Description

Description: 

Neuronetics is a small cap medical device turnaround stock with a leading position in a nascent and vastly underpenetrated market. Since joining in 2020, new CEO Keith Sullivan (formerly President of North America at Zeltiq) has sharpened focus on patient throughput versus prior focus on pushing capital sales and has rebuilt STIM’s go to market model and sales team based on his learnings at Zeltiq. These changes are poised to return Neuronetics to rapid revenue growth and margin expansion over the coming years. Despite a recent run up in shares, STIM trades at just 4x 2022E revenue with healthy gross margins approaching 80%. I believe STIM is capable of growing revenue 20-30% per year for the next 5 years and eventually being sold for a healthy multiple of revenue just like Zeltiq leading to healthy IRR for STIM equity holders. 

Company Background: 

Neuronetics is the market leader in the emerging field of transcranial magnetic stimulation or TMS for the treatment of medication resistant depression and other psychological disorders. The initial target market is psychiatrists in the United States. There are over 50k psychiatrists in the US and Neuronetics has sold over 1,100 systems compared to competitor Brainsway at around 600 systems.Since commercial launch STIM has treated over 100k patients with 3.4m treatment sessions. 

TMS is a technology with a large addressable market and significant unmet need given the number of depressed people in the US (over 13m) and the limitations of these medications for a large percentage of the depressed population.

Additionally, while not perfect, TMS is effective for a significant portion of patients who fail multiple medication treatments.

For those of you who like me don't specialize in reading clinical data, I believe the fact that they have almost universal commercial payor coverage validates that the technology does in fact work. Payors like United Healthcare dont pay for expensive treatments without significant data and medical society recommendation. 

From the perspective of the physician, he/she buys the device for ~70k and then gets reimbursed between 7-10k per patient cycle leading to an attractive payback of within 12 months. 

Where things went wrong in the past: 

Neuronetics was a high flying IPO which traded over $30 per share in 2018. Under prior CEO Chris Thatcher, STIM focused on pushing boxes and discounting in order to build a footprint, but didn’t have a solid plan for driving utilization. As a result, while revenues grew, losses mounted and per system utilization stalled and then started to decline. 

Thatcher is now gone. The issue with his strategy was that the company did not invest enough in helping practices with patient conversion. For example, patients who were interested in getting treated would find a highly ineffective website physician locator [the website is now being fixed as just one small example of the overhaul]. Another example is that patients would call physicians for information, but wouldn't receive a call back due to lack of office staff training and the building of proper procedures. 

Additionally the marketing message was driven by old line media like television, radio and targeted at the 50+ female demographic. This demographic is much more expensive to reach than the 30-49 demographic that heavily uses social media and can be more effectively targeted. 

Why things will likely improve from here: 

Keith has rolled out initiatives that will start to play out over the course of 2021 and beyond: 

1. Focus on utilization: The highest goal within the commercial organization is to facilitate each practice treating 1 additional patient per month given that 1 additional treatment per month equates to roughly $100k of additional practice revenue per year, a very significant number for a psychiatrist. If this can be attained then many more psychiatrists will want to buy the machine, driving the flywheel. 

A big part of driving utilization is the Five Stars to Success program that was recently rolled out at the January 2021 sales meeting. Keith describes this program as a prescriptive and detailed program for improving each psychiatrists TMS practice spanning from novice users to high volume clinics. The program involves best practices for identifying, consulting and treating patients, a concierge call center, national marketing and digital and social engagement. This program is very similar to a 5 stars program that Keith deployed as President of Zeltiq. 

Additionally Neuronetics also introduced the Precision Pulse program where customers can unlock rewards based on attaining certain levels of utilization. These rewards include access to the co-op marketing dollars and co-branded social media advertising assets. 

2. Improved Sales Team:  Keith brought in Zeltiq veteran Sara Grubbs to be VP of Sales at Neuronetics. Over the past several months they together recruited and brought in 28 new sales rep hires representing over 55% of the total sales force. Nearly all of these reps are Zeltiq veterans. Of these reps 18 are in the capital category, and comprise over 80% of the total capital sales rep count. 

Keith has stated that the typical ramp to rep productivity is 6-9 months but that he expects given the veteran nature of the crew he and Sara recruited and the new reps familiarity with the capital/recurring model that the new reps can start to be productive in the second quarter of 2021. 

Recent Equity Raise Derisks Balance Sheet: 

Neuronetics took advantage of a strong stock price and recently issued 5.5m shares at $15.5 per share. This makes the proforma net cash balance over $90m as of 12/31/20 and desrisks the balance sheet. 

Cash burn will persist through 2021 which is a negative to the story, but my belief is that most of this is related to turbo charging the investments in driving utilization and new reps, the costs of which are included in guidance for operating loss in the -15-20m range but to the degree that these investments generate a good return I believe its possible that losses could narrow sharply in 2022 and beyond leading to a nicely profitable business over our investment time horizon. 

The company proved in the second half of 2020 that they can operate at a reduced operating cost and should the investments that Keith and team are making  not pan out I expect costs to be significantly reduced. I believe the company could operate at break even today given their 77% gross margin and highly treatment session driven revenue stream. 

Valuation: 

For upside valuation, I believe $100m in sales is achievable in 3-4 years. At this level STIM should be profitable but still growing fast given the size of the addressable market. Applying a sales multiple of 7.5-10x gives us price targets of $25-$35 assuming 30m FDSO and reduced cash balances versus today's levels. 

In a downside scenario, I assume the company can operate at its precovid revenue level of around $60m and given the recurring nature of treatment session driven revenue can cut costs enough to be break even at this level. Given the potential of the technology I believe the company could trade for 3x revenue in this scenario. Adding back 60m of cash (assumes they burn for a while before they cut costs) and 29m shares out gives us a $8.25 risk price target.  

Risks: 

Cash burn

Turn around plan stalls 

Technological obsolescence 

Catalyst

Revenue accelleration 

Utilization improvements 

Reduced cash burn