Ticker: SIEN US
Price: $6.64
Market Capitalization (US$ m): $120
Enterprise Value (US$ m): $28
Business Overview
Sientra sells breast implants in the U.S. exclusively to certified plastic surgeons. The company received FDA approval in March 2012 and entered the duopoly market dominated by Allergan and Mentor (owned by Johnson & Johnson). In three short years, they have captured ~10% market share with FY14 sales reaching $45m for CAGR 63%. The business is not yet profitable, but close to reaching cash flow breakeven. The implants are manufactured by Brazilian implant manufacturer Silimed.
There are several reasons for Sientra's rapid gains on the incumbents:
- Compared to incumbents Sientra's product is superior and also has the best warranty terms for rupture owing to a lower rupture rate, lower capsule contracture (scar tissue) and more natural look.
- Leveraging on their superior product, Sientra only markets and sells to board certified plastic surgeons; this has helped them generate a strong following among certified practitioners who on average spend an additional 6-8 years in training compared to a regular cosmetic surgeon
- The competition is in disarray. Allergan was distracted by the Pfizer acquisition and has just re-aligned their executive team; moreover, cosmetic surgery products are not within their core therapeutic areas. Mentor is in poor shape post-JNJ acquisition. Aside from R&D and sales staff cuts the culture has shifted violently according to www.glassdoor.com
A Series of Unfortunate Events
Sept 23, 2015
- Sientra sells 3m shares in a secondary to raise $66m
- At Silimed's facilities, trace particles of silica and cotton were discovered by a German certification company that was inspecting on behalf of The Medicines and Healthcare Regulatory Agency (MHRA) in UK (FDA-equivalent)
- MHRA suspends Silimed's CE certificate, barring products they manufacture from being placed in Europe.
Oct 2, 2015
- The Brazilian regulatory agency, ANVISA, temporarily suspends manufacturing and distribution of all products made by Silimed
Oct 9, 2015
- Sientra voluntarily suspends all sales in U.S.
Oct 22, 2015
- An enormous fire destroys one of Silimed's two manufacturing facilities
Nov 12, 2015
- CEO Hani Zeini stepped down to be replaced by Jeffrey Nugent, a Board member since July 2014, with immediate effect
Implications & Analysis
Let us consider the events in order with the benefit of information we have today. These qualitative elements give me significant confidence in the recovery of Sientra.
- Sientra had been threatened with shareholder lawsuits for the timing of the raising coinciding on the same day the inspection raised issues with Silimed facilities. It is difficult to make a case that the company was being opportunistic. Hani Zeini is a respected professional in the aesthetic surgery community and founder of Sientra; for him to stake his 27 year professional reputation on $66m, cash that the company did not need (FY15 cash $112m on $4m cash burn excl. goodwill impairment), is ludicrous speculation.
- Despite the "heavy-hand" MHRA dealt by suspending Silimed's CE certificate followed by ANVISA's ban on manufacturing and distribution, the actual impact on Sientra is infinitesimal. According to an article written by a board certified plastic surgeon, the presence of silica and cotton particles is common to all three company's manufacturing processes; they cause no harm to patients and have been known to exist on implants. Investors can read more about this from plastic surgeons themselves. Furthermore, Sientra exclusively sells its products in the U.S. meaning the Europe ban has no effect on sales.
- Naturally, the risk that arises would be if the FDA also enforces the ban in U.S.; there are two reasons this is unlikely (1) Silimed was last inspected by the FDA in 2013 and there were no issues and (2) according to a Leerink Partners report, Sientra's products are manufactured under separate protocols guided by FDA compliance. Sientra's voluntary suspension was erring on the side of caution; indeed, since March 1 2016 the company's products have returned to the U.S. market.
- The fire was an untimely accident but the fears of supply disruption are unfounded on two fronts. Firstly, according to management Sientra has 18-24 months of inventory on hand. The company also has a FDA Pre-Market Approval (PMA) which allows them to switch to the second manufacturing facility within 30 days. The PMA also allows Sientra to switch to another manufacturer completely within 180 days by filing a "PMA Supplement" detailed here. The margin of safety here is significant in that their inventory position allows Sientra 2-3 blunders with the FDA in switching manufacturing sites (excluding the fact that they can actually source from Silimed's other facility).
- Yet management looks unlikely to blunder. Hani Zeini remains on the Board while the new CEO, Jeffrey Nugent, is an experienced executive responsible for conducting successful turnarounds at Neutrogena (acquired by JNJ), Revlon and Precision Dermatology (acquired by Valeant)
Source of OpportunityIn any investment, I like to ask why the opportunity exists. Most of the time, Howard Marks proffers the appropriate answer: the market does not know any better. However, in Sientra's case there are other drivers:- Portfolio managers believe it's a quality control issue within Sientra itself; this is unfounded, as cited above the particles on the implants are not unique to Sientra but rather a harmless part of the manufacturing process present for all three players
- Institutional imperatives as dictated by fund mandates create many restrictions on companies that managers may invest in. For Sientra, the size of the company and present day losses would hold many funds back from investing in the shares
The margin of safety is also strongly reflected in Sientra's numbers. The company has net cash per share $5.93 and net assets per share $6.21; put another way, Sientra is trading just above liquidation value before we even account for the significant off-balance sheet asset/entry barrier of their FDA approved product, PMA and surgeon relationships. Furthermore, they have significant net operating loss (NOL) carryforward per share $7.63 which only begin to expire 2027!
EV/Sales is ~0.5x which is not only far below industry average of 4-5x, but also assigns nothing to the company's growth. The equity may as well trade like an option. Simply converging to 4x multiple implies $15 per share post-dilution.
As for growth prospects, with Mentor and Allergan sizing down their teams, the $640m market is ripe for Sientra to capture with consideration to their superior product and relationships. Furthermore, their ambitions were never limited to breast implants; the company revealed the acquisition of bioCorneum for US$7m with 4Q15 earnings. bioCorneum has the first and only FDA-accepted advanced silicone gel scar treatment cream with SPF30 sunscreen protection. We will not pretend to have insights into the market share or potential of the product; however, we can assuredly claim the target market is relatively large with 10m cosmetic surgeries performed per annum in U.S. and there are cross-selling synergies with Sientra's breast implants.
Impressive Recovery
Sientra's recent 1Q16 results only served to reinforce my conviction. In short, since returning to the U.S. market on March 1, 2016 the company's product volume pipeline has recovered substantially.
Key comments from management:
Jeffrey Nugent
Let me describe our market re-entry strategy. Demand has exceeded our expectations in the first months of commercial activity. Since the market re-entry, we have contacted 84% of our total previous customers who were active prior to our voluntary hold. Nearly 80% of the customers we contacted are committed to using Sientra products and only 2% have decided to pass, for now. In addition, more than 90% of those in the committed category have already made at least one purchase during the precision launch, and that's through the first quarter of 2016.
...the inventory we have on our balance sheet equates to conservatively $60 million in revenue.
...we've got a high number of requests to get back into Sientra products. And before we bring new customers onboard, we work out a specific forecast for their practice, and in effect put a lien on the inventory such that we are reserving the products that they are going to need.
And I think one other statistic that I don't think was mentioned is that the customers that we brought on to date represent over 70% of the inventory that we have available spread out over the next year and a half, plus or minus. So we're being very seriously reserving the products that we jointly agree that they need.
So another way to answer your question I think more directly is that we have room for additional accounts. It's going to vary based on what their projected needs are, and we make decisions literally on a daily basis as to how many more we bring in.
Effectively, the implication here is:
- From the original set of customers, Sientra has re-established commitments with 67% of surgeons and secured a purchase from 60% of them within only ONE month.
- Sientra has already secured $42m of revenues over the next 12-18 months (70% of $60m inventory). Recall that prior to the voluntary suspension of sales, Sientra was on track to generate over $45m sales in FY15.
Granted, while execution has been excellent there remains two key questions:
- When will Sientra turn profitable?
- When will the company secure an alternative permanent manufacturing partner?
The timeline for profitability is rather simple. If we consult the 2014 Plastic Surgery Statistics, there were approximately 450,000 breast implant related surgeries. Sientra's 10-K estimates the market size is $640m in United States, thus implying an ASP ~$1,400. From that assumption, we see Sientra roughly sold 32,000 units in FY14 and earns a gross profit ~$1,050 per unit. If we assume normalization of operating expenses will fall somewhere between 2014-2015, then the required market share is ~15% vs 10% currently. I do not believe this is difficult to accomplish, considering they captured the said 10% in 3 years.
As for the manufacturing partner, unfortunately there were few details on a timeline from management aside from communication that the transition is on track. Having said that, we know the FDA Pre-Market Approval (PMA) allows Sientra to switch manufacturers within 180 days so I'm inclined to believe it is only a matter of time. At the end of the day, the current valuation presents an immense margin of safety. Even if the manufacturing does not pan out as expected, Sientra represents a clear takeout opportunity for larger pharmaceuticals. The growth prospects and incredible execution on recovery only offer us extra upside.
As for the manufacturing partner, unfortunately there were few details on a timeline from management aside from communication that the transition is on track. Having said that, we know the FDA Pre-Market Approval (PMA) allows Sientra to switch manufacturers within 180 days so I'm inclined to believe it is only a matter of time. At the end of the day, the current valuation presents an immense margin of safety. Even if the manufacturing does not pan out as expected, Sientra represents a clear takeout opportunity for larger pharmaceuticals. The growth prospects and incredible execution on recovery only offer us extra upside.
Warren Buffett "“I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”
