The stock of Stereotaxis (STXS) has had a huge run this year, almost quadrupling from $1.20 to $4.60 – and one could argue for no reason. 

As I’ll explain in my report below, financials are flat to down – and have been for years. But a recent takeover of a somewhat similar company may tell the tale.

The other odd part of this story – to me anyway – is the large number (36 million shares or a full 1/3rd new dilution) of 65 cent warrants that are now deep in the money. This stock only trades 140,000 shares a day on average. That dilution could swamp the stock for months.

Stereotaxis is a medical equipment device maker. They are focused on the development of magnetic robotics to improve surgical procedures.

The company’s offers a large robotic surgical unit.  It provides physicians with better control, vision and speed during the surgical procedure.  

The system uses a varying magnetic field to navigate a magnetic catheter through the patient. The physician operates the device remotely from an adjacent control room.

The clinical value of the robotic magnetic system has been written up in over 350 papers and used in over 350,000 procedures.

In August Siemens Healthineers (SMMNY, SHL – GR) provided a baseline when it bought competitor Corindus (CVRS) for $1.1 billion. 

Corindus has a robotic-assisted surgical system used in interventional vascular procedures. 

STXS targets cardiology procedures and arrythmias. In the 10-K vascular procedures is named as a potential application.

Analysts had been forecasting relatively modest revenue for Corindus – $19 million for 2019, $29 million for 2020. Corindus had $10 million of revenue in 2018 and recorded a large loss.

The relative similarity of the products leads to comparisons of potential takeover value. Given that Corindus was taken over for roughly 60x sales, a similar valuation can make Stereotaxis appear quite attractive.

Assuming $30 million of revenue for Stereotaxis and applying a 60x multiple gives us an impressive price target of $17.50!

A second acquisition datapoint comes from the February takeover of Auris Health by Johnson & Johnson (JNJ-NYSE). 

Auris is a private company so I don’t have much information on their financials, but J&J took them over for $3.4 billion of cash and a $2.5 billion contingent payment.  Auris was a venture capital firm that had raised more than $700 million prior to the acquisition.

Auris has a surgical robotics device called Monarch that focuses on lung cancer and FDA approved for bronchoscopic diagnostic procedures.

QUICK FACTS

Trading Symbols:                      STXS
Share Price Today:                    $4.25
Shares Outstanding:                 115.6 million
Market Capitalization:              $491 million
Net CASH:                                   $31.6 million
Enterprise Value:                       $460 million
2019 Revenue Estimate:           $30 million
EV/Sales                                       15x

BACKGROUND

After spending a lot of time walking through Stereotaxis, I have to conclude that the stock is pricing in a takeover premium.

But I don’t mean that in a bad way – this premium may be a fraction of what the stock could be worth if the company is acquired.

What’s more, there is evidence that large acquisitors are on the prowl and willing to bid large premiums to acquire similar businesses.

That makes this stock a gamble – a bet that a large medical device company swoops in and makes an offer they can’t refuse. If that happens this stock could be a double, a triple or maybe more.

On the other hand, if it doesn’t happen, after having such a strong move up over the past few months, it could be dead money for a while.

That’s the bet, in a nutshell.

The Business

This isn’t a new product, and this isn’t a fly-by-night operation. Stereotaxis is a pioneer in robotics magnetic navigation, having launched the first ever system in 2003.

Magnetic robotics is shown to reduce major complication rates by 62%, minor complications by 43% and patient radiation duration by 31%. SOURCE THIS PLEASE

The core elements, including the robotic magnetic system, are patented. The patents begin to expire in 2022. But there is a new, redesigned system about to be introduced, and new patents will likely take effect with its introduction.

The Niobe and Genesis Systems

The existing robotic magnetic navigation system is called the Niobe ES. This system has been around for 9 years. Before that its predecessor, the Niobe II, was available.

Beginning in 2020 Niobe ES will be phased out by the next generation system called Genesis.

Niobe ES has an installed base of 125 systems. We are not talking about some small device here – this is a large surgical procedure table, attached robot and magnetic generators that take up the space of an operating room.

Source: Stereotaxis Website

The Genesis was designed to use smaller magnets and have a smaller shell than Niobe ES, making it more compact, lighter, and faster. The company has said that Genesis is 70% to 80% faster than Niobe.

Niobe ES is approved in the U.S., Canada, Europe, China, Japan, and various other countries. 

Genesis is only approved in Europe so far.  Stereotaxis is pursuing FDA approval and is part way through it. The company expects broad commercialization of Genesis in 2020.

In addition to the robot, Stereotaxis sells Odyssey, which is an imaging and data management tool, and the Vdrive System, which is a robotic navigation arm that is used with the system.

Source: Company Website

The final product worth a mention is a new proprietary magnetic catheter (called V-CAS Deflect) that Stereotaxis has in development. 

While still prototyping the device, they believe that commercial launch of the catheter is possible by the end of 2020.

The catheter is an opportunity to bring production in-house and capture more margin – right now Stereotaxis has an agreement with J&J’s Biosense Webster for catheter supply.

Systems and Recurring Revenue

This is a razor-razor blade model. Hospitals purchase Niobe ES (and soon Genesis) systems and pay for installation.  They agree to recurring payments for disposables and catheters, equipment service costs, and ongoing software updates (I’ll refer to these together as “recurring revenue”).

These systems aren’t cheap. Triangulating from revenue in the third quarter, I estimate that Niobe ES systems cost around $1 million each.

Systems revenue is lumpy.  It depends on one-time sales to hospitals. In the first two quarters systems revenue was negligible. In the third quarter it jumped to $1.7 million from the sale of a Niobe ES.

Systems margins depend on the mix but have been in the range of 60% this year.

Recurring revenue is much higher than System sales. The revenue also carries very high gross margins – around 85%.

A No-Growth Story The Last Few Years

Stereotaxis has NOT been growing revenue—for years.

The Niobe ES System has been around since 2011. Before that Stereotaxis sold its predecessor, the Niobe II. After the release of the Niobe ES, Niobe II’s were upgraded. All systems in use today are Niobe ES.

The install base of the Niobe ES peaked out in 2016 and has flatlined since. Only a handful of new installations over the past 4 years. There were no new systems sold in 2018 and a single one in the third quarter of this year.

Source: Company Disclosures

As a consequence, recurring revenue has been relatively flat over the past number of years and saw declines so far this year:

Source: Company Disclosures

Convertible Shares

I want to touch on the convertible shares because they represent a lot of dilution but for some reason (that I have not been able to figure out) they are not included in the diluted share count. 

In 2016 the company offered 24,000 shares of a Series A convertible.  Each is convertible at 65c – well into the money with the stock now over $4.00. 23,780 units remain outstanding, which represents 36.6 million shares of potential dilution. 

I am not able to explain why these shares aren’t included in the share count. Management did not return any emails.

August 2019 Share Offering

On August 7th Stereotaxis entered into a securities purchase agreement to sell 6.585 million shares at $2.05 and 5.61 million Series B convertible shares which are convertible at $2.05.

Two companies, Redmile and Opaleye, took the vast majority of these shares. Together they bought 6.3 million of the common shares offered and all of the preferred shares. These are both reputable buy-side funds that invest in a wide variety of biotech and healthcare companies.

It would seem like a fair deal for Stereotaxis. After all, up until June the share price had not been above $2 for over 4 years.

Valuation

Stereotaxis is not a cheap stock.

The current market capitalization is $439 million. The company has no debt and a $30 million cash position.

Revenue at Stereotaxis declined as systems sales fell and has hovered around the $30 million mark the last few years.

Source: Company Disclosures

Even though gross margins are high, the combination of R&D and Sales & Marketing expenses have led to operating losses. 

Cash flow has also shown a slow bleed – a $2.7 million cash burn this year, which follows up on $2.5 million in 2018 and $4.7 million in 2017.

Given that the company is not profitable and revenue has been shrinking, at a glance the current 15x Price/Sales multiple seems more than a little lofty. 

But the market is rarely up like this without a reason. 

So Why is the Stock Up?

There are a couple of things going on that have moved the stock.

First, anticipated growth from new products. There are 2 new products on the horizon:

1. Genesis System
2. V-CAS Deflect Catheter

Let’s look at Genesis. The introduction is anticipated to bring about a replacement cycle that will drive volumes. 

Overall, there are ~110 active Niobe ES systems. Management has forecast that you might see 10 or 11 of these replaced each year. From the first quarter call:

“I really take the roughly 110 active robotic practices we have globally, assume a replacement cycle of approximately every 10 years, 12 years and then multiply that by the ASP that we expect to accomplish for replacement at existing labs and that takes me to $15 million a year.”

Stereotaxis has made similar projections about the new catheter. Again, from the first quarter call:

“We estimate a proprietary ablation catheter generating over $20 million in incremental high-margin annual revenue for Stereotaxis.”

Together these products represent $35 million of extra revenue at high margins.

The second reason is likely the even bigger driver – the assets are potentially worth far more to an acquirer.

Takeover Speculation

The takeover speculation brings us to an unusual exchange on the third quarter conference call. The following was a question from “Dr. Raoul Grande from CBTN”:

“This is Dr. [Grande]. I have been hearing rumors that Stereotaxis will be taken over by Intuitive Surgical (ISRG) for more than $10, $20 around in the range of between $10 to $20? Do you have any comment on it?”

David Leo Fischel, Stereotaxis, Inc. – CEO & Chairman: “No, that would be inappropriate to comment on anything on the biz dev side. I apologize.”

Suffice to say it is extremely unusual to here such a question broadcast live on an earnings call.

This the part of the story raises my eyebrows. I did some searching for a Dr. Grande, a Raoul Grande and various subsets and I can’t find any such person. I also cannot figure out what organization CBTN is.

It’s odd enough to have a dollar value takeover rumor cited on a call, but by a professed doctor that has no social media footprint?

It’s just plain odd.

STOCK CHART

CONCLUSION

Let’s look at what the valuation looks like with some forward looking assumptions.

There will be uptake from the introduction of the new Genesis system. There will be revenue from the new catheter. 

Because management has been candid with guidance of both, we can assume a model of what earnings would look like once Genesis and V-CAS Deflect catheter are contributing:

Source: Company Estimates and Historical Results

So there’s the problem – using the company’s own forecast it is hard to justify the current share price let alone higher. And this is without the 36 million warrants being converted into common equity.

That leaves us to conclude that the real story here is whether the magnetic robotics business has much more value to an acquirer.

I think the answer may lie in procedures not yet approved. These systems are applicable to a far broader range of surgical procedures than what they currently approved for. 

In the 10-K, Stereotaxis lists: structural heart repair, interventional neurosurgery, interventional neuroradiology, peripheral vascular, renal denervation, pulmonology, urology, gynecology and gastrointestinal medicine.

We already know from the takeover of Corvindus that the vascular indications were worth a lot of money to Siemens Healthineers.

It could just be that this is a product that needs to be in the hands of a large device company with money to spend on trials and FDA submissions to get the system into broad surgical use.

What makes the story doubly difficult is evaluating these two questions:

1. the likelihood of a takeover
2. what it might be worth to an acquirer in that event

Without a deep understanding of surgical robotics, it is very difficult to answer those questions and to handicap the stock.