Description

Tactile Medical: own at your own risk

Before we get into why TCMD is fundamentally a broken company that is a short, we’d like to point out a massive red flag: ~40% of the company is owned by 2 venture capital firms: Galen and Radius.  Based on our diligence, one has been invested in TCMD for ~4 years and the other for ~9 years.  Here’s the red flag: in November 2016, TCMD filed a S-1 to sell more equity.  The company has publicly told investors they were seeking to sell ~2M shares.  Of these ~2M shares TCMD wanted to sell, a significant amount of it were shares owned by the insiders.  Just to be clear, the insiders are likely Galen and Radius, both with board seats and theoretically perfect information of how TCMD is doing.  Less than 1 month of the S-1 filing date, TCMD withdrew this equity financing because there was not enough interest.  Here’s the set up: if Galen and Radius were able to strong-arm TCMD to sell their shares in November 2016 but could not because there was minimal demand or interest from the public markets, then what do you think happens when Galen and Radius are able to sell their shares after their window opens?  Earnings occurred recently 2/27/17 and the window should be open soon if not already.  And giving the liquidity of this stock, it won’t take a lot for the stock to be crushed.

Outside of this red flag, here are the fundamental reasons why we are short TCMD:

1. It sells an undifferentiated product called Flexitouch that is a commodity (an ultra-expensive air compression wrap that you Velcro around your legs or arms)

2. Patents expire this year (2017)

3. Even without patents, the barriers to entry are incredibly low: look at the number of competitors in this space!

4. The actual product itself has a lot of product design issues

5. Even worse, payors are pushing back and don’t want to pay for this product (this driver is what we think will ultimately cause TCMD to miss guidance)

6. Revenue growth is already declining and we expect it to go down even more

7. Margins (profitability) are low and margins (profitability) will not improve because TCMD needs to keep its large back office to cram every sale they can get

8. The actual market size is much smaller (TCMD inflates the market size)

9. We think the stock is worth less than $6, which is 60%+ downside

Issues #1-3: TCMD sells an undifferentiated product called a Flexitouch, which has patents that expire this year.  Even with the patents intact, Flexitouch already has a ton of competition.  Imagine the competition that occurs when the patents do expire!

TCMD sells Flexitouch, which is a wrap you put on your legs or arms that fills with air.  Simply, the pump causes the wrap to fill with air, which then pushes the fluid in your legs or arms.  It is used primarily for lymphedema, a swelling of your extremities caused by variety of disease (surgery from cancer, obesity, vascular disease, etc.).

This is what the Flexitouch product looks like:

TCMD clearly states all of the Flexitouch patents expire this year from page 19 in its corporate presentation:

We know what happens when patents expire: competitors will come in and copy what TCMD has spent so much time and money developing.  We just want this to be clear even though it is obvious: patent expiration for TCMD’s primary product will be very bad for TCMD.

However, the story only gets worse.  Even before TCMD’s Flexitouch patent expiration this year, there are already a ton of competition!  This shows that the squeezey-leg-wrap product is really undifferentiated.  And we know that undifferentiated, or commodity-like, products compete by lowering prices.  Lower and lower prices is never good for business.

Here’s just a few of the competitors that we found:

Issue #4: the actual product has a lot of design issues

TCMD’s product causes genital swelling

TCMD’s product is hard to use (so many tubes and don’t know which tube goes where)

TCMD’s product is hard to clean

Issue #5: Even worse, payors are pushing back and don’t want to pay for this product

From Glassdoor, these are what we’re reading publicly online.  Imagine how much worse the discussion and dialogue is behind closed doors!  

Also, through speaking with management and other consultants, we learned that commercial insurance payors is ~70% of business.  Commercial insurance typically takes ~1 mo to get approval before TCMD can send the device to a patient (payor must approve first!).  That does not sound like a product that can be sold very easily: “Here’s a product you’d like.  But you have to wait 1 month first.”

As you’d expect, it’d also not cheap: patient pays $500 out-of-pocket for this device (10% of the $5K ASP)

Wait, there’s more.

Medicare is ~13% of TCMD’s business: it takes ~2 mo (!!) to get approval before TCMD can send the device to a patient.  This is what happens logistically: doctor needs to 1st try ~1 mo of conservative treatment (compressive garments) and ~1 month of a cheaper compression device.  Only then (after 2 months), can the doctor get approval from Medicare to even think about using Flexitouch, or any of the other number of squeezy-wraps out there.  For Medicare, the patient pays $1,000 for this squeezy wrap.  It does not sound like a bargain to us: “If you want this product, you have to wait 2 months.  And only then, after you fail everything else in 2 months, can we even consider you for this product.  Oh yes, this costs $1,000 cash.”

Issue #6: Revenue growth is already declining and we expect it to go down even more

We are making a call to say that revenue growth is going to slow.  It already is.  We think it will only get worse.  We’re not highlighting anything new.  We’re just trying to be sure that people recognize what’s happening right now.

Source: TCMD 10Q and 10Ks

Issue #7: Margins (profitability) are low and margins (profitability) will not improve because TCMD needs to keep its large back office to cram every sale they can get

Looking at the actual financials, we see an inefficiently run business that is using its superior GMs to pay for large fixed cost infrastructure (primarily a huge back office staff to help with all the logistics of selling this device), leading to inferior overall profitability (inferior net margins).

The big difference between TCMD and its comparable companies is that ~22% of TCMD’s revenue is the “Reimbursement, General, and Admin” line item, which is largely made up of paying for their 65+ staff that helps patients get their device reimbursed:

The takeaway is simple: TCMD needs a huge back office support staff to push every single sale of Flexitouch it can because patients have a lot of other options and payors are pushing back.  Because TCMD needs this huge back office and needs to spend approximately $1 of every $5 of revenue it receives to pay for this back office and all other competitors don’t have that massive of an expense, this means that TCMD will always be a company with lower profitability versus its competitors.  Does that sounds like a good business to be a shareholder of?

Issue #8: The total addressable market is not as big as TCMD would like us to think

TCMD is saying the market is ~$4B market:

TCMD’s math is completely wrong.  Here’s why:

• The thing TCMD is missing is that each patient with the disease only gets 1 device, which lasts 10+ years based on our diligence

• Why is this important?  Because you can’t take the entire population of the 820K people with the disease today and multiply it by the ASP for a device ($5K) to get to the $4B (how TCMD is doing the math)

• Because each patient that gets a Flexitouch or any of the other competitor devices is no longer available

• Just to be clear, the 820,000 patients should be smaller because that 820,000 patients includes many patients who already have devices and are no longer actively looking to purchase another device

• Our math, below, suggests that market is actually ~$750M, which is ~20% of the $4B TAM that TCMD is saying!

  • For each patient that is on a compression device, you have to take that patient out of the TAM because that patient will not be buying another device

  • Thus, the faster TCMD grows and sells its devices, the quicker that growth will have come to a halt because the market is just no longer there: the patient market grows likely at population growth rate (~0.7%) and the faster the devices are sold (by TCMD plus all the dozens of other compression devices that compete with TCMD), the faster the TAM is depleted of patients

Issue #9: We think the stock is worth less than $6, which is 60%+ downside

The downside case that the stock is worth ~$6 (60%+ down from current) based on assuming a 0.5x EV/sales multiple in FY18E (currently trading at ~2x) and a DCF (using Adj. EBITDA as a proxy for FCF).  

Catalyst

Technicals: Insider sellling: 2 legacy venture funds (Radius and Galen) own ~40% of this stock and have been in it for ~4 yrs and ~9 yrs

Fundamentals: Earnings report and missing guidance and / or lowering guidance, which we think will happen