BWAY - Why I Am Passing On BrainsWay And Neuronetics

Summary

• I am bullish on the niche industry that uses magnetic stimulation for brain therapies.
• BrainsWay and Neuronetics are US-listed stocks in this niche, however they are highly unprofitable with volatile sales growth.
• BrainsWay is a deep value stock with cash in excess of its enterprise value, but without a catalyst in the horizon to unlock.
• Nexstim is a growth leader and the only profitable player, trading at only a 11% premium to Neuronetics, which is the market leader.
• Overall, whilst I like BrainsWay and Neuronetics, Nexstim is my preferred option to play the magnetic waves.

Introduction

I read Richard Durant's cover on BrainsWay ( BWAY ) ( OTCPK:BRSYF ) and David Zanoni's piece on Neuronetics ( STIM ) and this got me bullish on the niche transcranial magnetic stimulation ((TMS)) industry. TMS treatments involve shooting magnetic waves at specific parts of the brain to control activation or de-activation of certain functions. The treatment methodology and business model shared some similarities to Novocure ( NVCR ), which is a large alpha-generator I identified in September 2022.

But both these companies are highly unprofitable currently and I am hesitant to add more unprofitable risk exposure to my portfolio after Docebo ( DCBO ). So I looked at other listed competitors in search of a better opportunity.

In this article, I present my comparative analysis of 3 listed TMS companies based on company filings and feedback of depression psychiatrist Dr Khaled Bowarshi , who has experience with all solutions. I hope this helps you better understand BrainsWay and Neuronetics relative to its competition:

1. Israeli company BrainsWay
2. US company Neuronetics
3. Finnish company Nexstim, which is listed in the Helsinki Stock Exchange

My findings lead me to prefer Nexstim for my portfolio for reasons discussed below:

Layman's Primer to Types of TMS

rTMS (repetitive transcranial magnetic stimulation) is the standard type of TMS that involves delivery of magnetic pulses around a broad region of the brain for upto 45 minutes, and on average 19 minutes per session. The 'r' prefix stands for repetitive.

iTBS (intermittent theta-burst stimulation) uses theta-wave frequencies in its treatment, which is the same type of frequency that the brain uses to communicate between synapses . This makes the treatment more effective with faster sessions of only 3 minutes.

nTMS (navigated TMS) uses more precise targeting of specific parts of the brain for TMS treatment. The focused application here increases the chances of successful treatment of depression.

Business and Product Overview

BrainsWay is known for its heavy R&D focus, perhaps to an excessive extent. It utilizes something called Hesel coils to stimulate wider and deeper stimulation albeit without specific targeting. This makes it more prone to discomfort with higher seizure risks than typical TMS which has a narrower focal point of action. Furthermore, Dr Bowarshi notes that they have a tendency to "re-invent the wheel" and spend copious amounts in marketing to communicate technological superiority of their product.

Neuronetics' Neurostar is the current market leader in the US, with about 60% market share, according to The Market for Bioelectronic Medicine . However, from an innovation perspective, it seems to be a relative laggard as they were late to the iTBS industry development.

Nextstim's SmartFocus product makes it the only player among the three and one of two players among the 7 key vendors to have capabilities in all major types of TMS - rTMS, iTBS and nTMS. This gives it the best scope for precision treatment. Nexstim's expertise in navigation TMS comes from its expertise in its main product that is the Navigated Brain Therapy ((NBT)) system, which has use-cases that extend into pre-surgical planning .

Scale of Business Comparison

Neuronetics is 4-5x larger than BrainsWay and Nextstim in terms of market capitalization but only 2-5x larger than BrainsWay and Nextstim from a scale of sales perspective. This discrepancy suggests that to me that there may be a discovery re-rating premium that is yet to be realized among the smaller companies here.

Interestingly, the increased scale has not come at the benefit of better profitability. Rather, the smallest player Nexstim is the only player that is marginally profitable at on an LTM EBITDA basis.

Sales Growth Analysis

Around 43% of BrainsWay's sales comes from a fixed annual fee lease model for 2-5 years. This may be why it had lower sensitivity in the pandemic-stricken 2020 year, seeing only 2 quarters of negative YoY growth with greater resiliency than Neuronetics. Surprisingly however, it has seen a sharp 35.9% YoY and a 35.4% QoQ decline in 3QCY22, unlike its peers. In the earnings call , management noted that customers kept pushing off purchases:

...more than we expected, our business was impacted by inflationary and recessionary headwinds in the third quarter.

I have difficulty reconciling the commentary with the results across peers since similar commentary and results was not seen with Neuronetics or Nextstim. Also, BrainsWay's more defensive leasing model should in theory insulate it more from these kinds of headwinds.

This may show early indications of product penetration failures, perhaps to the greater side-effects risks highlighted earlier based on feedback from Dr Bowarshi.

The decline in 2020 in the COVID quarters indicates the high vulnerability of the capital purchase or usage-linked spends for Neuronetics. On a recent run-rate basis, Neuronetics is growing at 15-19% YoY growth rates. This is above the 8-yr 9.69% CAGR forecasted for the industry by Vision Research Reports. However, for context, it is still lower than the 20%+ growth profiles seen by billion-dollar market cap software companies.

Unlike its peers, Nexstim saw minimal decline during 2020 and has been seeing tremendous organic sales growth in since 2021. This is partly due to a low-base effect as the company only has $12 million in LTM revenues. However, it is also due to a more resilient business model and wider use-cases. For example, Nexstim's NBS system is used in research are often used in clinical research, which would not have correlated with the nature of patients' clinic visitation and usage declines for the TMS products.

The high growth in recent quarters times is due to recognition of a $19 million license agreement to Magnus Medical for its NBT system. I believe this is a huge milestone for the company, leading to incremental sales uplift from $9 million to $38 million. Importantly, these revenues have a virtually 100% pass-through effect on margins as they are based on an initial fee and a royalty.

Profitability Analysis

BrainsWay has a highly volatile margin profile. Combined with its unusually weak sales execution. Debt is not a concern as it has a net cash position of $49.6 million. However, I lack confidence in BrainsWay's sustainable future prospects.

Neuronetics is unprofitable with -42.8% EBITDA margins. I believe it will still take many quarters for it to reach profitability. Fortunately, the company's net cash position stands at $34 million .

Yet, for growth exposure in my portfolio, I much prefer 20%+ CAGR growth businesses that are on the verge of turning sustainably profitable such as Docebo .

The EBITDA margin trend profile for Nexstim is what I like to see in growth businesses; steadily improving profitability without sacrificing on growth, driven by operating leverage effects. With its recent licensing and royalty deal, I believe the company has sustainably crossed the profitability line. Nexstim also sits on a net cash position on $3.2 million so there are no issues on the leverage risk front.

Valuation Analysis

With a 2.0x LTM EV/Sales multiple, the higher growth and profitable Nexstim is trading at only a 11.1% to the unprofitable market leader. BrainsWay has a negative EV due to its cash balance outsizing its market capitalization. This makes it a deep value play, but without strong activist support, I believe it would be difficult for minority investors to take on actions that involve for example taking control, liquidating the business and releasing the value in the stock.

All things considered, I believe Nexstim is the most attractive player.

Risk Considerations

As these are all small companies, it is prudent to analyze cash burn, stock dilution and liquidity risks:

Cash burn

I calculate cash burn here by summing the cash flow from operations and capex. I represent cash burn with a negative number in the charts below:

Unsurprisingly, the unprofitable nature of operations in BrainsWay has contributed to an average of $1.24 million every quarter. I anticipate the next quarter to see a larger cash burn as the steep drop in accounting revenues and EBITDA materialize into the cash flows.

Given Brainway's $49.4 million cash balance, the company has a maximum of 23 quarters till another fund raise of debt or equity is required, assuming last quarter's cash burn of $2.12 million continues on.

Here too, the unprofitable nature of operations has contributed to an average cash burn of $8.05 million. I anticipate this to continue in upcoming quarters as profitability is nowhere in sight.

Given Neuronetics' $73.7 million cash balance, the company has a maximum of 10 quarters till another fund raise of debt or equity is required, assuming the average cash burn of $8.05 million continues on.

Nexstim is an outlier in this regard. It has steadily reduced its cash burn over time and in H1 CY22, it has eliminated all cash burn as it has turned profitable. Given my expectations of sustained profitability due to the licensing deal benefit mentioned earlier, I anticipate cash flow generation as opposed to cash burn for Nexstim in future quarters.

Stock Dilution

Fresh issuance of common stock is a proxy for stock dilution.

BrainsWay has had equity raises in a lumpy manner. On an averaged basis, it has diluted $3.25 million a quarter for the past 13 quarters. Based on current market capitalization terms, this corresponds to a 8.8% dilution.

Neuronetics too has had equity raises in a lumpy manner. On an averaged basis, it has diluted $6.50 million a quarter for the past 13 quarters. Based on current market capitalization terms, this corresponds to a 4.4% dilution.

Nexstim has raised equity in a more phased manner. On an averaged basis, it has diluted $2.54 million a quarter for the past 14 quarters. Based on current market capitalization terms, this corresponds to a 9.1% dilution. However, as the company has turned profitable on both an accounting earnings and cash flow conversion basis in what I believe is a sustainable way, I think there won't be continued dilution in the stock. Note that the last two half-year periods had much lower dilution compared to the historical norm, giving support for this trend.

Liquidity Considerations

Given the small and microcap nature of these stocks, liquidity becomes a very important consideration:

Seeking Alpha's BrainsWay ticker page data implies an average daily volume of merely $193,000. For Neuronetics, the average daily volume is $241,570. Nexstim, being the smallest stock listed only in foreign exchanges has very thin liquidity, with average daily volume of $25,000, according to Capital IQ data.

It is critical to ensure that one uses limit orders and exercises patience to build up a position. Otherwise, you may unsettle and move the market, even with an order of a few thousand dollars.

Takeaway

I like the industry and business growth opportunities in the transcranial magnetic stimulation ((TMS)) industry and hence BrainsWay and Neuronetics. Indeed, BrainsWay seems to be a deep value play as its net cash balance exceeds its current market capitalization. But without the backing of large investors or similar catalyst, I don't see a route to unlocking value in that stock.

In my view, a catalyst is highly important, especially for unprofitable stocks and history proves this: despite consistent 'Strong Buy' ratings on BrainsWay since October 2019 by the Seeking Alpha author community, the stock has fallen 77.72% since then, generating negative alpha of 115.12%.

I believe Finnish company Nexstim is more attractive due to its higher growth, already profitable operations and only 11.1% LTM EV/Sales valuation premium to Neuronetics. Here, I believe the company has a catalyst in the form of its licensing deal with Magnus Medical.

Overall, if you're interested in BrainsWay or Neuronetics, perhaps you can consider Nexstim, which I believe is a more attractive way to play the growing magnetic pulse oriented brain therapies industry. If you choose to go along this route, remember to use limit orders with dollops of patience in getting your fills.

Note that Nexstim has no active stock listing in the United States. Investors considering Nexstim for their portfolio would need to consider the Helsinki listing (if your broker offers that option).

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