Over the last few weeks we have written on why we feel Solta Medical (NASDAQ:SLTM) is a strong buyout candidate. Based on the current actions of Voce Capital and the company, we feel Solta will be bought out within six months. This week, we want to detail why we believe Solta is also a good speculative investment, regardless of whether it is acquired soon or not.
Solta has an array of aesthetic device products and has the potential to generate large revenues down the road if managed properly. Recently, management has already started showing signs of turning the company around. With the correct moves, Solta should be able to increase shareholder value and actually begin to turn a profit.
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Change in Management
The most significant problem with Solta Medical was the company’s former Chief Executive Officer (CEO) Stephen Fanning. For years he bought and merged products into Solta and continually destroyed shareholder value by not focusing on producing proper earnings for the products the company already had. A better CEO would have levered the existing products to turn a profit, and then used those profits to acquire and develop other products. However, Fanning decided to acquire numerous products without a system set in place to generate profit and proper revenue. This has lead to a stale and bleeding stock price over the last few years.
Shareholders and board members both recognized this problem and on August 23, 2013, decided to show Fanning the proverbial door. Afterwards, Chairman of the Board Mark Sieczkarek was placed in as the interim President and CEO. On September 3, Solta engaged CT Partners to lead a search for a new CEO to permanently replace Fanning.
Replacing Fanning and finding new leadership is key for the company going forward. Solta has an array of products that have the potential to generate large revenue and profit. If new management can lever its current products correctly, the company should generate significant earnings per share (EPS).
Array of Products
Although Fanning helped to destroy shareholder value, he did leave the company with an impressive array of products.
The “Baby-Boomer” generation is the largest demographic of people in the United States and the population as a whole is aging more rapidly. With the increased acceptance of aesthetic procedures, many people are looking for ways to look and feel younger. The aesthetic market is one of the fastest growing markets in the world, with worldwide global sales of $5B in that sector alone.
Solta’s has products that are a part of several multi-billion dollar industries. If new management can capitalize on correctly monetizing these assets, Solta’s shareholders should see better results over the next year or so. We still strongly believe Solta will be acquired soon, as suitors would likely have to pay a higher price as the company executes.
Fat Loss Market: Body Contouring
The weight loss business has become one of the most valuable and fastest growing businesses in the world. As of today the fat loss market is valued at over $60B total. People are becoming more health conscious and also want the fastest and easiest solutions to attaining a good physique. It is becoming more acceptable to forgo the traditional methods of good nutrition and exercise. Many people are opting for surgery or pharmaceutical solutions to their weight problems.
However, many have questioned the safety of these newly approved weight loss drugs.
In 2012, both Arena Pharmaceutical’s (NASDAQ: ARNA) Belviq, and Vivus’s (NASDAQ: VVUS) Qysmia received FDA approval for its weight loss drugs.
Both of these products were the first weight loss drugs approved in years by the FDA. However, the European Merdicines Agency (EMA) rejected both of them due to concerns over potential dangerous side effects which include heart disease and depression.
Sidney M. Wolfe, MD, offered his point of view on the EMA’s rejection of these drugs:
“Are Americans more resistant to the risks and more likely to benefit from certain drugs than Europeans? Or, on the contrary, is the European Medicines Agency more resistant than the U.S. Food and Drug Administration to the drug industry’s desire to get approval for drugs with unique risks but without compensating benefits?”
Belviq showed a 16% increased risk of heart failure compared to placebo, but only yielded 3% more weight loss. Qsymia saw 4.2% of trial patients experience heart arrhythmia, compared to 1.8% of patients on placebo. The FDA took note of these risks when they approved both these drugs.
Orexigen Therapeutics (NASDAQ: OREX) is also developing its weight loss product Contrave, which has completed Phase III clinical trials and is currently being studied in a cardiovascular outcomes trial. Orexigen’s stock price over the last year has increased significantly on the heels of both Arena’s and Vivus’s successful FDA approvals. Many feel Contrave could offer a better solution than both of these companies. However, on Contrave’s first try at regulatory approval, Orexigen received a complete response letter (CRL) from the FDA in 2011 rejecting the drug and requiring the company to perform additional clinical trials, as noted by the FDA:
“Before your application can be approved, you must conduct a randomized, double-blind, placebo-controlled trial of sufficient size and duration to demonstrate that the risk of major adverse cardiovascular events in overweight and obese subjects treated with naltrexone/bupropion does not adversely affect the drug’s benefit-risk profile.”
Contrave is a combination of two drugs that have been on the market for years, Wellbutrin and Naltrexone. Wellbutrin is an antidepressant and Naltrexone is used for addictions. One of the side effects of both these drugs is weight loss, so in part, this acts as a mechanism of action in Contrave.
Orexigen has complied with the FDA, and is currently in a longer duration Phase III trial with Contrave to determine its effect on the heart, if any. The common negative denominator among these weight loss drugs is the increased risk of heart issues which could arise after years of use, potentially leading to some of these drugs being recalled by the FDA.
We point out the risks of these weight/fat loss drugs not to “bash’ on these companies, but to show a potentially safer alternative. We feel these weight loss drugs have a potentially substantial market for them, and should produce the companies who create and market these drugs significant revenue over time. However, questions over their combined safety remains, as clearly shown by the data.
Solta’s VASERshape and Liposonix have the potential to become top procedures in the market for quick and easy shaping and fat loss. These products are non-invasive and use heat and lasers to shape the patient’s body. In relation to other options, body contouring devices have practically zero downtime, are more cost-effective, and are more efficacious in reducing fat.
In 2010 the body contouring market was valued at about $857.5M and is forecasted to reach $2B by 2017. The numerous advantages of this type of procedure has many analysts speculating that it could be very successful. Millennium Research Group Analyst April Lee stated:
“These non-invasive products will have the effect of expanding the fat reduction market. While some physicians have doubts about their efficacy, the desire for eliminating body fat without surgery and the extensive marketing efforts of the device manufacturers will bring in many patients who previously would not have considered a procedure. As a result, while the body contouring device market is expected to average around nine percent annual growth through 2016, revenues for the non-invasive segment will show growth of more than 40 percent annually.”
Skin Care Market: Anti-aging and Acne
Solta also has numerous products in the large skin care market. The anti-aging market is projected to be worth over $5B in 2015 and is expected to grow very rapidly. Analysts from World Health explain why skin care is going to be a rapidly growing market:
The primal desire of humans to remain young forever has long groomed and nurtured an ever-growing anti-aging industry worldwide. The market for anti-aging products should post strong growth patterns for the upcoming years, backed largely by affluent aging baby boomers with high levels of disposable income. The anti-aging products market is traditionally resilient to economic cycles, given consumers unchanging desire to look young and healthy.
Solta is set to grab significant market share with products that focus on skin tightening, skin rejuvenation, and acne. Solta’s leading skin tightening product is called Thermage Total Tip 3.0 and is currently the company’s top product. Thermage is another noninvasive treatment that uses radio frequency to smooth the skin. The company also has three other products called Fraxel, Clear+Brilliant, and ReAura that have shown great results as skin rejuvenation devices.
Solta is also involved in the acne market, which is projected to grow at a 3.2% rate and reach a $3B valuation in 2016. If over the counter treatments are included, worldwide global sales of acne products is valued at about $5B. Analysts view this market as stable regarding growth, and if Solta can generate some revenue from this avenue, it would be an added bonus. According to industry analysts:
Because acne-prone individuals consider treatment products a necessary expense, revenue continued to rise during the recession, though growth did slow as consumers switched to more inexpensive products. In addition, the increasing prevalence of adult-onset and persistent acne conditions has given rise to new targeted products.
Solta has a product called Isolaz that has some advantages over current acne treatments. One of the mainstream solutions to acne problems is with prescription medication. However, some of these patients have concerns regarding side effects, have a delay for the medication to work effectively, or have a resistance to the medication. Isolaz is a treatment that effects acne in 24-48 hours, is painless, and is a rapid treatment of only 10-20 minutes. These advantages could give Solta a unique avenue to generate even more profits for the shareholders.
New loan agreement
As per the company’s recent 8k last week, it has entered into what can basically be described as an extended line of credit/re-worked loan agreement. A source of mine spoke with the company CFO about this, and he informed the source that the company engaged in this to give it more flexibility in regards additional liquidity on hand, and to spread payments out. While the company has increased its debt to $33M or so, it can make smaller interest payments over time. Furthermore, according to the loan agreement:
“All obligations under the Amendment are secured by substantially all of the personal property of the Company. The Amendment contains restrictions that include, among others, restrictions that limit the Company’s and its subsidiaries’ ability to dispose of assets, enter into mergers or acquisitions, incur indebtedness, incur liens, pay dividends to make distributions on the Company’s capital stock, make investments or loans, and enter into certain affiliate transactions, in each case subject to customary exceptions for a credit facility of this size and type.”
Former CEO Fanning’s continued pursuit of spending company money on acquisitions and parent mergers did not increase shareholder value, but wrecked it. Free cash flow was used for these activities rather than to produce EPS. Shareholders overwhelmingly voted down a company proposal to add an additional 100M shares that Fanning would have certainly used to further dilute them again and use the money to parent merge and acquire more companies for their assets. The new loan agreement forbids both of these activities, signaling the company’s serious intention of moving towards producing increased revenues and EPS. The agreement obviously does not forbid Solta from being acquired itself.
Interim CEO and Chairman of the board, Mark Sieczkarek, should know and understand his legal fiduciary responsibility as the leader of a public company. Based on what we are seeing so far after Fanning’s removal, it does “appear” Sieczkarek seems to understand this.
Activist shareholders Voce Capital and David Callan onboard and watching
In case Sieczkarek does not fully grasp his legal responsibilities to the shareholders, Voce Capital and David Callan are onboard here to ensure the correct course of action is taken for themselves and the shareholders. However, after Sieczkarek was appointed interim CEO, Voce released a letter that admonished the company for this decision, mainly because Sieczkarek hinted that his interim title could become a permanent one. Voce remarked how Sieczkarek was also responsible for shareholder equity destruction, and is dead set against him ever becoming the permanent CEO here ? we agree with Voce on this point.
In response to this letter, Solta issued a press release where it informed the market that it has engaged CT Partners to lead a search for a new CEO to permanently replace Fanning. This is a positive sign and step in the right direction for the company in our opinion.
In its letters, Voce has mentioned that there are at least three companies with acquisition interest in Solta, with our sources telling us they have heard about one additional company interested in addition to a private equity group. This brings the rumored total to five companies.
With Solta apparently abiding in Voce’s wishes to find a new CEO, and with its new loan agreement which it’s legally bound not to incur more debt, we feel Solta should be in a position now to receive a fair offer for the company. This is unless these interested companies want to risk Solta executing and hitting on guidance, which would force them to bid even higher if they want the company and its high potential assets. As mentioned, Voce public letters, along with our sources, say these companies very much want to acquire Solta
It’s imperative that Solta understands that both Voce and Callan are not going away and will be actively involved in how this plays out. Though we have no direct knowledge, in our opinion Callan is likely to acquire the shares to take his position over the 5% threshold to become a major shareholder, providing him the needed leverage to effect a change if necessary.
According to one source of ours, Fanning may have miscalculated and misplayed his hand with trying to sell Solta, figuring that acquiring new assets would equate to Solta receiving a high offer for acquisition. He didn’t realize that the company needed to first show it could execute correctly with these assets, gaining a leveraged position of strength from which to negotiate with.
The weight/fat loss market is valued at over $60B. As mentioned and shown by the data, weight loss drugs could have health concerns moving forward, sparking doctors and patients to look more closely at body contouring devices.
Furthermore, Solta’s international revenue is up 24% YOY, and is sure to increase as the company recently received regulatory approval in Singapore, Brazil, and Taiwan for Liposonix, which should further bolster both top and bottom-line numbers.
Solta’s product line in the hands of a bigger operator with a strong international market presence such as Valeant (NYSE: VRX) could net billions in peak sales over time, especially in Asian and South American markets where these treatments are really catching on.
Valeant has aggressively expanded itself through various smaller acquisitions, making around 25 deals a year since 2010 which are mainly focused on specialized high-margin markets, lately with its focus on the aesthetics market.
Valeant has a long-term strategy of buying high-margin health care product businesses that are strong in emerging markets ? for example, Asia. In these markets, customers tend to pay directly for products and services rather than relying on government health plans.
Because of the above factors, we feel Valeant will ultimately end up acquiring Solta within the next six months or so.
Companies with acquisition interest in Solta have watched the company over time lose acquisition leverage with Fanning’s poor leadership. Until now, there has been no legitimate urgency for any company to bid for Solta at an acceptable price.
Our opinion is that management’s current course of action should turn around Solta to produce substantial revenue growth and EPS. Our take therefore is that interested companies can offer a fair price now that is acceptable, or watch Solta execute a simple plan and gain a higher valuation moving forward.