Description

STRATA Skin Sciences, Inc. (“SSKN”) is a microcap medical device company that sells the XTRAC excimer laser systems to dermatologists primarily for the treatment of psoriasis and vitiligo.  It has a recurring business model earning a high gross margin on recurring sales from its growing installed base.  SSKN is particularly interesting at the current time because last year the company acquired its largest competitor, Ra Medical, giving it a monopoly on excimer laser systems.  More importantly, SSKN is in the process of converting Ra Medical’s customers to XTRAC under a recurring sales model.  The remaining Ra Medical conversion should increase SSKN’s installed base by 22%, growing EBITDA from $1.5mm in 2021 to $8.5mm run-rate by the second half of 2023.  SSKN trades at just 3.8x our estimated fully ramped EBITDA.

The original XTRAC laser was developed by PhotoMedex and approved by the FDA in 2000.  It delivers precisely targeted UVB light therapy to specific treatment areas of the skin, for both adult and pediatric patients suffering from inflammatory skin conditions such as psoriasis, atopic dermatitis and vitiligo.  The XTRAC laser has maintained its position as the leading excimer laser in the US, and utilization of the device has been stable as it’s covered by insurance.  SSKN acquired the XTRAC laser business from PhotoMedex in 2015, expanded the recurring business model – SSKN places the XTRAC laser systems for free; it charges dermatologists $70 per treatment while dermatologists get reimbursed $166 to $246 per 5 to 10 minute treatment; it services and maintains the systems; and it markets the XTRAC treatment to patients to drive additional traffic to dermatologists’ offices.  As of March 31, 2022, the XTRAC system installed base is 958.  This installed base grew 8 out of the last 10 years, including each of the last 3 years.  There’s still significant market penetration potential, as XTRAC is only in 312 of the 1,962 group clinics in the US.

Operating in a small niche market, SSKN historically faced one main competitor – Ra Medical, which received FDA approval for its own excimer laser system in 2007.  Ra Medical sold laser systems to dermatologists upfront instead of charging a fee per use.  While this business model allowed Ra Medical to take some high volume customers who preferred keeping 100% of the procedure revenue in-house, Ra Medical suffered years of losses and the model proven unviable as it never reached scale.  In August 2021, SSKN announced an agreement to buy Ra Medical, a significant catalyst.  SSKN paid just $3.7 million to absorb its largest competitor, gaining access to approximately 250 high utilization customers while adding minimal incremental operating costs.  SSKN immediately announced that existing Ra Medical customers will need to switch to SSKN’s XTRAC lasers in order to continue receiving maintenance and support after their Ra Medical service contracts expire.  As of March 31, 2022, SSKN has converted 45 Ra Medical customers, and we expect the company to convert the majority of remaining Ra Medical customers over the next two years, as some customers will run their laser systems without maintenance service until the system breaks and they must convert to XTRAC.

Another tailwind to the business is the recovery of dermatology practices as C19 concerns fade.  SSKN’s results in 2020 and 2021 were severely impacted by C19 as many patients avoided going into doctor’s offices.  While average annual recurring sales per customer improved from $20.6k in 2020 to $25k in 2021, they’re still well below the $30k in 2019.  The trend continues to improve, and we expect average recurring sales per customer to approach pre-C19 levels starting in 2Q2022 as the Omicron spike quickly died out in late 1Q2022.  Once recurring sales return to the normal $30k per year level and assuming SSKN converts 90% of Ra Medical’s customers, SSKN will generate $11.2 million higher recurring revenue compared to 2021 (50% increase) and $7.1 million higher EBITDA compared to 2021 (482% increase).

SSKN’s largest shareholder, Accelmed, installed CEO Bob Moccia in March 2021.  Moccia has a clear vision to create a platform company, adding products opportunistically and creating synergies by leveraging the company’s existing sales force and customer base.  We believe he has a solid background and a credible playbook as he built and sold five healthcare companies in thelast 20 years.  One example of this strategy at SSKN is the acquisition of TheraClear in January 2022.  TheraClear is an acne treatment system used by dermatologists.  The product was approved in 2013, but did not achieve commercial success, as the prior owner did not have a sales force or the funding to build out a sales effort.  SSKN structured the deal in a low-risk manner creating lots of optionality while paying just $1 million upfront and agreeing to additional contingent consideration tied to the future success of TheraClear.  SSKN’s plan is to rebrand TheraClear and offer it on a recurring sales model, initially targeting existing XTRAC laser customers.  If successful, TheraClear will bring in significant incremental earnings as it leverages SSKN’s existing sales infrastructure.  We estimate that depending on the level of success, TheraClear could add $1.4 million to $7.8 million to the company’s annual EBITDA.   

We think SSKN is attractive due to its cheap valuation and the highly visible growth ahead.  SSKN initially acquired the XTRAC laser business from PhotoMedex for $42.5 million in 2015 when the business only had an installed base of 640.  Today the installed base is 958, and we expect it to increase to over 1,100 in the next 12 to 18 months.  Despite this dramatic increase in scale and elimination of its only competitor, SSKN today trades at a 18% discount to the 2015 purchase price.  We expect SSKN to achieve our estimated fully ramped EBITDA by the second half of 2023, and at medical device peers’ 8.4x 2023E EBITDA multiple, there’s 107.8% to 287.6% upside, depending on how successful TheraClear is.  The company has an unlevered balance sheet and does not need to raise additional capital to operate its business.

Finally, we believe that 35% shareholder is positioning the company for a sale through the hiring of CEO Bob Moccia.  A strategic buyer should be able to realize additional synergies allowing for upside higher than shown above.

Catalyst

Acceleration in conversion of Ra Medical’s customers

Earnings inflect as sales increase from both installed base growth and utilization growth drive high incremental margin

Successful launch of the rebranded TheraClear

Sale of the company