual night flights, this is not a "fly by night" company that will try to take advantage of the hot environment for Brazilian stocks and then disappear. The founding family's company owns roughly 75% of the shares and they're trying to build a business that will stand the test of time and revolutionize South American travel.

-- They have huge advantages over comparable US airlines in cost control. I admit that I still suffer from the admonition "never buy an airline" but GOL seems different. Price controls from the government through Petrobras allow them to have much lower fuel costs than most of the rest of the world. A dramatically different operating environment allows them to provide world class service at developing world salaries without nearly the legacy costs of their competitors -- so their pilots, for example, make about $35,000 a year versus over $200K at Southwest. And unlike the bankrupt Varig, the flagship airline in Brazil, they don't have the same kind of legacy costs as the US carriers. That means they can operate at a profit even while charging rock bottom ticket prices -- right now, the operating margin for GOL is 37%, which blows every other airline I've ever heard of away.

The Bear case for GOL:

-- Currency risk with the recently appreciating Real (R$)

-- Political risk with the leadership scandals and just the general emerging market risks that we take on when we invest outside the established western investor world.

-- Varig, the current flagship carrier of Brazil and GOL's largest competitor seems to be finding its way out of bankruptcy. Varig has been faced with very similar problems to the US flagship carriers in the past couple of years, including a legacy of heavy regulation, huge labor costs, and large liabilities and big debt on the books. There is some risk that their bankruptcy will enable them to dramatically cut costs, as some of the big US carriers have done, which theoretically would enable them to move more toward the low fare model that GOL has followed to great success. Just a remote risk, given US Airways is not a viable competitor for JetBlue and Southwest today, even though they've been through bankruptcy twice! :-)

-- Government regulation of the airline industry was a significant issue 20 years ago in the US, and it can certainly be argued that the removal of regulatory controls dramatically changed the landscape and brought real competition and allowed new entrants to grow into the marketplace, making air travel much more feasible for all Americans. Brazil is not about to deregulate its airline industry, as far as I can tell. The governmental philosophy is dramatically different -- as evidenced by the controlling stake the government holds in Petrobras, the big oil company. The government is committed to letting private enterprise grow, but in my opinion it is also very concerned about directing growth in their economy. The focus on overall steady growth and the lack of a truly free market means that GOL’s competitive picture should remain relatively steady. GOL now has a significant edge over the small upstarts that might fly a dozen or so routes and who want to build their business -- GOL is now an established company with 400+ flights a day, and they can certainly make a stronger argument for their ability to effectively manage additional routes than can a very small and, in most cases, financially unstable competitor. So the way I read the regulatory landscape in Brazil (and I'm no expert on this topic), GOL has some protection from smaller carriers that might try to horn in on it's routes by buying market share with even lower prices, because the government doesn't want to see that kind of instability (prices moving dramatically up and down, small companies betting the farm on their ability to buy market share until they run out of money. Compare with Independence Air for the US version of this cautionary tale).

-- The biggest bear case would be the discussion of if I have sat and watched this too long and if it has already had its run and I am too late for the party. This stock would be a case for Buy High, Sell Higher and is not really “value-priced” (unlike another stock I will blog on today – ELOS)

The reason my interest has really perked up lately, in spite of the excellent run GOL has had:

-- GOL just increased their guidance for 2006

-- Petrobras, which controls prices for oil in Brazil under governmental guidance, just cut jet fuel prices by 5.3%, according to both Investors Business Daily and Marketwatch articles on Feb 15^th. So this aids in GOL’s relatively cheap jet fuel in Brazil, where they do most of their fuel consumption and where prices were already well below international market rates.

Disclosure:

Position: None, but bullish on GOL and looking to buy some on any pull back.

Last Updated: February 20^th 2006

SeekingAlpha: This blog also appears in the Transport Stock blog of SeekingAlpha at http://transportstockblog.com/article/8729