Description

Sientra is a challenger US breast implant provider which at one point had built a 7% market share position in the 3-player market, but has since fallen on hard times. Whereas it had once traded in the 20's when business momentum was strong, it traded down to a low below $3 in 2015 following two unfortunate events:

• Sales by its European and South American counterparts were suspended due to contamination concerns, causing SIEN to voluntarily halt US sales as well
• Its sole manufacturing facility in Brazil burned down in a freak accident

Sientra does not own its own breast implant design, nor does it do its own manufacturing. Instead, it operates as the exclusive US distributor of Brazil-based Silimed. (Silimed is one of the largest global implant manufacturers.) It has been selling breast implant products in the US since 2012, when it first gained FDA approval.

Silimed lost its European CE certification after a German inspection team detected cotton and silica particles on the surfaces of Silimed's devices. While the perception of a public health hazard would seriously impair SIEN's marketability, there are numerous primary and secondary sources that explain why this was a red herring. Most recently, that the Dutch National Institute for Public Health and the Environment reported back to European authorities in October that Silimed products pose minimal risk to patients, which should finally put Silimed back on track to regaining commercial authorization, including regaining CE. 

http://www.raps.org/Regulatory-Focus/News/2016/10/17/26015/Dutch-Report-Finds-Silimed-Breast-Implants-Carry-Little-Risk-to-Patients/

In the US, Sientra is now selling product again (notably, it never lost FDA approval, despite the precautionary stops in Europe and SA), operates under new and credible management, and is rebuilding its manufacturing and sales capabilities. Trading at just above the value of cash and inventory (more on this at end), this is a company is being treated as a venture-stage startup when it actually has the risk profile of a company that 1.) has low technology risk, 2.) is already FDA-approved, 3.) has already proven that it can stake out significant share in an oligopolistic, high barrier market, 4.) has an existing distribution base and 5.) is well capitalized.

Industry Structure

The US market is more or less owned by two major players, Allergen's Natrelle and J&J's Mentor, each of whom own roughly half of the market. Sientra is the 3rd player and, as mentioned earlier, Sientra had fought its way to 7% market share prior to its recent mishaps. Additionally, there is a newly FDA-certified competitor called Ideal Implant which is saline-based with a silicone shell, as compared for the majority of the market (80% silicone). Distribution is limited only to Ideal Implant shareholders and roughly 45 doctors who were involved in gaining FDA approval, so for now this appears to be a niche product. Should attitudes change about silicone safety, this and other saline based products could upset the status quo, but there has been no indication this is happening yet.

American Society of Plastic Surgeons statistics indicate a slow decline of 1-2% annually in US breast augmentation procedures in recent years, with 2015 procedures totalling 279k. This seems to reflect changing social attitudes as well as a reversion to the mean after catch-up growth in procedures after the Financial Crisis. Additionally, the breast reconstruction market (where SIEN does not play) has grown in the low-to-mid single digits the past several years, with 106k procedures in 2015.

The company has a unique marketing pitch with doctors in that only board-certified/board admissible plastic surgeons are allowed to implant its product, creating a point of marketing differentiation in a field where physicians create the product "pull" and physicans are always looking for a way to stay ahead of the pack. This is a bit of a gimmick, because board-certified plastic surgeons conduct ~90% of all procedures. Still, perception matters in the aesthetics business, where government and insurance have little input. 

SIEN's product also has different qualities in terms of shape ("teardrop"), firmness ("gummy"), texture and procedure compatibility, but for all intents and purposes, the competitors appear to have caught up since these unique features were innovative in 2012. Also, if you want to review the clinical data, there are multi-year studies out there which show rupture rates, capsular contraction, and other performance metrics are equal to or better than peer products.

The Road to Recovery

SIEN began selling its products again in March 2016 in a "controlled market re-entry". Q2 results provided the first signs that SIEN's brand was intact and that it is capable of holding its ASPs by selling through at its previous ~70% GM level. (Despite having no manufacturing capacity currently, SIEN is sitting on approximately $65 million market value in inventory.) SIEN appears intent on rationing sales at low levels, currently about $6-$7 million a quarter, to its lead users, until manufacturing is re-established. Polling with SIEN's physican base shows a willingness to again buy their product.

The company announced on its Q2 call that they have contracted with a subsidiary of Lubrizol LifeSciences to prepare a new manufacturing facility and confirmed construction was complete on their Q3 call. This facility will require a minimum 180 day review period by the FDA before it is allowed to provide saleable product to consumers, and management has guided to "end of 2017" as timeline for shipping Lubrizol manufactured products.

Old management either luckily or in a premeditated way did a capital raise when stock was ~$22, just before everything went wrong, so the company is cash capitalized with no debt. The old CEO is out and the company is now led by Jeffrey Nugent, board member since 2014 and former CEO of Neutrogena (sold to J&J), Revlon, and a derm startup (sold to Valeant). The new CFO, formerly of Zeltiq, was just announced on the Q3 call.

Valuation

A few useful data points:

• For comparison, 2015 revenues were tracking in the ~$55+ million range (~7% market share) before the two business disasters. 2014 sales were $45 million and unit sales were 28k pairs. Gross margins were in 70-75% range. 
• Prior to current troubles, analysts projected they were on track to profitability in Q1 2016 and ranges of 10-15% market share by 2018. 
• SIEN also currently holds exclusive rights in Canada, where the major competitors are Mentor and Natrelle once again, but this is whitespace right now as their Health Canada application is likely in limbo until CE certification comes back and in any case will not become an area of focus until the US is stabilized.
• SIEN just announced an acquisition of Specialty Surgical Products to extend their tissue extender product line, with the goal of targeting the growing reconstruction market.
• SIEN also sells a silicone gel scar cream called bioCorneum (acquired through recent acquisition), as well as tissue expanders (primarily used in breast reconstruction). While these products (especially bioCorneum) appear to have traction in the market, we do not give them any credit here just due to materiality to the overall story. Note this product accounts for a little over $1 mm in Q2 and Q3 sales.
• Also, they have $138 million in NOLs, but I doubt anybody will care about this in the near term.

Given a capped TAM, valuation is going to depend in large part on what analysts and investors eventually believe the company can achieve in terms of market penetration. It is interesting to note that the home market for Sientra had been breast augmentation (outpatient, uninsured) and not reconstruction (hospital, reimbursed, appears correlated with rising incidence of breast cancer). So, in fact the actual 2014 market share was closer to 10% after only three years of selling if considering just the augmentation market, whereas analysts quote the entire market including reconstruction.

Looking out to 2018 or 2019, if we assume they reclaim 10% augmentation market share = 28k procedures priced @ $1,400 per set, they can get back to $52 million in annual revenue, plus a little bit extra for tissue extenders and bioCorneum. It is probably optimistic to believe they'll be trading at 5-7x revenue as they did in headier days when they were in the $20's, but it might not be unreasonable to peg them at 3-4x or $12-$15 (60%-100% upside). This guess at valuation is eminently debatable, of course. So is the possibility that they have a shot at Canada or will make inroads in the reconstruction market.

Downside is theoretically protected by cash of $79 mm (no debt) + inventory of $19 mm (worth ~$65 mm at current margin levels, not a taxpayer) = $144 mm vs. $150 mm market capitalization. At approx. $10 mm in quarterly cash burn, they won't need any equity between now and manufacturing startup if things don't go off track.

Note, however, it is unlikely in a wind-down scenario that they could liquidate the entire inventory at full price, because 1.) inventory needs to be specific to each patient (and popular specs probably will run out first) and 2.) in a wind-down scenario, doctors are unlikely to continue prescribing Sientra product with no ongoing corporate support. The downside view should also consider warranty risk and ongoing cash burn, so you would not be fully covered here.

Risks

Stock is likely to be volatile until 2018, when they have manufacturing back up and would be showing good progress toward a steady state financial profile. In the interim, expect to see punctated equilibrium-type changes in fundamentals and news flow, with long periods of erratic trading. 

Risks other than the obvious regulatory and liability items:

• Silimed Agreement - Silimed just prior to the Q3 earnings call claimed that Sientra was in violation of their commercial agreement. More to come on this, but it is clear why: Silimed is paid on a unit shipped basis, with no licensing fees, so they won't make any money on Lubrizol manufactured product. SIEN's 10-K states, "[Pursuant to the Silimed Agreement] In the event Silimed fails to supply products ordered by us, we may, under certain circumstances, exercise manufacturing rights to manufacture the products directly or through a third party manufacturer." The agreement ends in April 2017, so it needs to be renegotiated in any case. Considering that SIEN owns all the FDA approvals and clearances, and it would take 5+ years for Silimed to refile in the US, the renegotiation should result in a reasonably fair outcome to all parties
• Market/competion - Given the stable oligopalistic industry structure, SIEN's premium positioning and the flattish/shrinking market size, it seems less likely there will be some sort of mutual assured destruction play on J&J or Allergen's part, but it is up to SIEN to prove they can reclaim share in the market in what one can claim is a less high-flying medtech environment
• Capital allocation - new management has shown maybe too much willingness to do tuck-in M&A. Although they appear to be complementary to the product portfolio, they could in fact be value destructive and I'd prefer they just held onto their cash
• Execution - Perceptions on timing and achievement of concrete milestones will be key to valuation until SIEN gets back up to growth mode. Expect the stock to be extremely sensitive to operational or approval delays, etc.
• Recession - just like people buy fewer Harleys in a recession, this discretionary spending category also suffers (~6% drop in 2009 for reference)

Final Thoughts

I thought this was interesting enough to write up as I'm doing the research, but do have a call into management on a number of issues and will provide further updates as they come. 

This investment looks a lot like a venture capital investment from the outside, considering that the company is essential resetting its business and shows startup-like sales levels heading to the promised hockey stick. What makes this much less risky is the fact that SIEN has 1.) no technology risk, 2.) has established distribution channels and users, 3.) is FDA-approved, 4.) has already proven it could take 7% (10%) market share as late as last year, 5.) operates in a (theoretically) rational oligopoly industry with high barriers to entry, and 6.) is well capitalized. If you're a pure value investor, I think this wouldn't be for you despite cash and inventory, as SIEN is very much execution-dependent and this will still trade like a growth stock two years out.

One could also make a very rational argument that as a standalone company, they will never achieve enough scale to generate an appropriate CF and ROI and so you would have to think about the value of SIEN to a buyer given its static product set (R&D through acquisitions not in vogue these days). But, taking a VC perspective, put a hurdle rate of 25% on this with a 2 year exit at $12-$15, and you're at $7.50 - $9.50 today. Looking at it this way, SIEN probably shouldn't be a large holding in any portfolio, but is nevertheless an interesting complement. 

At the end of the day, though, this is a call on whether 1.) you believe management can execute their recovery plan and 2.) the marketplace hasn't changed substantially for the worse since 1.5 years ago.

Catalyst

The biggest catalyst is the startup of Lubrizol production and a stairstep in sales in 2018, for which unfortunately there won't be much attention paid until next year

Smaller catalysts include:

• Announcement of a 2nd manufacturing partner/facility
• Reinstatement of European CE for Silimed
• Management claims their timeline guidance is conservative