Note to Readers: All changes since last report date have been highlighted.
Reason for Report: Announcement of definitive merger agreement. Prev. Ed.: May 8, 2006.
Overview
Laserscope (LSCP), based in San Jose, California, is a provider of medical laser systems for surgical and aesthetic applications. Founded in 1984, the company currently has installed over 8,000 lasers worldwide in doctors' offices, out-patient surgical centers and hospitals. LSCP primarily serves the needs of two medical specialties: urology and aesthetic surgery. Laserscope offers a variety of surgical instruments and other accessories for use with its surgical laser systems. These products include disposable optical fibers, side-firing devices, scanning devices, couplers, micromanipulators for microscopic surgery, and various other devices, procedure-specific kits and accessories developed in close consultation with leading surgeons. This portfolio of products includes more than 300 medical devices. The company’s newest product treats a urological disorder called benign prostatic hyperplasia (BPH), an enlargement of the prostate gland experienced by most men after the age of fifty. For aesthetic applications, LSCP offers products for a wide variety of treatments including the removal of leg and facial veins, unwanted hair, pseudo-folliculitis, wrinkles, and acne. For more information visit the company’s website at www.laserscope.com.
The analysts have identified the following factors for evaluating the investment merits of LSCP:
Key Positive Arguments / Key Negative ArgumentsUK National Institute for Health and Clinical Excellence (NICE) has approved the photoselective vaporization of the prostate (PVP) procedure for BPH, opening up a considerable market opportunity. / Modest reductions in TUMT fees make LSCP’s product PVP less attractive to physicians.
The three year non-exclusive distribution agreement with Henry Schein is expected to bolster aesthetic sales, going forward. / CMS announced the final ruling for the Outpatient Prospective Payment System for 2006 at $2500 (previously $3,750). This will reduce revenue in 2006.
International sales continue to experience strong growth.
The PVP procedure is steadily gaining market share.
LSCP has entered into a definitive merger agreement with American Medical Systems Holdings, Inc (AMS) whereby AMS will acquire LSCP for $31 per share in cash or approximately $715 million. The transaction is expected to close in 3Q06.
Analysts generally note that the company has been experiencing good growth in the urology sector with its PVP procedure. However, growth expectations in this area are mixed in the long term. Some analysts note that physicians make less from a PVP procedure than a TUMT procedure, creating the disincentive for the PVP procedure. But analysts agree that international growth would continue and the new agreement with Henry Schein could help distribution in the aesthetic division. The company has achieved positive early stage clinical results for treating kidney tumors. The company has increased its research and development expenses to develop this and other applications for treating more medical ailments non-invasively.
Note: LSCP’s fiscal year ends on December 31; all fiscal references coincide with the calendar year.
Recent Events
On June 5, 2006, Laserscope and American Medical Systems Holdings, Inc announced that they have entered into a definitive merger agreement providing for the acquisition of Laserscope by AMS. The board of directors of both AMS and Laserscope unanimously approved the transaction. Under the terms of the agreement, AMS will acquire all of the outstanding shares of Laserscope at a price of $31.00 per share in cash. The total acquisition price for Laserscope shares and options is approximately $715 million with the transaction expected to close during the third quarter of 2006. Upon the closing of the transaction, Laserscope will become an indirect wholly owned subsidiary of AMS. The transaction is expected to be accretive to AMS’s earnings per share in 2008 and beyond. Analysts in the digest group believe that the acquisition makes strategic sense for both the companies, as LSCP's products (i.e. the popular GreenLight) are a natural complement to AMS's urology business, and offers AMS an entry into the obstructive BPH treatment market. Since LSCP will become a subsidiary of AMS, according to analysts, it can leverage AMS's robust sales force to increase its presence in the BPH treatment arena. Laserscope's aesthetics business is not considered a strategic fit for AMS; therefore AMS will consider alternatives for that business including divestiture. Accordingly, the financial results of this product line will be put down as a discontinued operation.
In May 2006, LSCP introduced GreenLight HPS, which it believes is a revolutionary new laser system for the treatment of BPH and other medical conditions, at the American Urological Association (AUA) meeting held in May, 2006 in Atlanta, Georgia. Four other urological products as well as three aesthetic products were also introduced at the meeting, all scheduled for launch between 2Q06 and 4Q06.
On May 1, 2006, the company announced the acquisition of privately held InnovaQuartz, Inc. (IQ) for $7.5 million cash, a debt assumption of $1.1 million, and future milestone payments. IQ is a supplier of key components for the GreenLight fibers, and LSCP expects cost savings from vertical integration. IQ also develops fibers for the treatment of kidney, bladder, and other urinary stones using Holmium laser technology; the fibers are used in 200,000 procedures annually. The acquisition is expected to be earnings neutral in FY06 and accretive in FY07. One firm (Stanford) views this as a positive acquisition for the company. Another firm (Jefferies) also believes the acquisition provides the company with an opportunity to expand into other indications. The firm believes the deal makes solid strategic sense as it will result in an immediate realization of COGS savings (as it relates to fiber material costs) and is expected to be accretive in FY2007.
Revenue
Laserscope designs, manufactures, sells, and services an advanced line of KTP, Nd:YAG, KTP/Nd:YAG, and Erbium:YAG medical laser systems and related energy delivery devices for office, outpatient surgical centers, and hospitals. The laser systems are sold for $75,000 to $93,000. Those units that are designed for use in cosmetic applications have multiple-use hand pieces. However, those sold for urological or other surgical procedures have a single use. Disposable fiber optic energy delivery systems are sold for $485 to $795. Reimbursement for use of the disposable fiber optic systems is approximately $2,500. Since cosmetic procedures are generally not covered by third party payers, physicians are free to choose whatever rate they believe the market can bear for use of the laser systems in cosmetic applications.
Total revenues in 1Q06 grew a modest 14% y-o-y to $32.0 million. This represents the company’s third consecutive quarter of decelerating topline growth. One firm (Rodman & Renshaw) anticipates further lumpiness in sales over the next few quarters. US sales of GreenLight PV delivery devices were 14,782 units in 1Q06 compared with 11,792 units in 1Q05. International sales of GreenLight PV delivery devices were 6,224 units compared with 4,463 units during the first quarter of the prior year. GreenLight PV worldwide laser system installed base grew 71% y-o-y to 868 units. Sales of aesthetic products totaled $7.6 million in 1Q06 compared with $6.2 million in 1Q05. Sales continue to be impacted by the transition of distributor from McKesson to Henry Schein.
Urology revenues increased a mere 10% y-o-y to $20.4 million in 1Q06. One firm (Rodman & Renshaw) does not view seasonality as a major factor for this deceleration, as the urology business had grown during Q1 over the prior three years. The firm believes that the company is making up for volume through price reductions, which has resulted in a lower-than-expected absolute increase in urology revenues.
At the American Urological Association’s (AUA) annual meeting in May 2006, Laserscope launched five new urology products and three new aesthetic products. The most significant product was the next generation GreenLight surgical laser technology called the GreenLight HPS (HPS stands for High Performance System), representing a new technology platform of the company’s flagship BHP product. The new High Performance System utilizes a more powerful continuous wave laser compared to the older pulsed laser. These results in a much more efficient device which is expected to reduce procedure times by 25% or more. The new system also is powered using a standard 30 Amp 220V source and is internally air-cooled, which eliminates two previous drawbacks of the older system. Management believes that the new system will be attractive to hospitals and may improve the opportunity to move the system into office based surgical facilities. One analyst (Stifel Nicholas) believes that the new system improves LSCP’s competitive position relative to the Lumenis system that is being marketed aggressively by Boston Scientific. The product began shipping on May 22, 2006 on a limited basis, with up to 20 machines expected to ship over the final 6 weeks of 2Q06.
LSCP also introduced several other products at AUA that will be launced over the coming quarters. In 2Q06, LSCP will be launching the following Urology products: 1) the GreenLight HPS Fiber Optic in BPH, bladder tumors, strictures and lesions; 2) the Aura XP Desktop, for use in bladder tumors, strictures and lesions; and 3) the IQ Urinary Stone Fiber Optic Line, which is LSCP's new entry into the urinary stone treatment market through the InnovaQuartz acquisition. In Aesthetics, LSCP will be launching: 1) the Gemini Custom (for Rejuvenation, Port Wine Stains, Rosacea and Telangiectasias) in 2Q06; 2) the Solis Full Body Rejuvenation system (for full body high-speed rejuvenation with IPL) in 3Q06; and 3) the Venus Reveal (for fractional skin resurfacing) in 4Q06. One analyst (Jefferies) believes that these new product launches will not only provide LSCP with highly competitive new product offerings, but also technologies that can be significantly leveraged over time.
Laserscope entered into a new domestic sales distribution agreement with Henry Schein in November 2005. While management is pleased with the success so far, the company is continuing to train and familiarize Henry Schein’s sales force with its products which has caused a drag in sales in 4Q05 and now in 1Q06. The management is committed to restore this business and its competitive edge by introduction of new products and expects its ongoing relation with the new distributor will stabilize around 3Q06. Long-term, one firm (Sterne, Agee & Leach) remains positive on Laserscope’s ability to return the aesthetic business to industry growth trends. However, another firm (Rodman & Renshaw) feels that the aesthetics business is a drag on the overall focus of the company as the segment shows declining trends. It believes Laserscope’s attractiveness as a potential takeout candidate would increase significantly if it divests its aesthetics business.
Management highlighted that concerns over the reduction in reimbursement rate for PVP procedures may be exaggerated, and would have no impact on utilization from the reimbursement change. The alternative treatment for BPH, traditional surgery, although effective, poses several potential side effects including excessive blood loss, blood transfusion, incontinence, impotence, infection, painful urination, and a high rate of retrograde ejaculation, making these procedures more invasive versus laser surgery. Besides, the reimbursement rate for the TURP (trans-urethral resection of the prostate) surgical procedure of $3,750 usually covers the duration of any post-operative hospital stay. In contrast, the PVP procedure can usually be handled on an outpatient basis. Therefore, one analyst (Sterne, Agee & Leach) believes that the lower reimbursement rate of $2,500 for the PVP procedure will produce a better return than the higher reimbursement TURP procedure.
Management pointed out that Japan is the second largest market after US and they hope to commence a clinical trial soon with prospects of receiving approval and entering the market by the end of 2007. One analyst (Sterne, Agee & Leach) believes that the company is gaining solid ground, but certainly has room to grow its market share of prostate procedures while international market remains a major driver of PVP growth. For this, the company plans to increase its direct sales efforts internationally, which will likely increase its gross margins going forward. Another analyst (Stanford) believes that 2006 will be a base building year as the company invests in infrastructure in overseas markets to increase the penetration of its GreenLight PV from less than 5% of any market to closer to the 20% penetration it enjoys in the US
The company continues to expect FY06 revenue and fully taxed earnings to increase by 20% to 25% over 2005 levels to $0.72 - $0.75 per share, assuming a 43% tax rate is applied to both 2006 and 2005 pre-tax earnings, and excluding the impact of FAS 123 stock compensation expenses in 2006. At the AUA meeting, management indicated that it expects EPS to come down in 2Q06 from 2Q05 levels. The company anticipates that revenue and fully taxed earnings will be larger in 2H06 (approximately 55% to 60% of the full year's total) due to new products the company will bring to market as a result of internal R&D and strategic activities.
Laserscope’s GreenLight PVP had demonstrated excellent long-term clinical results and the highest patient satisfaction among all other modalities to treat severe BPH. It is believed that the GreenLight PVP procedure remains the best alternative to in-patient prostate surgery. With the baby boomers entering retirement, the patient population with severe BPH is estimated to expand significantly. Many men previously on drug therapy are now entering the ‘severe’ stage of the disease. Moreover, the company is generating patient awareness regarding the benefits of its technology. The company expects to grow from just $23M in FY99 to $162M in FY06, implying a healthy 30% CAGR over the seven years. With over 70% of patients worldwide adopting a ‘wait and see’ approach, and over 90% of the men over the age of seventy worldwide suffering from some form of BPH, the need for clinically effective procedure is on the rise.
The analysts are perplexed by the state of the BPH market as channel checks suggest that physicians are not aggressively adopting thermal therapies, TUNA therapies, and Holmium-based laser therapies. They are confounded by the sequential decline in PVP fiber sales since the BPH market is not shrinking by any means.