Waiting For A Rebound In Vanity

By Stephen D. Simpson, CFA | September 03, 2010 AAA

I have seen it written that you cannot put a price on beauty. The performance of stocks in the aesthetics sector would seem to suggest otherwise. As the housing bubble exploded, the economy fell into recession, credit suddenly became tight, and people stopped finding the money to pay for all manner of personal exterior renovations. (For related reading, take a look at Lipstick And The Stock Market: Connection?)

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If it is true that whatever goes up must come down, can it also be true that a sector laid low by a punishing reduction in disposable income and easy credit could rebound again? Since people do not really change all that quickly, it seems reasonable to assume that the demand for cosmetic procedures is still out there and that when disposable income rebounds, so too will this sector.

Allergan (NYSE:AGN) does have a sizable eye-care business, but aesthetic and cosmetic procedures are a large part of the story. Allergan not only has its well-known Botox franchise, but dermal fillers, an obesity product (the Lap-Band) and a silicone breast implant business as well.

Like Allergan, Medicis (NYSE:MRX) is something of a hybrid between a pharmaceutical company and an aesthetics company. Medicis has a sizable franchise in acne-related dermatological products (which are not generally thought of as aesthetic), but is looking to augment this with products like Dysport (a rival to Botox) and the Liposonix ultrasound system for body sculpting.

Lasers, Ultrasound And Heat ... Oh My!
In addition to the two large quasi-pharmaceutical companies, there are a host of companies that market systems that use laser, ultrasound, or thermal energy to rejuvenate skin, remove hair, eliminate scars and tattoos, or reduce cellulite.

Palomar Medical Technologies (Nasdaq:PMTI) is a leader in the light-based approaches to aesthetics. On top of very competitive products, Palomar owns a valuable IP estate and has managed to force many of its rivals to license those patents. With the launch of the Aspire system in 2009, Palomar is getting more involved in the body sculpting market and introducing a consumables component to its business model.

Israel's Syneron (Nasdaq:ELOS) was once a stock market darling, but those days are long past as revenue as fallen by more than half from its peak in 2007. Syneron pioneered technology that combines RF energy and optical energy into products that offered both better results and more comfort to the patient. Since then, the company has acquired one-time competitor Candela to add to its laser-based technologies and products.

Solta Medical (Nasdaq:SLTM) brings something a little different to the game. Solta offers three different laser-based platforms, but builds them with disposable treatment tips. That may seem like only a minor engineering detail, but these high-margin consumables give the company a direct stake in the procedure volumes as well as more flexibility in marketing its units (Solta can participate in the common practice of all but giving away units in exchange for higher tip prices). Of course, it certainly does not hurt that Solta boasts of shorter treatment times for its users as well as more enduring benefits.

The Prettiest Pick
With the whole sector in the doldrums, it is probably not surprising that there are more than a few bargains to be found here. Solta seems to be getting a market value that suggests a lot of investors either have completely forgotten about the company or expect it not to survive this downturn. Palomar is likewise not afforded the sort of multiples you might expect from an industry leader - Palomar's current enterprise value is just $65 million, even though the company has a clean balance sheet and credible prospects to return to profitability and free cash flow generation.

Allergan and Medicis do not offer nearly the same discounted valuation as the "laser companies", mostly because the businesses are more diversified and have continued to grow through the recession (while Palomar's revenue run-rate is half of its peak level). Both are fine companies, but not really cheap enough to be rebound stocks or value picks.

The Bottom Line
Aesthetics is a volatile and intensely competitive sector. It also happens to be quite lucrative during the good times and the right combination of company, technology and timing can produce winning stocks. There is still time for due diligence here, and risk-tolerant investors may want to consider making a play on the idea that vanity can still pay.

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