Consensus community valuation
Looking through the trading update and quarterly for SomnoMed some positive indicators which may see results improve considerable going forward and thus see share price improve accordingly.
Firstly SomnoMed although operating in a competitive landscape has reached 860,000 pataints worldwide and are clearly meeting the needs for sufferers of Obtrusive Sleep Apnea (OSA) whom do not require CPAP.
Revenue for the half ending 31st December were 45.1m up 13% (7% constant currency). In annualising this we are approaching 100m in revenue and with a gross margin of 61-62% this revenue is SHOULD be meaningful enough to allow positive operating cashflow and in turn profitability to flow though over the next year.
What is of interest ?
- Operational Impacts in Q2 - In Q2 SomnoMed operationally were impacted by 8/23 milling machines being down for 2 weeks (which are all back up and running). Growth run rate to that point was 15% with an estimated revenue impact off 900k for the quarter. This has been resolved and do not expect to see such impacts to results moving forward.
- Growth in revenue across the globe is solid at low double digit however currency movement has provided significant assistance.
- What is of interest is the move to finally reign in costs. Neil flagged this at AGM in November 2023 and stated we will see significant costs eliminated in the second half of 2024.
Unpacking this there were some positive signs in the release of 4C for Q2 whereby product costs fell 30% to $6,345,000 comparable to Q1 and if they can hold this % will be a significant contributor to the improved financial results going forward.
To further elaborate on Neil's comments re shareholders reaping the benefits of significant cost improvements in the second half i am anticipating costs as a % of revenue to be at 95% of lower.Over the past eight quarters costs as a % of revenue has varied enormously from as low as 83% to 144%.
If costs of 95% to revenue were to be achieved, consistently operating cashflow will be positive to the tune of $1.1m -$1.2m for Q3 and Q4. The assumption regarding revenue is that SomnoMed will grow revenue at 10% above Q3 and Q4 last year.
The consistency regarding cost control is key for SomnoMed and when combined with 10% growth in revenue should see 2024-2025 Operating Cashflow exceed 5million.
Is this was to occur it the current market capitalisation of 53.8m presents value as i would expect a higher multiple to be paid for the cash being generated.
Disc- Hold in RL and SM
SOM - Quarterly-Appendix-4C-Cash-Flow-Report.pdf
SomnoMed still on track.
Good traction in North America and Europe, with revenue there up 12% and 15% respectively for the quarter (quite a bit better too when you factor in FX movements).
Cash flow from operations breakeven, compared to -$2.2m in the pcp.
The reiterated guidance represents >50% growth in EBITDA for FY23 and has been consistent since the issue of last year's results.
Rest Assure validation has now been completed and regulatory filings have begun. It's been some time in the making, but they're getting very close to commercialisation of this new product now. It's hoped this will help overcome some of the prescription and reimbursement hurdles, and gives them a real point of difference.
Shares are presently on <0.9x sales, which is rather low given the top line growth. Then again, the EV/EBITDA ratio is 37 so from a valuation perspective a lot is riding on the success of Rest Assure. So far it's all upfront cost and added expenditure, but if it sees any traction and they can get anywhere close to their stated targets (FY26 rev of $150m in revenue and 10% operating margin) there's good value here.
Disc. Held.
Shares in Somnomed are down 6% after releasing results (see here), now at a 3 year low.
You'd think the results were a disaster!
All regions saw double digit growth, with a record result in Europe. Also improved gross margin and EBITDA positive, which is trending above guidance. This is despite a big investment into sales and marketing and R&D.
Still, it's only been about 7 orders worth $17k that has driven the price action on the ASX today, but the shares just cant seem to catch a bid!
Management did say that they had a challenging end to Q2 in the US, which is facing increased competition from lower cost providers, plus a few supply chain issues. And they've secured more debt to help fund their growth initiatives (although given the share price that's a better funding option than issuing new shares). But I dare say that's why the market has reacted as it has.
They are guiding for FY revenue growth of 15-20% (last year was 16%). EBITDA is expected to remain positive at $2m, compared to $1.3m last year. That'd put shares on a P/S of roughly 1x, but an EBITDA multiple of 43x.
If you expect sales momentum to more or less continue, and some operating leverage to emerge, it seems good value. For context, management reiterated the FY26 aspirational goal of $150m in revenue and 10% operating margin. If they did that, you'd only need shares to trade on an EBITDA multiple of about 9x at that point to get a 15% average annual capital gain.
Held.
Quarterly update and cashflow statement was out earlier in the week. Overall the results fine, but there were a few things mentioned that is not ideal:
- Revenue guidance for the full year downgraded from 20%+ to 15-20%. EBITDA guidance of $2m+ is maintained.
- Rest Assure, the new digital product, is probably 3-6 months behind schedule due to CE mark testing taking longer than expected.
- A weak Q2 performance in the US blamed on supply chain, logistics and macroeconomic pressures and increased competition.
The last point and especially the word “competition” sounds ominous.
I’ve had some clarification from management on this, and feel they could have communicated the US situation a bit better.
Essentially the company had a few logistical issues converge in Nov-Dec 2022. Fedex/UPS from the Philippines (manufacturing plant) to the US blew out from 2-3 to 6-10 days, staffing issues and covid at the US distribution hub, staffing issues and covid at the Philippines plant. All these issues blew out the time for patients to receive a SomnoMed oral appliance. Dentists were desperate to fulfil orders before the end-of-year reimbursement deadline so some went with cheaper products that were in supply. Most of the logistical issues have or are in the process of being resolved. The CEO is confident that this is a temporary shift in behaviour, and that the dentists will be back now the delivery times have normalised.
Of more concern is the poor global economic environment and its impacts on consumer discretionary spending. Oral appliances are not fully reimbursed in the US, and patients need to contribute to a co-payment. Recently there have been more instances of patients pushing back on these co-payment. Much of the business in Europe is fully reimbursed and does not experience this same dynamic.
Not the best update. Hopefully it’s just a small bump in the road. This time next year it could very well be self-funded, with Rest Assure generating accelerating growth rates and the market could be looking at it very differently.
The final annual report for FY22 was released yesterday. I had a read through, and refreshed my understanding of the unvested options situation. Others may find this interesting.
In June 2021, a vote was passed to grant board members, the CEO and key staff members a whole heap of options.
- Vested over 5 years, with 1/3 vested over the 3rd, 4th and 5th anniversaries.
- Exercise price is $2.00
- Vesting condition is the share price will need to exceed $3.50 for a period of time
- At the time was worth around $0.15/option - so translates to $90k/year over 5 years for the CEO, and $18k/year for non-exec directors.
Bottom line: Everyone is very well incentivised to get the share price over $3.50 by mid-2026.
Details of the options grant: https://www.asx.com.au/asxpdf/20210422/pdf/44vs4btr6r2ln5.pdf
[EDIT -- changing future EBITDA multiple assumption]
The market is hard to impress.
FY22 revenue was up 16% to $72.6m (up 17% in constant currency, and ahead of guidance for 15% growth). The second half, as seen below, was especially strong and represents a record result.
North America was the standout, showing 33% revenue growth for the year and 42% growth in the second half. They really seemed to have recovered from their strategic stumble and are returning to very solid growth.
EBITDA was $1.3m versus guidance for breakeven. In FY21 EBITDA was $3.9m, but they said at the time that EBITDA would be flat for FY22 due to increased investment in growth (primarily in Rest Assure). To wit, Somnomed grew sales & marketing expenses by 27%, and corporate and head office expenses (mainly R&D) by 40%.
Importantly, Gross margin steady at 70% and the investment in growth seems to be paying off. The CEO said he expected 20% revenue growth for FY23. They are also targeting EBITDA of $2m (50% growth).
Looking further ahead, Somnomed is targeting FY26 revenue of $150m -- about 20% compound growth between now and then -- with an EBITDA margin of 10%.
A lot depends on how well Rest Assure goes -- which still has some hurdles to pass before commercialisation. But following our conversation with CEO earlier this year, i think there's good reason to be optimistic here.
Shares are presently on a P/S of 1.5x or an EV/EBITDA of 76 (although that's a very variable figure given how close they are to break even). Taking the company at it's word, and assuming EBITDA of $15m in FY26, and applying a multiple of 15 (which is fairly conservative, i think), you get a target price of $2.71. That's $1.85 per share when discounted back at 10%.
Makes the current market price of $1.30 seem pretty cheap.....if they can deliver to expectations.
Still, quite a decent margin of safety.
Full results presentation here.
Disc. Held IRL & on SM
Looks like a decent result for Somnomed, with a 10% lift in third quarter revenue, or a 14% lift on a year to date basis. In fact, third quarter sales were over 20% higher when you strip out a Covid related allowance from the previous corresponding period is removed.
The US, which accounts for roughly 1/3 of revenue, saw an especially pleasing result:
The company also reaffirmed guidance for full year revenue growth of at least 15% and breakeven EBITDA. The business remains well capitalised with $14.8m in cash on hand, and a net cash position of $8m.
The business was cash flow negative for the quarter, and reported -$5.5m in free cash flow, due to investment into the Rest Assure product and also the timing of insurance, legal and audit fees, as well as a $500k increase in working capital (inventory) to allow for supply chain disruptions.
Rest Assure was apparently well received when displayed at the World Sleep conference in Rome and patents were lodged in all commercial jurisdictions. Commercialisation is still a ways off, with the company needing to first lodge regulatory filings, which it expects to do in FY23.
Based on guidance, Somnomed is on roughly 2.3x forward sales.
SomnoMed did +10% top line growth for the 1H FY22. Mainly held back to a soft Europe result. In the European markets, a lot of the sleep apnea diagnosis happens in a hospital setting and, along with dental (for oral appliance fitting) cancellations, was heavily hit by Omicron. North America was very strong - partly to do with seasonal reimbursements and partly due to a maturing sales and business development team.
With omicron easing in Europe, the company is confident in hitting their +15% top line full year guidance which means they’ll need to do ~20% in 2H. Revenue is now back to pre-covid levels, and 2H should put them well and well ahead for a record half.
The hot new thing is the disclosure of the new Rest Assure device. It's a oral device with an enclosed set of sensors that will measure adherence (whether you're wearing it) and effectiveness (measured apnea events). This will provide a slew of sleep data for the patient and their sleep doctor to monitor how well the treatment is progressing. Essentially bringing it slightly above par to a cloud connected CPAP machine.
Management is betting that this will unlock adoption on a few fronts:
- Bring the oral appliance on par with CPAP in its ability to monitor efficacy and adherence.
- In turn this will reduce the biggest barrier that sleep doctors have in prescribing oral appliances.
- Over time use the collected data to improve reimbursements with insurance companies and therefore reducing out of pocket expenses.
Although the commercialisation of the digital device is still a year off, the company appears well positioned to start hitting its straps in the coming years.
SomnoMed reported positive operating cash flow for the 3 months to Dec 31, 2021 at $2.2m.
With 0.9m in investing cash flows, it generated $1.3m in free cash flow and has $17.5m of cash at hand.
4C is here
For the half, the company was essentially break even on an operating cash flow basis, and due to higher investment in Q1 reported -2.6m in FCF for the past 6 months.
A part of that cash was likely related to the development of the world's first "technology enabled oral appliance" which was announced today (a mouthpiece that wirelessly collects patient data for compliance and treatment effectiveness purposes -- an area the company identified as a key limitation for the uptake of oral devices). More info will be released in late February, but hopefully this will help improve adoption.
For context, the past 2 years of cash flows are as follows (negative quarters impacted by COVID)
You can clearly see the increased investment being made. Hopefully this proves worthwhile over time.
I’ve been a bit loathed to talk about SomnoMed, because it has one of the poorest liquidity levels that I’ve come across. But since both @Strawman and @SleepEasy have put content up with a fair bit of insight, I may as well throw in my two cents on the bull case.
- Robust underlying growth over the past 5 years with evidence that it’s out-growing the CPAP market darlings. Obscured by a strategy misstep and negative impacts from the pandemic.
- Has recovered from earlier missteps, and with the pandemic easing, is looking to accelerate top-line growth.
- A refreshed board and management team with some big hitters.
- Undemanding valuation metrics.
- Consumer awareness for sleep apnea is nearing a tipping point.
Obscured robust underlying growth
In 2017, when there was an equal sales split between North America and Europe, the company embarked on a strategy in the US to establish its own sleep centres to target patients that rejected CPAP as a solution for sleep apnea. Part of this was to prevent US dentists from price gauging. Long story short, dentists saw this arrangement as a threat and started boycotting the product. SomnoMed admitted defeat less than 3 years later, a new CEO was appointed, and the failed strategy was rolled back in the US. A year later, the company had clawed back ground in the US, and Europe had grown to be a significantly larger percentage of sales. And then the pandemic hit - hospitals, dentists, medical practices were impacted heavily, and oral appliance sales were hit hard.
What is obscured from the turmoil is a European business that grew at a strong 17.8% CAGR for the 5 years preceding the start of the pandemic. In fact, growth was considerably faster than both RMD and FPH in Europe. Outside of the US, SomnoMed was actually gaining market share, not losing it.
Accelerate top-line growth
The most compelling argument for oral appliances are the prescription rates for the Nordic countries. While in the US only 8% of OSA cases are prescribed an oral appliance, it's 25% in Finland, 30% in Norway, 40% in the Netherlands and 52% in Sweden. This really demonstrates the potential upside in prescription rates.
The biggest bull case for this company is if you believe the Nordic countries are leaders in the treatment for mild-moderate OSA, and that Western Europe and North America are likely to follow in the coming decade, then there will be an enormous tailwind.
With the pandemic easing, management is seeking to increase investment and accelerate revenue growth to above 20% for the coming years.
Europe has historically grown at a rate only slightly lower than 20%, and as long as there's no further strategic mishaps in the US - I see no major reason to believe that a 20%+ growth rate over the next few years is out of reach.
A significant portion of the reinvestment will go into a new “technology project” to be revealed in early 2022. If I was a betting man, I’d say it’s likely to be a device that records compliance/effectiveness and allows for sharing of the data with physicians. Which brings it at least on par with the high end CPAP machines, and addresses a major gap. It will also provide objective data that can be used to convince physicians of the overall effectiveness of oral devices over CPAP for mild to moderate OSA sufferers.
Board refresh
A big board renewal happened in August 2020, with some accomplished people entering including Guy Russo as chairman. A few new board members purchased not insignificant amounts of stock following their appointments, ranging from AUD$80k to $200k.
Guy Russo had a long history with McDonald's that culminated in the position of the Australian President and later the Greater China President. He is known for a highly successful turnaround of Kmart in Australia during his time heading up the department store from 2008 to 2016. A straight talker that is very attuned to people, culture and customers, but ultimately measures success on sustained long-term "Sales, EBIT and ROC". He purchased A$500k worth of stock on market a few weeks ago.
Undemanding valuation metrics
3x sales, 60% gross margins, EBIT breakeven, Europe has demonstrated it can grow at 17% pa and is now 64% of group revenues. Looking to accelerate top line group revenue to 20%+ for the coming years.
Consumer awareness of sleep apnea near tipping point
Consumer wearables have come a long way in the past decade. I’m a bit of a health metrics nut, and currently have an Apple Watch to track sleep. It’s amazing that I'm able to pin point alcohol consumption just by looking at overnight heart rate stats.
The Apple Watch introduced sleep tracking in 2020 along with an oxygen monitor sensor in that year’s model. This year they introduced the recoding of “Sleeping Respiratory Rate” data simply by training machine learning models on the watch’s accelerometer data. In my opinion, they’re not far away from surfacing sleep apnea notifications to end users - as they’ve already done with atrial fibrillation.
WSJ (paywalled) also wrote about this according to information from insider sources: https://www.wsj.com/articles/apple-plans-blood-pressure-measure-wrist-thermometer-in-watch-11630501201
Should this happen, then a lot more people will be seeking medical treatment for sleep apnea. Oral device and CPAP makers will be flooded with increasing demand
Somnomed (ASX:SOM) develops and manufactures medical devices for the treatment of Obstructive Sleep Apnea (OSA). Unlike Resmed and others that use CPAP (Continuous Positive Airway Pressure), Somnomed have a mouthguard like device that is based on COAT (Continuous Open Airway Therapy). The advantage being that it is more comfortable, makes no noise and requires no power. It's also much cheaper.
So instead of sleeping with this on your head:
You have this:
Each appliance is custom made and the treatment has been proven to be very effective. It's not quite as good as CPAP therapy, but given 50% of people using CPAP quit within a year due to the discomfort, it's arguably more effective overall.
Somnomed operates in 28 countries and has helped over 650,000 patients. The majority of sales come from North America and Europe (32% and 61%, respectively), with APAC making up the remainder.
OSA is a huge problem globally, with an estimated 900+ million sufferers. Untreated, it can lead to increased risk of stroke, heart attack, depression and diabetes. (if your partner values a good night's sleep, it'll also likely undermine your relationship...)
At present, only 8-10% of OSA treatments use COAT-based solutions. As such, the growth potential is meaningful -- the question is whether it can be effectively exploited by Somnomed...
The real challenge is to overcome the default recommendations of CPAP therapies by sleep physicians and better establish the COAT treatment as a viable alternative with recognised advantages. Interestingly, COVID has impacted the availability of CPAP machines in places like North America (I assume because manufacturing was diverted to ventilators?), and this could provide an opportunity to help promote Somnomed's solutions.
It's worth noting that Somnnomed is a relatively small company, with a current market capitalisation of ~$180m (at time of writing). It's also very thinly traded -- over the last year the average daily value traded is less than $100k. It's not uncommon to see less than $10k traded in a day and the buy/sell spread can be significant.
The company listed all the way back in 2004, and since then has grown revenues from (essentially) zero to $62m in FY21. That being said, revenues took a bit of a hit over the last few years and although reporting a modest net profit between 2010-2016 has been mostly a loss making operation. It is therefore no surprise that they have been a prolific issuer of shares. In fact, the share count has grown by ~28% over the past 5 years alone.
Nevertheless, in the recent full year we've seen some evidence of a return to sales momentum:
In the most recent quarter, revenue was up 16% in constant currency terms.
The risk here is that this is going to forever remain a "gunna" company. Always on the cusp of delivering attractive and growing cash flows, but never quite getting there. The company continues to invest heavily into R&D, and although that will dampen profitability it is necessary for long term success. So that's cool, but it'd be great if the company can stop relying on capital raisings. On a free cash flow basis, they look like they are right at that inflection point.
Somnomed has $17m in cash with approximately $2.3m in long term debt.
Overall, the company appears to be well placed in a large market with a unique and compelling product set -- one that may finally be seeing increased adoption.
The CEO is Neil Verdal-Austin who has been at the company for 13 years; 10 years as the CFO and the last 3 as CEO. He has 1.7m shares.
The biggest shareholder on the board is TDM Growth partners, a private investment firm that took a substantial stake in the business in 2012 and has a couple directors on the board. it owns 26% of Somnomed.
The company is presently trading on 3x sales, and has guided for 15% revenue growth in FY22, with an EBITDA at breakeven as the business invests further in growth.
These are all early thoughts. I'll continue to investigate and would welcome any insights from others.
disc: not held