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We don’t have to tell our readers that it’s been tough to find many, if any, feel-good stories in the tech market. Based on our risk-averse approach to disruptive tech investing, we’ve been able to stave off the kind of losses more aggressive funds have experienced over the last year. That’s largely because we’ve developed – and continue to tweak – an objective methodology to why and when we invest in a company.
Revisiting the Simple Valuation Ratio
One metric that we often mention regarding timing is our patent-pending simple valuation ratio. The math is simple enough for an MBA to understand: divide market cap by annualized revenues. The resulting number – lower equals better – is a rough guideline as to how cheap or expensive a stock is based on the size of a company versus its revenue. A $1 billion company with $50 million in revenue is a better value (20) than a $10 billion company with $100 million in revenue (100), even if the latter is bigger on paper and pulling in more money overall. This guideline helps us avoid overpaying for a company no matter how great it looks on the outside.
We originally capped the number at 40, which meant we wouldn’t touch a stock with a ratio higher than that. It was somewhat arbitrary and worked well in a bull market where tech companies were rapidly growing both revenue and market cap. However, last year, many of those tech stocks started trading at bargain prices – many at single-digit ratios – with strong growth but significantly smaller market caps. Here’s a snapshot of the richest tech companies, with a market cap of over one billion dollars, from the latest release of our Disruptive Tech Stock Catalog:
In response to the bear market which started at the beginning of 2022, we dropped our 40-point ceiling to 20. It was probably always a bit too high anyway. But we never really vetted our retooled metric. Today, we’ll see how well it reflects reality by revisiting PROCEPT BioRobotics (PRCT) stock, a pure play in robotic surgery that has beaten the odds by growing revenues 40% over the last 12 months. While such short-term performance wouldn’t be apparent in short-term share price performance (the stock is now down nearly 25% in the last month, for example), the anomaly itself is reason to check-in on this company, one of only two robotic surgery stocks that we like.
About PROCEPT BioRobotics Stock
We last covered PROCEPT BioRobotics stock just days before the company IPO’d in September 2021. In that article, we did a deep dive into every man’s favorite topic – the prostate gland. You can reread that article for all of the gory details, because we’re going to keep it brief this go around. In summary: When men get old and fat, their prostates also grow larger, sometimes causing a condition called benign prostatic hyperplasia that involves a lot of trips to the toilet. It’s the same feeling you get in your bladder after slamming five beers before the taps are shut off at the seventh inning of a ballgame – but all the time. Drugs and surgery can help, but not everyone responds to the former and the latter can cause all sorts of mechanical problems.
Enter the AquaBeam Robotic System from PROCEPT BioRobotics for your unruly urologic problems. The surgical robotic system is better than the alternatives, according to nine clinical studies and more than 100 peer-reviewed publications on the platform. It looks like marketing gurus are making the case to both investors and customers. The California-based company shot out of the gate by opening 40% above its up-sized IPO price in September 2021, raising nearly $164 million. It then promptly cratered in January 2022 before steadily climbing back up for most of the year when the majority of tech stocks headed south. More recently, PROCEPT BioRobotics stock is again on the decline for reasons we can’t really fathom, since the company just announced its preliminary 2022 revenues, which grew 117% compared to last year. What’s behind the recent pullback?
Market Analysis for Urologic Robotic Surgery
The main thing we want to evaluate and challenge in our analysis of PROCEPT BioRobotics stock is the total addressable market (TAM). The company has not revised its TAM since at least 2020, estimating an opportunity of more than $20 billion. It’s important to note that the figure only includes the cost of the AquaBeam Robotic System’s single-use handpiece, which was selling for an average of $3,100 per surgery as of Q3-2022. That’s a pretty smart approach to benchmark the TAM on consumables alone, because there is certainly going to be an upper limit on sales of the robotic system itself. Based on estimated Q4-2022 revenue of about $10.5 million on the sale of 28 AquaBeam Robotic Systems, each unit costs about $375,000 each.
So how did PROCEPT BioRobotics come up with a $20 billion TAM? That figure is based on a total addressable patient population in the United States of 8.2 million men, including 6.7 million who are receiving drug therapy, 1.1 million who have tried but failed drug therapy and 400,000 who are undergoing surgical intervention each year. Based on those numbers, the average selling price of a single-use handpiece was presumably about $2,500 at the time when the company’s MBAs calculated the market opportunity. The revised TAM, using the $3,100 current price, is more like $25 billion.
But let’s challenge some of these assumptions. The company says its immediate focus is on resective surgical treatments that involve removing a small bit of the prostate using a heat-free waterjet. Eventually, management says it will compete with non-resective and non-surgical treatments like drugs. In the mid-term, we would argue that a more realistic target population is about 1.5 million – drug dropouts and surgeries – resulting in a TAM under $5 billion based on the current consumables price.
In addition, the PROCEPT sales force is initially making its pitch to 860 high-volume hospitals that average about 200 resective procedures annually, accounting for something like 70% of all hospital-based resective procedures. Some more back-of-the-napkin math (860 hospitals X 200 procedures = 170,000 procedure / .7) gives us a total of 245,000 resective surgeries per year, which pretty much aligns with PROCEPT’s estimates. At $3,100 a pop, that works out to be $760 million annually. That’s probably a fairly realistic near-term market opportunity.
Should You Buy PROCEPT BioRobotics Stock?
Before we slyly skirt the usual question, let’s close the loop on our little mathematical exercise: The finance guys at PROCEPT just released estimated total 2022 revenues of $75 million, with consumables accounting for nearly 50% (based on recent historical trends), or about $37.5 million. So, surgeons performed about 5% of all resective procedures (37.5 / 760) in 2022 using PROCEPT’s robotic surgery system. The company has installed 167 systems in the United States (236 globally), so that’s nearly 20% of its target high-volume hospitals, though probably a few units ended up elsewhere.
In other words, there’s plenty of room to run in the near term, even if we’re uncertain about some of the bigger market opportunities on the horizon. There are also some vague promises about future applications with the AquaBeam Robotic System, though presently that’s probably not worth considering. Nor are we evaluating PROCEPT BioRobotics stock on its international exposure, which is projected to be just $2 million in Q4-2022, representing less than 10% of Q4-2022 revenues of between $23.6 million and $23.8 million.
What does matter to us – since we do like the company for its business model and revenue growth – is if it’s fairly valued. Here’s where we get back to our simple valuation ratio, which for PROCEPT BioRobotics is 15 based on its market cap of $1.45 billion and annualized revenues of $95 million using the latest quarterly results. In the previous bull market 40-point ceiling, that would put us somewhere in the middle. A score of 15 is reasonable, but trending toward the high end based on the new 20-point ceiling. While it may seem like we’re just moving the goalposts to justify a conclusion, we have to remember that the market is dynamic. If the model doesn’t represent reality, you need to adjust your model.
Conclusion
The most recent slide in PROCEPT BioRobotics stock may reflect the dawning recognition from other investors that perhaps the share price is a bit too rich. After all, the company’s immediate market is less than $1 billion, according to our math. The current growth in revenue is impressive but is it sustainable, especially with many hospitals in financial trouble? In addition, losses are mounting, though the company had about $250 million in cash at the end of September 2022, so it can continue to burn money for a while (losses over the past four quarters averaged $20 million). One measure of progress for retail investors will be gross margin, which stands around 50%. That should increase as consumables account for more revenue over time.
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