Deep Dive: Cutera, Inc. (CUTR) Stock Analysis

Not a treatment, but a first of its kind CURE to a massive market, treating acne.

Disclosure: I am a shareholder of CUTR, however the position is weighted at less than 1%. This is a very high risk, high reward opportunity where the company could VERY well go bankrupt… none of this is to be construed as investing advice.

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Part of the reason I haven’t posted a write-up in nearly a month is due to a lack of high quality ideas, and market opportunities I’ve been able to find. One of my goals for this Substack page is to discuss businesses I’m drawn to, that ideally offer asymmetric risk / reward. I want to preface this right now… Cutera is not one of these examples.

With long-term debt amounting to: $417.6 Million, and cash & equivalents last quarter sitting at: $180.6 Million, it’s no secret that changes need to be made in order to right the ship. Frankly, they have ~2 quarters to patch the holes, so new CEO, Taylor Harris can institute his vision for the next phase of Cutera. This should be viewed as a turnaround play. However, one that Taylor Harris is familiar with, as he brings experience as the CFO of MyoKardia, which was acquired by Bristol Myers Squibb two years after he joined. Prior to his tenure, he was the VP and CFO of Zeltiq Aesthetics, before it was acquired by Allergan PLC. Despite his impressive track record, I’ll be closely monitoring this situation to protect my capital in the event that bankruptcy becomes imminent.

In this writeup, I will not be discussing the steps I’d like to see them take in becoming cash flow positive (although I may in the future). I simply want to share my research, and talk about a unique product, a massive addressable market, operating in a duopoly. It’s one of the most fascinating situations I’ve investigated… enjoy.

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Cutera, Inc.

Ticker: NASDAQ - CUTR

Share Price: $2.92

Market Cap: $54.8M

EV: $291.8M

What I’m Drawn To:

• Uniquely segmented product offering with only one true competitor

• AviClear is a solution to a problem that plagues nearly 100% of teens… no shortage of addressable market

• Great economics of AviClear devices

• A turn around play with a new CEO that has a proven track record in scaling, and getting acquired by larger healthcare names

• In the event that they can push the maturity dates of their debt out, they will have some breathing room to change business models, and the stock should react dramatically

Associated Risks / Pre-Mortem:

• High interest rate environment persisting… reduced disposable income for consumers to spend $1,000 a session for AviClear treatment

• AviClear treatments not covered by insurance

• New management fails to bring a strong go-to-market strategy in place, and they’re unable to scale top-line

• Slowing adoption of AviClear machines in dermatology offices in the U.S.

• “Higher for longer” interest rates making interest payments unsustainable, forcing a buyout or bankruptcy

• Dr. Rox Anderson designed the first iteration of this machine, on a competing platform called “Accure”… if Anderson was able to sue for a royalty, this would impact margins

• The rise of new competitors offering a more enticing unit-economic proposition for consumers

Brief Description:

Cutera (CUTR) is a medical aesthetic company focused on acne, body contouring and skincare. CUTR was founded in 1998, has been public since 2004, and has been expanding their portfolio of products, selling to dermatologist offices across the U.S. for 25 years. 

The highlight of their portfolio is an acne solution called AviClear, which is the basis of what this write-up will consist of. What makes AviClear intriguing is that it’s not a treatment for mild to severe acne like Accutane, it is truly the first CURE. 

Cutera’s solution: AviClear:

AviClear uses a chemical-free, non-hormonal, non-invasive laser treatment targeting sebaceous glands on skin without the need for medication. After each treatment, (3 on average), skin produces less sebum oil, therefore, breakouts are less common, less intense, and heal faster. This device was FDA approved in March of 2022, and Cutera has been distributing machines to dermatology offices since. The process is very straightforward. Customers go to their local dermatologist and undergo a 30-minute session in which acne and acne scars are targeted in three separate treatments over a 9 month period. The Illinois Dermatology Institute reports that 87% of patients were satisfied after just one month of the first laser treatment (https://shorturl.at/htDIO). Additionally, AviClear is relatively painless given the cooling effect, while during treatment, customers may undergo at worst, a “very mild snapping sensation” that lasts for a few seconds. The treatment also has very few side effects, mostly described as slight redness in the treated areas a day or so after, and an occasional mild flare up. Nevertheless, it’s a dramatically faster, less painful process with less side effects, and more immediate results.

Legacy Competitor: Accutane:

Accutane customers typically only require one or two medication sessions, but the real issue revolves around the side-effects, and the common worsening of acne in the short term. Many sources report differing data, but the National Health Service (NHS) UK, claims that acne may worsen, but “will then normally start to improve after 7-10 days” (https://shorturl.at/doUY3). Accutane works on a very case-by-case basis. Therefore, the American Osteopathic College of Dermatology reports that treatment typically takes “four to five months” to experience skin clearing (https://shorturl.at/gjltJ). General consensus states that on average, the typical patient require 4-6 months of treatment, while some require more extensive treatment for an additional 4-6 months. In short, Accutane is a substantial time commitment.  

However, time is the least of patients’ concern, as symptoms range from discomfort, ie. dry itchy skin, nosebleeds, joint pain, skin infection, vision problems. And ramp up to more severe forms of: depression, suicidal thoughts / behavior, Inflammatory Bowel Disease, and although rare, Crohn’s disease . Another thing to consider, Accutane is appealing to the teen demographic. Hopping on Accutane in the peak of body development, when hormones are spiking means that side-effects can vary in dramatic ways. All this to say, the treatment is often painful, and ugly.  

Direct Competitor: Accure:

Accure uses a similar 1726 nm wavelength laser to permanently shrink sebaceous glands like AviClear. The Accure device was also FDA approved in December 2022, after AviClear’s 501k approval in March 2022. One notable kicker for Accure, is that the original pioneer of this technology, the “godfather of medical aesthetics”, Dr. Rox Anderson, founded this technology, as Accure was actually the first to create it. However, Cutera was able to improve the process, ultimately making it simpler, faster, and cheaper. Part of the more complete customer service, is from a preparation and pain perspective. AviClear patented a cooling system in the laser’s delivery tip. As a result, Accure requires 15 minutes of cleansing to remove organic oils, but an additional 30+ minutes of face numbing prep, while recommending four, 1 hour long treatments. On the contrary, AviClear recommends three, 30 minute sessions, requiring no facial numbing, and just 15 minutes of traditional cleansing. Additionally, AviClear claims that their treatment works more effectively on darker skin tones. However, when it’s all said and done, the treatment itself appears fairly similar in effectiveness. 

Prospective Market:

AviClear is a cure to the most common skin condition globally, impacting up to 50 million people a year in the U.S. alone. Given the fact that this treatment doesn’t cause intense flare ups or require hormonal treatment, this opens the addressable market to early age tweens, teens, and those struggling with puberty. In 2023, the Global Acne Treatment Marketplace has a market size of just over $10.04 Billion, and is projected to grow a CAGR just South of 5% until 2032. More accurately, the dermatology market globally was estimated at $8.7 Billion in 2022. An estimated six million people see a dermatologist every year. As a result, if AviClear can capture just 4% of the prospective market in 5 years, this would be 240,000 patients annually. Applying a conservative estimate that they only spend $1,500 on treatments, that’s $360 million in sales. Given the extremely attractive unit economics of these machines, I believe you can apply a conservative 50% EBIT margin, resulting in $180 million in EBIT. Assuming that 50% of EBIT trickles down to Net Income, and CUTR is diluting at 4% per annum, then AviClear alone could produce $90 million in net income / 24.1 million shares = $3.73 in EPS. In the event that the adoption rate picks up, applying a conservative 20x Earnings multiple brings AviClear alone to $75 a share, would result in 25x upside in a 5 year period. This is simply back of the napkin math, and looks like insanity today, but keep in mind, that’s only accounting for the acne component of AviClear. The 1726 nm laser that Cutera uses has further application that’s being testing in R&D for aesthetic use cases like Cellulite, stretch marks, and eye bags. Additionally, Cutera has an entire portfolio of products outside of AviClear, that only make up 8.9% of current sales.

Context: The last 22 Months:

If AviClear is truly this innovative, and solves a problem that a massive addressable market suffers from, why is it valued at a $50-some million market cap? To put simply, the last few years have been a disaster. In March 2022, AviClear was approved by the FDA as a solution to mild & severe acne. The stock reacted, jumping to the mid $70s range. 22 months later, the stock is down to $2.92 a share. Suspect management, internal proxy fights, poor performance, and a poor macro-backdrop all contributed to the current shit-show, that some view as an opportunity.

From April 2022 to January of 2023, $CUTR fell 44% (from all time high’s) somewhat in sympathy of the broader index, which finished the year down more than -20%. To add gas to the fire, Cutera reported two convertible note offerings, first of $200 Million in May ’22 (at an interest rate of 2.25% due in 2028) and $100 Million in December ’22 (at a 4.0% interest rate, due in 2029). Thus, driving over 3 million shares to be sold short. 

Next, Cutera ended FY ’22 missing sales and EBITDA numbers, while lowering guidance based on demand weakness and currency headwinds. In March, their 10K filing was delayed first on February 28th by former CFO, Rohan Seth. And delayed again on March 16th due to a boardroom debacle. The annual report was eventually published on April 7th. However, on April 10th, a special meeting was called in which the now former CEO, (David Mowry) & former Chairman, (J. Daniel Plants) made the case for 5 of the 6 directors on the board to be removed! Their position stated: “Current Board Has Become Factionalized and its Agenda is Being Driven by Directors Prioritizing Their Own Interests Over Those of Cutera Stakeholders”. That Tuesday, while the interim CEO was presenting earnings, the board fired both the CEO and the Chairman during the call! Additionally, they pulled next Fiscal Year '24 guidance. These complications explain the second leg in the fall from grace. Since April ‘23, $CUTR shares have dropped like a rock.

So what are we left with? Personally, I’m pleased with the firing of Chairman J. Daniel Plants, as he had a very poor reputation. Additionally, CEO, David Mowry was well-respected, but had demonstrated that he was no longer the man to scale AviClear, what’s widely regarded as Cutera’s growth story. On August 7th, 2023, former board member, Taylor Harris was appointed CEO. For the record, this was a great move in my opinion, as Harris had the experience, was already a large shareholder in CUTR. Ultimately, I think management got this decision right. Nevertheless, the last quarterly reports was Harris getting his feet under him, and working to pivot the ship away from the massive iceberg of bankruptcy. As a result, we will learn much about his plan for transitioning the business model in the upcoming Q4 earnings on: February 16th, 2024.

The Business Model:

Part of the thesis behind AviClear, is the razor / razor blade model they leverage. Their closest competitor, Accure, opts to sell their device to dermatologists for ~$120k a device, with a consumable cost of $125 a treatment. Whereas, AviClear offers their device to offices for a $5,000 rental fee annually, plus a $500 fee for usage. I’m very drawn to this business model, and feel that it demonstrates offers derm offices a more attractive proposition for use. Not only does it offer the customer more exposure to AviClear, but encourages adoption in a micro context, as offices want the most modern tech to meet customer needs. Another initiative, Cutera is really emphasizing the importance of social media marketing in grabbing teens attention, and medical-aesthetic offices that may be reluctant to laser treatment. In fact, I don’t mind if they dedicate a substantial amount of resource to this avenue, given how lucrative it once was for similar aesthetic products, Lasik, CoolSculpting, and Invisalign. Ultimately, I see this as a necessary sunk cost to better distance themselves from lesser-capitalized Accure, and further establish their first-mover advantage. Finally, and worth noting, four treatments of Accure are recommended, requiring a payout of $4,000, while AviClear only recommends three treatments equating to $3,000. Still pricey, but when rates are cut, and consumers perceive their disposable income to rise, this is an expense that many would be willing to endure.

My Overall Conclusion:

Cutera is still burning cash, and has continually been unprofitable. Nevertheless, my background research, resources I’ve contacted, and the dermatologist that undergoes clinical trials & laser publication all lead me to believe that CUTR is the most dynamic solution in curing acne. Yes, the management story is a headache, despite adding an abundance of talent to the board recently. Yes, they are facing tough macro headwinds with the threat of a recession on the horizon. Yes, they will be diluting shareholders for the foreseeable future. Yes, they have debt maturities due in 2026. However, this equity is de-risked to a degree that is worth initiating a position in. Given the potential for just the acne component of AviClear, and the growth they can see within one segment, I feel that it’s beyond cheap, as sentiment has reached rock bottom. Although the threat of new emergents will likely occur sometime down the road, FDA approval enables a significant margin of safety while they work to enhance their first-mover advantage. Although we’re still uncovering management’s go-to market strategy, I believe that they have selected the right captain to pivot the ship. I can’t emphasize how important it is that AviClear is a cure, and not another topical product. As a result, I’ve taken a small entry position in CUTR. I’m willing to add in the event that shareholders get word of new go-to market plans, or creative ways to refinance near-term debt, but until then, I’m fairly comfortable with the risk / reward this business offers.

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