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Nuvectra: Somewhere Joel Greenblatt Is Smiling


Nuvectra is a micro-cap spinoff that has been sold indiscriminately.

It sells for 0.6x book value.

One sell side firm (Piper Jaffray) covers the stock and has a $25 target (stock trades for ~$7).

Nuvectra (NASDAQ:NVTR) first piqued my interest because it is a microcap spinoff and microcap spinoffs generate huge returns in year one.

However, you have to be extremely careful investing in spinoffs and especially microcap spinoffs. While the average performance is extremely attractive, there is huge dispersion in returns. As an example, the average return for spinoffs with less than a $500mm market cap is +29% in the first year of trading. But the median return is only +7%. The outliers skew the results.

Similarly, a recent Deloitte and Edge Group Study found that top quartile performing spinoffs generate +98% total return in their first year while bottom quartile spinoffs generate 1 year returns of -39%.

So just to reemphasize, you need to be very careful.

Getting Back to Nuvectra

A couple weeks ago, I got an email from the folks at telling me that Nuvectra was trading below its cash levels. The stock ended up bottoming at about $4.30 which translates to a market cap of ~$44mm. The company was spun off with $67.6mm of net cash. This got my attention.

After doing a bunch of work, I've concluded that I don't know how much NVTR is worth, but I think it's worth a lot more than $6.87 (its current trading price).

Let me explain…

What is Nuvectra?

Nuvectra is a med tech company. It used to be a division of Greatbatch (TICKER: GB) which is an outsourced med tech manufacturing company. At the time of the spinoff announcement, Greatbatch had just announced a big acquisition and it decided to spinoff NVTR (formerly known as QiG Group) as the division had matured but was non-core and wasn't getting properly valued as a small division within a $1.7bn (at the time) market cap company.

How does Nuvectra make money?

Well it doesn't yet and it won't for the foreseeable future….but it should generate a lot of revenue

Nuvectra's First Product: Algovita

Nuvectra has two products currently. The first product is called Algovita. It is approved for the $1.6bn spinal cord stimulation market for chronic pain. It is also expected to be approved for the $500mm sacral nerve stimulation market for bladder and bowel control.

What exactly is the Algovita Spinal Cord Stimulation System?

It is an implantable device which delivers steady pulses of energy to certain nerves in and around the spinal cord in order to dull or mask severe pain.

Here's the Mayo Clinic's definition for Spinal Cord Stimulation:

"A small wire carries the current from a pulse generator to the nerve fibers of the spinal cord. When turned on, the stimulation feels like a mild tingling in the area where pain is felt. Your pain is reduced because the electrical current interrupts the pain signal from reaching your brain."

Here's a great video (~3 minutes) that explains how spinal cord stimulation works to relieve pain.

As mentioned earlier, the spinal cord stimulation market for chronic pain is currently a $1.6bn market. The market is currently made up of four major players: Boston Scientific, St. Jude Medical, Medtronic, and Nevro (newer player).

The neuromodulation platform that was developed at Greatbatch and is now Nuvectra was developed by the technology innovation group within Greatbatch after carefully working with patients and physicians to understand key areas of need. This group has been working since 2009 to develop differentiated products. The product is finally ready and FDA approved.

Key Differentiating Factors for Algovita vs. the Competition

  1. Thinner lead. The lead (the wire that carries the pulse) is thin and flexible, which is an improvement over the products that are currently on the market. This is important for several reasons. First, it makes it easier for the physician to place the stimulators in a region that will best block the pain. It's also important because it reduces risk of migration (the lead and/or stimulator moving) and breakage of the lead.
  2. Intuitive interface. The wireless interface (for the physician and patient) is very intuitive and user friendly. It helps with programing and user control. It's easier to use than other spinal cord stimulation systems.

How Much Revenue will Algovita Generate?

Piper Jaffrey is the only sell side firm that currently covers Nuvectra. Piper Jaffray estimates Algovita will generate revenue of $29.7mm, $55.1mm, $88.9mm, and $108.7mm in Fiscal 2017, 2018, 2019, and 2020, respectively.

The spinal cord stimulation market is $1.6bn in size and is growing at 6% per year. Assume the market grows to $2bn by 2020, Piper Jaffray's estimate of $108.7mm in sales in 2020 represents only 5.4% of the market. In Nuvectra's Form 10, Nuvectra management reviews key assumptions that are used in order to test for whether goodwill is impaired. One of management's assumptions is that Nuvectra market share grows from low single digits in the early years to a maximum of 6% to 15%. As such, Piper Jaffray's estimates seem reasonable, especially given that Nuvectra has worked on this project for over seven years in close consultation with patients and spinal cord stimulation physician thought leaders.

Nuvectra's Second Product: PelviStim

Nuvectra's second product is called PelviStim. The product is focused on sacral nerve stimulation for bladder and bowel control. The sacral nerve stimulation market is currently ~$500mm, growing at 10% per year, and dominated 100% by Medtronic. The market has seen limited innovation over the past decade so it could be a great opportunity for Nuvectra.

Similar to spinal cord stimulation, sacral nerve stimulation works by sending a mild pulse through a lead (a lead is a wire) to the sacral nerve (important nerve for bladder control). The theory is that mild stimulation of the sacral nerve helps the nervous system and brain coordinate and function properly, allowing patients to have better bladder and bowel control.

Here's a 3 minute

that explains how sacral nerve stimulation works.

Management expects to launch PelviStim in early 2018. Piper Jaffray notes: "While details of the PelviStim SNS system have not been made public, we expect a similarly (in reference to Algovita) differentiated technology offering vs. currently available commercial technologies."

How Much Revenue can we Expect from Pelvistim?

Piper Jaffray models sales ramping up to $56mm by 2020. Assuming the market grows to $750mm by 2020 (market is growing by about 10% per year), Piper Jaffray's estimate implies 7.5% market share and seems reasonable.

Other Revenue

Nuvectra has a couple of other products in development, but I'm not going to spend any time on them as they are of lower importance.

Implicit Guidance?

In the Piper Jaffray initiation report, the analyst wrote (italic and underline added by me):

"On an enterprise-wide basis, we are modeling FY16E revenue of $13.6mm, which represents 160% growth of FY15. In FY17 and FY18, we model revenues of $35.1mm (+158%) and $78.3mm (+123%), respectively. Management believes...