BFLY - Butterfly Network: Ongoing Strategic Pivot Substantial Cash Burn And Structurally Unprofitable

2023-11-11 03:07:54 ET

Summary

• Butterfly Network aims to use portable ultrasound technology to impact the healthcare sector.
• The company's recent financial performance has seen a sharp revenue decline and a need for further capital raises.
• Butterfly Network has announced a partnership to develop brain-computer interfaces and has obtained FDA approval for its AI-powered Auto B-line Counter.
• From a multiples-based valuation perspective, BFLY initially appears undervalued. However, after factoring in caveats, I think BFLY is a "hold".

Butterfly Network, Inc. ( BFLY ) is an interesting company that aims to use its portable ultrasound technology to impact the healthcare sector. They have a variety of products and services related to such products. However, the company’s performance has recently seen a sharp revenue decline, a new CEO, and a strategic realignment. Its current cost structure appears unsustainable even after workforce reductions and cost-cutting moves. I estimate the company’s cash runway to be slightly over a year, which is concerning and suggests further capital raises through debt or equity issuance. From a valuation perspective, I think the current price tag seems appropriate. I estimate this by a multiples-based valuation, which initially suggests the shares are undervalued. Still, after considering the potential dilutive risks and its ongoing structural unprofitability, I think BFLY deserves a “hold” rating.

Business Overview

Butterfly specializes in portable ultrasound technology. BLFY aims to make medical images accessible and contribute to global health equity. Their whole-body imaging products are portable ultrasounds, including Butterfly IQ, Butterfly IQ+, and Butterfly Blueprint. Butterfly IQ is a device for individual practice. The IQ+ line is the new version with better capabilities, improved ergonomics, and longer battery life. These ultrasound devices operate with cell phones and tablets using software cloud-connected software. Butterfly’s Blueprint is a workflow that works with the Caption Health platform, the world's first AI interpretation and guidance software approved by the FDA to support the practical application of ultrasound information.

Blueprint provides hospitals and health systems with a complete ultrasound solution that integrates with the health system's clinical and administrative procedures. Butterfly Blueprint is complemented by an extensive set of optional software and services, including Caption Health's AI-guided software. Caption AI enables healthcare professionals without ultrasound experience to capture and interpret cardiac ultrasound images for earlier disease detection and better patient management. Medicare & Medicaid Services ((CMS)) approved New Technology Supplemental Payments ((NTAP)) for Caption Guidance, a designation given to new medical technologies and services expected to improve the diagnosis substantially.

From an ownership perspective, it’s worth mentioning that BFLY’s main shareholder is Jonathan Rothberg, with 17.81% of the company worth approximately $38.7 million. Also noteworthy is ARK Investment Management LLC, which holds a slightly smaller number of shares, with a 6.14% stake in the company worth about $13.4 million.

Brain Interfaces and AI Markets

BFLY’s recent strategic moves have been interesting, recently announcing a five-year co-development agreement with Forest Neurotech to create next-generation brain-computer interfaces ((BCIs)) using Butterfly's Ultrasound-on-Chip technology. This chip would be the first whole-brain implanted neural interface, leveraging the BFLY's ultrasound-on-chip technology and its Butterfly Garden program, aimed at development and innovation in medical technology. Butterfly Garden is a platform designed to develop custom AI applications using the BFLY development kit ((SDK)) so that medical device companies, virtual care providers, and AI developers can program their integrated applications to ultrasound with augmented reality, virtual reality, or robotics. Butterfly Garden Marketplace is intended to host new applications so that users can access the latest AI capabilities in images.

Within this agreement with Forest Neurotech, BFLY will receive $20 million as various development milestones are met, and BLFY already received $3.5 million upon signing the agreement. Additionally, BFLY will obtain income for each unit sold. Forest Neurotech is part of the Convergent Research and Schmidt Futures Network that focuses on minimally invasive brain imaging and stimulation for medical and scientific use. The collaboration validates Butterfly Network's initiative, Butterfly Garden, aimed at co-development and innovation in medical technology. This partnership is an important step in the advancement of medical technology, particularly in the field of brain-computer interfaces, and will serve to apply ultrasound technology in revolutionary innovations within healthcare.

At the 2023 American College of Emergency Physicians Scientific Assembly in Philadelphia, ACEP23 Butterfly Network presented two ultrasound educational offerings as a strategic effort to drive awareness and adoption of its technology. Its purpose is to educate healthcare professionals about the capabilities and benefits of BFLY ultrasound technology to increase the visibility of the technology and facilitate its adoption in clinical settings.

Furthermore, Butterfly Network has obtained FDA approval for its AI-powered Auto B-line Counter that works with artificial intelligence. This is a tool designed to evaluate adults with suspected abnormal lung conditions. This device uses deep learning technology to analyze a six-second ultrasound clip and produce a B-line count. B-lines, or ultrasound lung comets, appear as bright vertical lines on an ultrasound, indicating lung dampness associated with a disease of the lung airspace. This tool offers a more precise interpretation than a manual count of B lines. In this way, early detection of cardiovascular diseases, one of the main causes of death worldwide, can be achieved.

Interestingly, Butterfly Network developed and trained its AI algorithms using more than 3.5 million ultrasound images from multiple US sites, covering a wide and diverse range of demographics. This FDA approval marks a significant advancement for Butterfly Network, particularly in improving diagnostic accuracy and efficiency in lung condition assessments using ultrasound technology.

Yet, one key event that recently occurred and showcases BFLY’s transitional stage is the recent appointment of Joseph DeVivo as CEO. This hire intends to boost the company's mission to innovate and expand in the point-of-care ultrasound (POCUS) market. DeVivo’s amalgamation of experience in telemedicine, ultrasound technology, and artificial intelligence, along with his leadership skills, positions him well to lead the growth and development of Butterfly Network. His experience at Teladoc Health ( TDOC ), a telemedicine and virtual healthcare company, could be particularly valuable as Butterfly Network looks to expand its digital health services. In addition, after working as executive president of Caption Health, the artificial intelligence company applied to ultrasound technology, ensures his experience in key areas for Butterfly Network.

Disappointing Financial Performance

Still, even though the company’s technology appears promising, its financials tell a different story. BFLY’s revenues are expected to drop slightly in 2023, mainly attributed to a decline in product revenue, and make a recovery by 2024 . In this context, it’s worth noting that product revenues are recognized at the point of sale. In contrast, service revenues are recognized over time, so these two are inextricably related, yet the timing is inherently different. Also, the 10-Q implies that BFLY expects the revenue mix to tilt over time toward service revenues. In any event, this more or less paints a picture of a company that has leveled off revenue-wise, even though since 2019, the company’s revenues have grown at a respectable CAGR of 25.5% . However, the main concern from a valuation perspective is that the company’s EBIT has deteriorated with revenue growth.

Looking closer at BFLY’s financials reveals that gross margins have improved over time, so the EBIT deterioration comes from operating expenses, not the cost of goods sold. This distinction is important because COGS would be more directly related to inflation pressures, which would be a reasonable explanation for EBIT deterioration given the ongoing inflationary macroeconomic environment. Yet, gross margins have actually improved from 49.6% in 2021 to 57.0% in the TTM. BFLY’s product COGS is mainly manufacturing freight and packaging costs. In contrast, service COGS are cloud hosting costs, processing fees, and personnel. So, it’s encouraging that these costs that seem to strike at the heart of BFLY’s business are not the problem.

However, the picture changes significantly in the operating expenses like R&D and SG&A. For the nine months ending in September 2022 and 2023, R&D expenses have decreased significantly, dropping 35.5% YoY due to workforce reductions and testing and fewer consulting fees paid. This is theoretically encouraging because it shows the company is trying to eliminate inefficiencies. However, I think R&D seems key for this type of company's long-term success, so I think it’s concerning in this context. Likewise, SG&A expenses decreased significantly. For context, sales and marketing dropped 38.9% YoY, and general and administrative expenses also declined 31.1% YoY. Again, this would normally be encouraging figures, but this would still leave the EBIT margin worsening unexplained.

It’s key to realize that the company’s “Other Expenses” have skyrocketed to $17.8 million during the nine months ending in September 2022 and 2023, increasing by 365.0% YoY. As mentioned earlier, these expenses are mainly severance costs and other legal expenses mostly related to the company’s workforce reductions. Yet, theoretically, these expenses should be one-time items and not recurring. Yet, even if we exclude these expenses from our EBIT calculations, it’d not be enough to be EBIT positive. For context, during the same period, EBIT losses were $98.9 million, so the $17.8 of other expenses is vastly overshadowed.

Cash Burn and Valuation Analysis

Overall, I estimate that without the “other expenses,” BFLY’s OpEx annualized run rate is about $147.2 million. These figures and the company’s current gross margins of 57.0% imply that BFLY’s breakeven revenues in EBIT terms are $258.25 million per year. Yet, currently, the 2024 revenue estimates are $74.08 million, which means BFLY will continue burning through its cash reserves. Thus, using the company’s cash from operations and net capex figures, I estimate its cash burn to be about $118.6 million annually. Given that the company currently holds just $150.0 million in cash as of September 2023, the current cash runway is just 1.26 years, which is alarming and suggests that further stockholder dilution is imminent. Alternatively, debt could be issued, which would also be detrimental for shareholders because of the currently high interest rate environment.

Therefore, since BFLY is still structurally unprofitable, I think the best valuation approach is multiples-based. In this case, the main variable is BFLY’s revenues. We can assess BFLY’s revenue potential using its current analyst estimates for 2024 revenues of $74.08 million, coupled with the forecasted sector CAGR of 4.9% until 2028. Then, remember that since 2019, BFLY’s revenue CAGR has been 25.5%, so let's assume a slightly lower CAGR going forward but still outpacing its sector’s CAGR. Let’s say a 10.0% revenue CAGR by 2028. With that, BFLY’s revenues would be $108.5 million, which, priced at the sector’s EV/Sales multiple of 3.10, would imply an enterprise value of

As you can see, this valuation approach would suggest the shares are undervalued and have a 45.6% upside potential. However, the caveat is that this ignores the likely equity dilution, which would limit this upside to some extent. Moreover, I don’t think a structurally unprofitable company should be valued at the same median EV/Sales multiple as the rest of its sector. Instead, it should have a discount because of this. Thus, factoring in those caveats offsets the purely multiples-based valuation upside, leading me to a “hold” rating for BFLY.

Conclusion

Overall, BFLY is an interesting company and seems promising from a valuation perspective. In fact, the current revenue estimates would be more than enough to justify its current price tag if it were profitable or at least had a concrete path toward profitability in the long run. However, at this time, the company is evidently in a transition phase. It’s unprofitable, burning through its cash reserves, and under a new CEO. This, coupled with potential dilutive risks for current shareholders, makes the shares less attractive than they initially seem under a multiples-based valuation approach. Thus, I believe the prudent rating is a “hold” for BFLY.

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