2023-05-15 06:12:41 ET
Summary
- Outset Medical looks to transform the dialysis market but in controlled settings and at home.
- The company has not really lived up to its promise in recent years, with sales growth disappointing and reported losses being very substantial, and furthermore not coming down.
- I am very cautious amidst this new reality, as notably losses are severe, making me not automatically compelled to a 60% pullback.
Shares of Outset Medical ( OM ) have largely stabilized around the $20 mark here, leaving those investors (including myself) which bought around the time of the IPO with severe losses.
In spring of 2021, I concluded that Outset continued to impress, amidst strong commercial traction and a solid 2021 guidance, which looked conservative in my eyes. Believing there was a potential for a multi-bagger, I was a happy holder around the $50 mark, which with the benefit of hindsight has proven to be too optimistic.
A Recap
Outset Medical went public in September 2020, as the medtech firm seemed to tick all the boxes at the time of the IPO, including strong growth, a long runway for growth, approved product and superior characteristics versus competitors.
The company is the developer of the Tablo Hemodialysis System, designed to reduce cost and complexity of dialysis in acute and home settings. In essence, the Tablo allows for dialysis anytime, anywhere and to anyone, only requiring tap water and electricity. This has the potential to alleviate the healthcare system and patients from reasonably unnecessary and frequent hospitals and clinic visits.
The FDA approved solution had the potential to drive great cost savings, but moreover add a lot of convenience for patients as well. The market was large with 800,000 people in the US suffering from kidney failure, with spending on dialysis running at $70 billion per year.
Tablo was already approved by the FDA in 2014 for acute and chronic care in a controlled setting (supervised by healthcare professionals) as the home market was cleared in 2020, being key as that market is much larger than acute care.
The company went public at $27 as shares rose to $60 on the first day of trading, granting the company a $2.2 billion operating asset valuation. This was a huge valuation in relation to a mere $2 million in sales reported in 2018, but momentum was strong. 2019 sales rose to $15 million, although accompanied by a $70 million operating loss that year. Growth was strong as sales rose to $19 million in the first half of 2020, as I pegged the run rate at $50 million by the time of the IPO. With a $2 billion valuation, the 40 times sales multiple was huge, certainly given the losses, although the home setting approval was still not seen in the results of course.
I believed that sales might increase to $200-$300 million in the time frame of a few years, which made that I was compelled to shares. This came as the company furthermore reported a solid $13.8 million third quarter revenue number for 2020, to post $17.2 million in sales for the fourth quarter. There was some heavily lifting to be done as well as gross margins were barely profitable, although real gains were anticipated on this front following a new manufacturing facility to be opened in Mexico.
Recognizing that the 2021 sales guidance of $89-$94 million was conservative, I was upbeat around the $50 mark, which of course was in a different market mantra at the time.
What Happened?
My optimism in spring of 2021 has turned out to be a painful and a humiliating investment, with shares down 60% over the two-year period which we have seen ever since. Shares actually hovered around the $50 mark for most of 2021 and early 2022, and ever since shares have largely traded around the $20 mark following a pullback seen during 2022, although accompanied by quite some volatility.
Forwarding to February 2022 the company posted its 2021 results as the $102.6 million revenue number of the year was stronger than guided for, as I believed that Outset was guiding in a conservative fashion. Promising was that the company has been able to post gross profits, but the progress on the bottom line was not seen as operating losses rose from $117 million to $130 million, simply a very disappointing result. On the back of the lack of operating leverage (seen during 2021 as well) I cut part of my position around break-even in the $50s.
The company guided for 2022 sales to rise to $142-$150 million, but did not guide on margins. When the company posted its 2022 results earlier this year, it was evident that the growth story was somehow broken with full year sales up a mere 12% to $115 million, albeit that gross profit margins for the year doubled to 15% and change (which incidentally is still quite low). The lack of growth made that full year operating losses rose to $160 million, as the company was actually taking on some debt, all very wary signs.
While the company guided for 2023 sales to come in between $140-$150 million, accompanied by 20% gross margins, we might see some incremental improvements, but likely the company is set up to see huge losses for this year again. Net cash holdings have fallen to roughly $200 million as the company took on near $100 million in terms loan as well, preserving some liquidity.
First quarter results, as released in May, look quite resilient. First quarter sales rose 10% to $33.5 million, for a $134 million run rate as gross profit margins approached the 20% margin already. That is about the good news as operating losses of $43 million and change show no signs of coming down on an absolute basis.
For the year, the company raised the lower end of the full year sales guidance by four million to $144 million, although the higher end of the range was kept unchanged at $150 million.
And Now?
With 49 million shares now trading at $20 per share, the equity valuation comes to around a billion, including a net cash position of around $150 million. This translates into a $850 million enterprise valuation, equal to about 6 times sales here.
The reality is that sales growth has been a bit underwhelming, notably in 2022, but moreover that losses remain very severe. After all, net cash holdings are likely depleted within a year at this pace of losses, which is clearly concerning as losses are not coming down and topline sales growth is not too impressive.
These observations have permanently impaired the investment case at $50 back early in 2021, as it seems clear that the competitive position, but moreover operating leverage, have been much softer than anticipated, as notably the big losses here are concerning in this environment.
Hence, I am sitting with a remaining position which is well underwater, and while I am usually attracted to lower price action, the reality is that this lower valuations are fully "justified" by the poor fundamental performance, which makes me quite cautious here. Hence, I am happy to sit on the remaining position, but unfortunately I am not willing to add to my position here.
For further details see:
Outset Medical: Not Living Up To Expectations