Seeking Alpha • Sep 23
NeuroMetrix: Strong Unit Economics, Accelerating Growth; Possibly Worth $15 In 5 Years
Summary
DPNCheck is a screening product sold to MA insurers which gives better member health outcomes, lower cost, and increased revenue for MA insurers. The product has consistently grown >20%.
Discontinuation of Quell marketing in 2018 is masking the strong, underlying growth in DPNCheck. The result is rev growth is now accelerating.
Clean cap structure and balance sheet with $3.24/share which is sufficient to fund the business to profitability.
Potential $15/share fair value in 5 years based on 20x FCF.
For those who follow small cap med devices, NURO's business is ~85% SMLR and ~15% ZYXI.
Thesis Overview
The most profitable investments in microcap stocks are made when businesses reach inflection points, then go on to deliver years of organic growth and inflect to profitability. I believe that NeuroMetrix (NURO) is at that turning point.
After a long history of losses and shareholder dilution from spending on R&D that didn’t work and attempts to sell medical devices that were not successful, NURO now has a clean capital structure and balance sheet with a proven business that is scaling with strong unit economics.
NURO has a promising medical device called DPNCheck, which is used for early disease detection of diabetic polyneuropathy (DPN) and is sold to Medicare Advantage ((MA)) insurers with >80% of revenue from consumables. They are following the same business model as Semler Scientific (SMLR), who built a strong business by showing MA insurers that early disease detection leads to better patient outcomes, lower cost to serve patients, and increased revenue for the MA insurers through appropriately risk-coding patients. DPNCheck launched in 2011 and has grown at a >20% CAGR in recent years to $7.4m revenue in 2022. That >20% organic growth is set to continue indefinitely at ~80% gross margins. Most importantly, DPNCheck’s go-to-market is very efficient because they sell at the top level to UNH and HUM, who then push down to their organization.
DPNCheck’s consistent growth and strong unit economics has been masked by NURO’s Quell product which the company sells direct-to-consumer as an over-the-counter (OTC) medical device for pain management. The company created a slick product that works well and grew it to ~$14m of revenue in 2017, but had to spend aggressively on online advertising and TV ads to get that growth (negative unit economics). In 2018, management realized their market efforts were not going to pay off for Quell because the market for TENS-like devices is too crowded, so they stopped advertising. That led to revenue declining to <$2m in 2022, which is now mostly consumable pads that are ordered by customers and paid through credit card (no insurance pay).
Management pivoted the strategy for their Quell device to focusing on gaining breakthrough designation by the FDA for patients with Fibromyalgia. 10 million Americans suffer from debilitating pain from Fibromyalgia. Quell may receive FDA clearance for the device for patients with Fibromyalgia in late 2022 and begin marketing to physicians in early 2023. Having a physician prescription means they can pursue insurance reimbursement which results in a much, much higher revenue per device than selling in the highly competitive over-the-counter market. Zynex sells a prescription pain management device, but sells primarily through physical therapists and does not have specific indications or data supporting efficacy, like Quell does.
The takeaways are that NURO’s revenue growth is accelerating. After revenue declines in 2018-2020 from unprofitable Quell OTC revenue falling, NURO grew 12% in 2021 and will grow 12% in 2022. I expect revenue growth to accelerate to >20% and maintain that growth for several years, primarily from DPNCheck.
After significant losses from Quell advertising, NURO raised highly dilutive preferred capital in the 2016-2018 range (please refer to NURO's form 10-K filings for details). After cleaning up the cap structure, NURO raised over $20m through DRIP equity raises (selling shares directly into the market) in 2020 and 2021 (including some very attractive sales prices last year when the stock price spiked >$10/share). All this leads to an ugly and messy past, in which the share count has gone way up and the stock price way down. However, I believe that evaluating the business based on current facts, shows that NURO is an undervalued med device company that is well capitalized to pursue this growth. The company now has a clean capital structure with 7.1m shares and 0.5m options for management, no debt, no preferred, no warrants, and $23m of cash. I expect NURO to burn $3.8m in 2022, $2.7m in 2023, $1.7m in 2024, and $0.2m in 2025. Then it should start generating cash, with +$2.1m in 2026, +$4.9m in 2027. I model trough cash of $16m in 2025.
On profitability, I expect the business will generate $5m of free cash flow in 2027 and be worth 20x FCF plus net cash, which gives a value of $15/share. Studying Semler’s history, once the business crossed $14m in revenue, it inflected to profitability and never looked back. DPNCheck currently has $7.4m in revenue, and I expect it to cross that threshold exiting 2025. SMLR has proven how strong the unit economics are in this business with 37% EBITDA margins in 2Q22.
Revenue Mix Shift Well Underway
Higher quality, more profitable DPNCheck revenue is replacing negative margin Quell revenue (when including expensive marketing spend in the past).
As rev mix continues to shift, the growth will accelerate and the business will reach profitability.