LIBERATOR MEDICAL HLDGS INC 3LBMH
February 14, 2011 - 1:28pm EST by
rjm59
2011 2012
Price: 1.26 EPS $0.08 $0.14
Shares Out. (in M): 55 P/E 16.0x 9.0x
Market Cap (in $M): 70 P/FCF 16.0x 9.0x
Net Debt (in $M): -10 EBIT 6 10
TEV ($): 60 TEV/EBIT 10.0x 6.0x

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Description

I'm normally not much of a fan of GARP type investments, as they seem a bit "lazy" for an investor working with a smaller pool of capital where you can look for more glaring mispricings in the market. Liberator Medical (LBMH.ob) is more of a GAURP "Growth at an UnReasonable Price" investment which is at basically at 10X PE and growing at 40%+ per year going forward (Revenues were $2.25M; $9.55M; $25.8M; $40.9M in 2007-2010 FY ended Sept 30 respectively) with a founder with the most proven track record you could conceive.


Mark Liberatore founded Liberty Medical back in 1989 and sold it to PolyMedica for $9M in 1996 and stayed on as manager. He grew it to $100M in sales by 1999 and was later sold to Medco and I believe now does approximately $600M/year in revenue. Liberty may be familiar to you from their Wilford Brimley TV ads selling "diabeetus" products. The business model was to sell recurring revenue diabetes products through targeted tv ads and its success speaks for itself. Not wanting to be just one cog in a larger machine, entrepreneur Mark left the company and in 2000 founded Liberator Medical which would experiment a bit but largely copy the proven model in different markets from Liberty.

As an aside story - in 1895 when Sears was mostly a catalog business, they made sure to make their order catalog slightly narrower and shorter than the dominant Montgomery Ward catalog at the time. That way the advertisers when stacking them, would, as aesthetics demanded, put the smaller catalog on top and the customers would end up seeing Sears in more prominence inadvertently. Today's "stacking order" isn't paper catalogs but rather the alphabet...

 

Liberator's current business, at $40.9M revenues in the last year consists of urological products (catheters); mastectomy products; diabetes products; and ostomy products. While they don't disclose revenue by division, I believe the catheter business is more than half of their revenues and is primarily for disposable catheters that Medicare reimburses approximately $1.60 for each and a typical order is 400 per quarter for a customer. You might notice the step function in revenues in 2007-2008, this was because a rule was changed by Medicare increasing the number of catheters reimbursable from 4 to 200 per month. Before this change, people were inappropriately forced to sterilize/boil their own catheters and reuse them which would lead to numerous infections and expensive emergency room visits. Surprisingly logically, Medicare decided that an ounce of prevention was worth a pound of cure and decided to just let people use the disposable ones instead which is what lead to this change. From the Medicare billing data that I've glanced over Liberator seems to have about 5X the revenue in disposable catheters over their #2 competition, so are clear and away in the lead, having prepared for and anticipated this regulation change. This is still a fast growing area for them as the number of people (you can imagine how up to date with current events the customer base of this type is...) who are aware of this new rule still seems small in proportion to the reported market size ($1.5B according to the company).

 


Qualitatively, I like to look at a business from two main perspectives: the value they create; and how difficult it would be to copy their position in the world. The value that Liberator creates is largely one of convenience. They ship recurring products (you need a new catheter every time you would need to urinate...) straight to the home each quarter and bill Medicare directly for the customer. This saves enormously on the amount of time it would take for a customer to have to go to the store and bill Medicare on their own each time. You can imagine the psychic convenience as well of being able to order - privately from your own home with an anonymous person on the phone - products that are particularly embarrassing to talk about. I was just reading an article about how sales or pornography skyrocketed with the invention of the VCR since before you had to sit in a theatre with others in public to get that product - which is more limited to die-hard fans...

 


Liberator also is the point of "capture" for this value for two reasons. First is that the customers don't even care about how much they pay because they're not paying. So as long as their customer service is good (which is a huge point of effort for them) then the customers have no reason to shift to another provider seeking a better price. Second, the products are interchangeable - they carry over 5000 - so the vendors can't demand a higher margin. Additionally to this point the reimbursed price is regulated by Medicare, so there is no price competition.

 


In terms of "hard to copy" - the two key things about Liberator that fit this description are the logistical difficulties of billing Medicare and the execution factor on customer service and stocking and shipping. While some businesses prosper because of some unique asset or brand, most are all about execution. In particular, this is a business that can be screwed up easily with poor execution due to the thorough audits, etc with Medicare billing. The founder is the main competitive advantage here who has been doing this exact business for 20 years with an incredibly proven track record. I visited the company in Florida in January looking to see things that might have looked disorganized or have the potential to get to that point and was incredibly impressed how well run the place is and how much people seem to like working there (important considering how large a factor customer service is). They are very anticipatory of their growth and have made sure to build capacity ahead of their revenue so they don't get overwhelmed. Billing Medicare requires keeping detailed customer records and I understand that any time they have been denied; they have always been able to win in the end.

 


Of course, the key risk here is the payer concentration (Medicare is 80% / private insurance-copay is 20%). Medicare has been experimenting with competitive bidding processes in certain industries to lower their costs. Most recently was with diabetes products in Florida which has begun to change the landscape of that market and make it less interesting. While this is certainly a risk, I think it is insignificant for a player as small as Liberator because they are focused on trying to be a leader in smaller niche markets. The catheter market for Medicare is currently about $200M or so whereas diabetes products is over $2B. If Medicare acts rationally and goes after the bigger savings targets, they should be under the radar for a long time - it would probably cost more to conduct a competitive bidding study than the end savings for something like catheters. I should not too that the reimbursement rates for catheter products has never gone down and has gone up roughly with inflation for the last 10 years according to the company.

 


So, given all that qualitative stuff, what's it cost and what's it worth? 
They currently have 45M shares out, and say another 10M warrants and options so 55M shares to be conservative (some cash would come in from these so it would be a bit lower using treasury method) at $1.26 as of the last close or $70M market cap and no net debt.

 


The company's intention is to get to $100M in revenues as fast as practicable and at that point look to either sell the company or at least start being more of a "real" public company with a fair stock price. Mark Liberatore owns 1/3 of the stock, so we should expect things to be shareholder friendly - they haven't sold equity at unduly low valuations and have used creative convertible debt instead of straight equity. At this point they are established enough and cash flow positive enough to not need to raise new equity so I expect the share count to stay the same. Just this morning they announced they got a credit line from PNC at LIBOR + 2.75% which solidifies this.

 


While imprecise: at $100M revenue, they would have similar gross margins of 63%. So say: 
100M 
- COGS: 35% 
- Payroll, taxes, benefits: 20% 
- Advertising: 12% 
- Bad Debts: 5% 
- G&A: 10% 
EBITDA margin = 18% 
Depreciation = 1% 
Taxes = 35% 
Net margin = 11% 
Net income = 11M.

 


If they can decrease their overhead as they scale up, which seems likely considering they have spent a lot building capacity up front so it's probably overstated right now. In that case, they could maybe get net margins as high as 15-16%.

 


Conservative: PE of 15 = 165M mkt cap / 55M shares = $3.00/share in 2 years 
Most optimistically for 2013 I'd say a target price of 20X PE and 16% net margins = 20*16M/55M shares = $5.80

 


A key point here is that it would be very difficult to imagine revenues decreasing due to the highly recurring nature - the conditions they sell products for last indefinitely and they don't even need to bill their end customers, just Medicare. Also, an important accounting note is how they capitalize their advertising. While of course I'd like to see all advertising expensed, they expense half their advertising in the first year and the other half over the next 3 (so expensed over 4 years total). I think this is fair given how solid the recurring revenue is but this will lead to cash flow being lower as long as they are growing, similar to a retail store or manufacturer needing to expand working capital. The advertising is direct response so they have solid data on how high the return on investment is and they could easily justify far more aggressive capitalization under GAAP and choose not to. Were they to decrease advertising expense to a maintenance level (as opposed to aggressive growth currently), their current PE would be under 10 I'm quite sure.

 


So in summary, Liberator is a rapidly growing (40%+) medical supply company that has just in the last 12 months passed the point of requiring equity financing. Their leader owns 1/3 of the stock and has done this play before with great success and will repeat it. 

Catalyst

Company is cheap because it's an orphan right now becasue the company doesn't care of need to raise any equity, just trying to get to $100M revenue as fast as practicable.  Once at that point in ~2 years, will either try to sell the company or at minimum get the stock price up to a fair value with analyst coverage, etc.
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    Description

    I'm normally not much of a fan of GARP type investments, as they seem a bit "lazy" for an investor working with a smaller pool of capital where you can look for more glaring mispricings in the market. Liberator Medical (LBMH.ob) is more of a GAURP "Growth at an UnReasonable Price" investment which is at basically at 10X PE and growing at 40%+ per year going forward (Revenues were $2.25M; $9.55M; $25.8M; $40.9M in 2007-2010 FY ended Sept 30 respectively) with a founder with the most proven track record you could conceive.


    Mark Liberatore founded Liberty Medical back in 1989 and sold it to PolyMedica for $9M in 1996 and stayed on as manager. He grew it to $100M in sales by 1999 and was later sold to Medco and I believe now does approximately $600M/year in revenue. Liberty may be familiar to you from their Wilford Brimley TV ads selling "diabeetus" products. The business model was to sell recurring revenue diabetes products through targeted tv ads and its success speaks for itself. Not wanting to be just one cog in a larger machine, entrepreneur Mark left the company and in 2000 founded Liberator Medical which would experiment a bit but largely copy the proven model in different markets from Liberty.

    As an aside story - in 1895 when Sears was mostly a catalog business, they made sure to make their order catalog slightly narrower and shorter than the dominant Montgomery Ward catalog at the time. That way the advertisers when stacking them, would, as aesthetics demanded, put the smaller catalog on top and the customers would end up seeing Sears in more prominence inadvertently. Today's "stacking order" isn't paper catalogs but rather the alphabet...

     

    Liberator's current business, at $40.9M revenues in the last year consists of urological products (catheters); mastectomy products; diabetes products; and ostomy products. While they don't disclose revenue by division, I believe the catheter business is more than half of their revenues and is primarily for disposable catheters that Medicare reimburses approximately $1.60 for each and a typical order is 400 per quarter for a customer. You might notice the step function in revenues in 2007-2008, this was because a rule was changed by Medicare increasing the number of catheters reimbursable from 4 to 200 per month. Before this change, people were inappropriately forced to sterilize/boil their own catheters and reuse them which would lead to numerous infections and expensive emergency room visits. Surprisingly logically, Medicare decided that an ounce of prevention was worth a pound of cure and decided to just let people use the disposable ones instead which is what lead to this change. From the Medicare billing data that I've glanced over Liberator seems to have about 5X the revenue in disposable catheters over their #2 competition, so are clear and away in the lead, having prepared for and anticipated this regulation change. This is still a fast growing area for them as the number of people (you can imagine how up to date with current events the customer base of this type is...) who are aware of this new rule still seems small in proportion to the reported market size ($1.5B according to the company).

     


    Qualitatively, I like to look at a business from two main perspectives: the value they create; and how difficult it would be to copy their position in the world. The value that Liberator creates is largely one of convenience. They ship recurring products (you need a new catheter every time you would need to urinate...) straight to the home each quarter and bill Medicare directly for the customer. This saves enormously on the amount of time it would take for a customer to have to go to the store and bill Medicare on their own each time. You can imagine the psychic convenience as well of being able to order - privately from your own home with an anonymous person on the phone - products that are particularly embarrassing to talk about. I was just reading an article about how sales or pornography skyrocketed with the invention of the VCR since before you had to sit in a theatre with others in public to get that product - which is more limited to die-hard fans...

     


    Liberator also is the point of "capture" for this value for two reasons. First is that the customers don't even care about how much they pay because they're not paying. So as long as their customer service is good (which is a huge point of effort for them) then the customers have no reason to shift to another provider seeking a better price. Second, the products are interchangeable - they carry over 5000 - so the vendors can't demand a higher margin. Additionally to this point the reimbursed price is regulated by Medicare, so there is no price competition.

     


    In terms of "hard to copy" - the two key things about Liberator that fit this description are the logistical difficulties of billing Medicare and the execution factor on customer service and stocking and shipping. While some businesses prosper because of some unique asset or brand, most are all about execution. In particular, this is a business that can be screwed up easily with poor execution due to the thorough audits, etc with Medicare billing. The founder is the main competitive advantage here who has been doing this exact business for 20 years with an incredibly proven track record. I visited the company in Florida in January looking to see things that might have looked disorganized or have the potential to get to that point and was incredibly impressed how well run the place is and how much people seem to like working there (important considering how large a factor customer service is). They are very anticipatory of their growth and have made sure to build capacity ahead of their revenue so they don't get overwhelmed. Billing Medicare requires keeping detailed customer records and I understand that any time they have been denied; they have always been able to win in the end.

     


    Of course, the key risk here is the payer concentration (Medicare is 80% / private insurance-copay is 20%). Medicare has been experimenting with competitive bidding processes in certain industries to lower their costs. Most recently was with diabetes products in Florida which has begun to change the landscape of that market and make it less interesting. While this is certainly a risk, I think it is insignificant for a player as small as Liberator because they are focused on trying to be a leader in smaller niche markets. The catheter market for Medicare is currently about $200M or so whereas diabetes products is over $2B. If Medicare acts rationally and goes after the bigger savings targets, they should be under the radar for a long time - it would probably cost more to conduct a competitive bidding study than the end savings for something like catheters. I should not too that the reimbursement rates for catheter products has never gone down and has gone up roughly with inflation for the last 10 years according to the company.

     


    So, given all that qualitative stuff, what's it cost and what's it worth? 
    They currently have 45M shares out, and say another 10M warrants and options so 55M shares to be conservative (some cash would come in from these so it would be a bit lower using treasury method) at $1.26 as of the last close or $70M market cap and no net debt.

     


    The company's intention is to get to $100M in revenues as fast as practicable and at that point look to either sell the company or at least start being more of a "real" public company with a fair stock price. Mark Liberatore owns 1/3 of the stock, so we should expect things to be shareholder friendly - they haven't sold equity at unduly low valuations and have used creative convertible debt instead of straight equity. At this point they are established enough and cash flow positive enough to not need to raise new equity so I expect the share count to stay the same. Just this morning they announced they got a credit line from PNC at LIBOR + 2.75% which solidifies this.

     


    While imprecise: at $100M revenue, they would have similar gross margins of 63%. So say: 
    100M 
    - COGS: 35% 
    - Payroll, taxes, benefits: 20% 
    - Advertising: 12% 
    - Bad Debts: 5% 
    - G&A: 10% 
    EBITDA margin = 18% 
    Depreciation = 1% 
    Taxes = 35% 
    Net margin = 11% 
    Net income = 11M.

     


    If they can decrease their overhead as they scale up, which seems likely considering they have spent a lot building capacity up front so it's probably overstated right now. In that case, they could maybe get net margins as high as 15-16%.

     


    Conservative: PE of 15 = 165M mkt cap / 55M shares = $3.00/share in 2 years 
    Most optimistically for 2013 I'd say a target price of 20X PE and 16% net margins = 20*16M/55M shares = $5.80

     


    A key point here is that it would be very difficult to imagine revenues decreasing due to the highly recurring nature - the conditions they sell products for last indefinitely and they don't even need to bill their end customers, just Medicare. Also, an important accounting note is how they capitalize their advertising. While of course I'd like to see all advertising expensed, they expense half their advertising in the first year and the other half over the next 3 (so expensed over 4 years total). I think this is fair given how solid the recurring revenue is but this will lead to cash flow being lower as long as they are growing, similar to a retail store or manufacturer needing to expand working capital. The advertising is direct response so they have solid data on how high the return on investment is and they could easily justify far more aggressive capitalization under GAAP and choose not to. Were they to decrease advertising expense to a maintenance level (as opposed to aggressive growth currently), their current PE would be under 10 I'm quite sure.

     


    So in summary, Liberator is a rapidly growing (40%+) medical supply company that has just in the last 12 months passed the point of requiring equity financing. Their leader owns 1/3 of the stock and has done this play before with great success and will repeat it. 

    Catalyst

    Company is cheap because it's an orphan right now becasue the company doesn't care of need to raise any equity, just trying to get to $100M revenue as fast as practicable.  Once at that point in ~2 years, will either try to sell the company or at minimum get the stock price up to a fair value with analyst coverage, etc.
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