Company: Submitted By:

Liberator Medical Holdings Inc (LBMH) Request an Update from Ryan Morris (Meson Capital Partners) on Feb 14, 2011 at 06:25PM the Author
Ryan Morris is a SumZero Contributor - selection into this exclusive

Asset Class: Recommendation:

Return:

group is based upon quality of idea submissions and peer ranking. Common Equity Long
-28.6%

Expected Timeframe: Geography: Country:

Situation:

1 year to 2 years North America United States

Growth

Average rating: 8.3 Votes: 17

Iio - Extremely Compelling El [Rate Itl

Disclaimer: The author of this idea has a position in this security and may trade in and out of this position without
informing the SumZero community.
Thesis

I'm normally not much of a fan of GARP type investments, as they seem a bit "lazy" for an investor working with a smaller pool of capital where you can look for more glaring mispricings in the market. Liberator Medical (LBMH.ob) is more of a GAURP "Growth at an UnReasonable Price" investment which is at basically at 10X PE and growing at 40%+ per year going forward (Revenues were $2.25M; $9.55M; $25.8M; $40.9M in 2007-2010 FY ended Sept 30 respectively)
with a founder with the most proven track record you could conceive.

Mark Liberatore founded Liberty Medical back in 1989 and sold it to PolyMedica for $9M in 1996 and stayed on as manager. He grew it to $100M in sales by 1999 and was later sold to Medco and I believe now does approximately $600M/year in revenue. Liberty may be familiar to you from their Wilford Brimley TV ads selling "diabeetus" products. The business model was to sell recurring revenue diabetes products through targeted tv ads and its success speaks for itself. Not wanting to be just one cog in a larger machine, entrepreneur Mark left the company and in 2000 founded Liberator Medical which would experiment a bit but largely copy the proven model in different markets from Liberty.

As an aside story - in 1895 when Sears was mostly a catalog business, they made sure to make their order catalog slightly narrower and shorter than the dominant Montgomery Ward catalog at the time. That way the advertisers when stacking them, would, as aesthetics demanded, put the smaller catalog on top and the customers would end up seeing Sears in more prominence inadvertently. Today's "stacking order" isn't paper catalogs but rather the alphabet-

Liberator's current business, at $40.9M revenues in the last year consists of urological products (catheters); mastectomy products; diabetes products; and ostomy products. While they don't disclose revenue by division, I believe the catheter
business is more than half of their revenues and is primarily for disposable catheters that Medicare reimburses

approximately $1.60 for each and a typical order is 400 per quarter for a customer. You might notice the step function in revenues in 2007-2008, this was because a rule was changed by Medicare increasing the number of catheters reimbursable from 4 to 200 per month. Before this change, people were inappropriately forced to sterilize/boil their own

catheters and reuse them which would lead to numerous infections and expensive emergency room visits. Surprisingly logically, Medicare decided that an ounce of prevention was worth a pound of cure and decided to just let people use the disposable ones instead which is what lead to this change. From the Medicare billing data that I've glanced over Liberator seems to have about 5X the revenue in disposable catheters over their #2 competition, so are clear and away in the lead, having prepared for and anticipated this regulation change. This is still a fast growing area for them as the number of people (you can imagine how up to date with current events the customer base of this type is...) who are aware of this new rule still seems small in proportion to the reported market size ($1.5B according to the company). Qualitatively, I like to look at a business from two main perspectives: the value they create; and how difficult it would be

to copy their position in the world. The value that Liberator creates is largely one of convenience. They ship recurring
products (you need a new catheter every time you would need to urinate...) straight to the home each quarter and bill
Medicare directly for the customer. This saves enormously on the amount of time it would take for a customer to have to

go to the store and bill Medicare on their own each time. You can imagine the psychic convenience as well of being able to order - privately from your own home with an anonymous person on the phone - products that are particularly

embarrassing to talk about. I was just reading an article about how sales or pornography skyrocketed with the invention of the VCR since before you had to sit in a theatre with others in public to get that product - which is more limited to die
-hard fans...

Liberator also is the point of "capture" for this value for two reasons. First is that the customers don't even care about

how much they pay because they're not paying. So as long as their customer service is good (which is a huge point of effort for them) then the customers have no reason to shift to another provider seeking a better price. Second, the products are interchangeable - they carry over 5000 - so the vendors can't demand a higher margin. Additionally to this point the reimbursed price is regulated by Medicare, so there is no price competition.

In terms of "hard to copy" - the two key things about Liberator that fit this description are the logistical difficulties of billing Medicare and the execution factor on customer service and stocking and shipping. While some businesses prosper because of some unique asset or brand, most are all about execution. In particular, this is a business that can be screwed up easily with poor execution due to the thorough audits, etc with Medicare billing. The founder is the main competitive advantage here who has been doing this exact business for 20 years with an incredibly proven track record. I visited the company in Florida in January looking to see things that might have looked disorganized or have the potential to get to that point and was incredibly impressed how well run the place is and how much people seem to like working there (important considering how large a factor customer service is). They are very anticipatory of their growth and have made sure to build capacity ahead of their revenue so they don't get overwhelmed. Billing Medicare requires

keeping detailed customer records and I understand that any time they have been denied; they have always been able
to win in the end.

Of course, the key risk here is the payer concentration (Medicare is 80% / private insurance-copay is 20%)^Medicare
has been jgxperimenting with competitive bidding processes in certain industries to lower their costs. Most recently was

wTtFTdiabetes products in Florida^ which has begun to change the landscape of that market and make it less interesting.
While this is certainly a risk, I think it is insignificant for a player as small as Liberator because they are focused on trying to be a leader in smaller niche markets. The catheter market for Medicare is currently about $200M or so whereas diabetes products is over $2B. If Medicare acts rationally and goes after the bigger savings targets, they should be under the radar for a long time - it would probably cost more to conduct a competitive bidding study than the end savings for something like catheters. I should not too that the reimbursement rates for catheter products has never gone down and has gone up roughly with inflation for the last 10 years according to the company.

So, given all that qualitative stuff, what's it cost and wJiaJ^s-tt-worth^^^

They currently have 45M shares out, and say anothfl0M warrantsjpd options so 55M shares to be conservative
(some cash would come in from these so it would be a bit lowertising treasury method) at $1.26 as of the last close or
$70M market cap and no net debt.

The company's intention is to get to $100M in revenues as fast as practicable and at that point look to eithej>seirTfTe.

company or at least start being more of a "real" public company with a fair stock price. Mark Liberatore ov^ns 1/3 of the stock, so we should expect things to be shareholder friendly - they haven't sold equity at unduly low valuations and^
have used creative convertible debt instead of straight equity. At this point they are established enough and,cash flow _positive_nDiiQh to not need to raise new pgniry <;n I expect the share count to stay the same. Just this morning they
announced they got a credit line from PNC at LIBOR + 2.75% which solidifies this.

While imprecise: at $100M revenue, they would have similar gross margins of 63%. So say:
100M

- COGS: 35%

- Payroll, taxes, benefits: 20% - Advertising: 12%

- Bad Debts: 5%

- G&A: 10%

EBITDA margin = 18% Depreciation = 1%

Taxes = 35%

Net margin = 11%

Net income = 11M.

Kthgy caj3_dejxeaseJieir-oyerhead as they scale up._which seems likely considering they have spent a lot building

capacity up front so it's probably overstated right now. In that case, they could maybe_get net margins as high as 1516%^ ' ' '
Conservative: PE of 15 = 165M mkt cap / 55M shares = $3.00/share in 2 years Most optimistically for 2013 I'd say a target price of 20X PE and 16% net margins = 20*16M/55M shares = $5.80

A key point here is that it would be very difficult to imagine revenues decreasing due to the highly recurring nature - the conditions they sell products for last indefinitely and they don't even need to bill their end customers, just Medicare. Also, an important accounting note is how they capitalize their advertising. While of course I'd like to see all advertising

expensed, they_expense halftheir aj^rtisjngjnjjiejirst year and the other half over the next 3 (so expensed over 4
y^arsjLolaTj. I think this is fair given how solid the recurring revenue is but this will lead to cash flow being lower as long as they are growing, similar to a retail store or manufacturer needing to expand working capital. The advertising is^ direct response so they have solid data on how high the return on investments and they could easily justify far more aggressive capitalization under GAAP and choose not to. Were they to decrease advertising expense to a maintenance level (as opposed to aggressive growth currently), their current PE would be under 10 I'm quite sure. So in summary, Liberator is a rapidly growing (40%+) medical supply company that has just in the last 12 months passed the point of requiring equity financing. Their leader owns 1/3 of the stock and has done this play before with
great success and will repeat it.

Variant View

-Medicare could slash reimbursement rates

-Old people could have earlier than expected deaths or move into nursing homes (they sell to end customers, not old
folks homes) -Internal screw ups / ball dropping due to rapid growth

-Increases TV advertising rates (has been happening as economy recovers) -More competition in catheter space from better funded / bigger competitors

-Old people don't watch much TV anymore, change to Internet/talking to other old people
Valuation Metrics

(Units in millions, except for per share data or if otherwise noted.)

Trading Statistics
Price At Recommendation
1.26

Valuation Multiples Data

P /
EPS LTM EPS 12E 10.00 8.00 6.00

Multiple Valuation Multiples

EV/
O.lx
0.2

Data
1.7

Multiple
37.8x

Price target
% premium / (discount) to
target

4.00

Sales LTM Sales 12E

(68.5%)

1.2
0.8

53.6
80.4

EPS 13E

0.2

Sales 13E

Shares outstanding - diluted

Market Cap
Cash + short-term investments

55.0
69.3 5.0

2012 PEG F

O.Ox

P /
Book value
3.0 23.lx

EV/
EBITDA LTM 8.0 6.0
4.0

8.Ox 10.7
16.1

Credit Statistics

Debt

0.0

EBITDA 12E

Net debt / EBITDA LTM

Total debt / EBITDA LTM Cash / share

(0.6x)
0.0 0.09

Minority Interest

0.0

Enterprise value

EBITDA 13E 64.3 0.0 0.0% 40.0%

Annual Dividend per Share

% yield

FCF LTM FCF 12E FCF 13E

8.0

8.7x 11.6 17.3

6.0
4.0

Projected 2012 EPS growth %

Market cap / Debt

O.Ox

Comments

Steven Roge (R. W. Roge & Company, Inc.)

posted about 1 year ago - 02/14/2011 at 07:44PM
Nice find!

It looks like changes in working capital prevented them from becoming FCF positive in 2010, not surprising since they are growing rapidly. Any idea of what % of revenue will drop to FCF as this company matures?
Regards,
Steven

Ryan Morris (Meson Capital Partners)

posted about 1 year ago - 02/14/2011 at 07:50pm

The only significant difference between net income and FCF for this company is going to be the advertising capitalization. They don't really have any significant capital expenditures since it's just a fairly capital-light warehouse and call center. If they stopped growing the FCF = net income, if they grow revenues by 50% in a year and increase ad spending the same amount, then it would work out to something like a difference of net income FCF = ~25% of ad spending that year. That's all for growth though, so on a maintenance level, they are expensing more advertising than the 'treading water level'. If they expensed all advertising up front then FCF and Net income
would be equal. Sorry for the long answer, I hope that makes sense.

Christian Alpers (Trans-Atlantic Group, Inc.)

posted about 1 year ago - 02/14/2011 at 08:10PM

Yes, very nice write-up. But tough to get into, due to liquidity being very narrow.
Ryan Morris (Meson Capital Partners)
posted about 1 year ago - 02/14/2011 at08:24PM

Yes the liquidity is annoying, but there's also not likely anything imminent going on in the next 3-6 months so you
can accumulate gradually with limit orders... Paras Dagli (Private Fund)
posted about 1 year ago - 02/15/2011 at04:53AM

I've watched Rochester Medical (ROCM) for a few years now. ROCM is in the catheters market. They do around $40M in rev. When the Medicare bill was changed, ROCM used the same logic, as per your write-up, that rev would increase. Although the increase never came through. Any reason why you think Liberator will be able to get the sales
increase?

Ryan Morris (Meson Capital Partners)

posted about 1 year ago - 02/15/2011 atO5:00AM

Paras - the law changed in 2008 I believe which is where their revenues increased from 2.5M - 10M in one year... What's the story with ROCM, I see their revenues are flat the last few years? I'd be interested to hear your thoughts
on it.

Paras Dagli (Private Fund) posted about 1 year ago - 02/15/2011 at 08:iiAM

I never looked into the details of ROCM and why it wasn't able to deliver. Mainly because I was never impressed w/ management. I think the biggest issue was C.R. Bard owned a majority of the market share. Bard was able to use its market share and established relationships w/ providers to keep ROCM out of the hospital network. ROCM always had a chance to get into the direct-to-consumer market but it never seemed to be able to break through. "Supported by its strong sales force, Coloplast had over 50% of the market in 2009, with C.R. Bard, Astra Tech, Rusch, and Hollister also accounting for a notable share in this segment that year. A substantial sales force is necessary to develop appropriate relationships with health care providers in order to ensure that prescriptions are

being written specifically for a manufacturer's device and with distributors in order to ensure that they promote specific devices to end users. The dominant presence of larger competitors in this market and their existing relationships with health care providers and distributors may therefore prevent smaller competitors from entering or
being more successful in this segment."

http://www.news-medical.net/news/20101026/Medicare-reimbursement-changes-increase-demand-for-intermittentcatheters.aspx

Although I think Liberatoris focused on the direct-to-consumer market (this is from my quick read on Liberator),
whereas CR Bard is focused on the direct-to-providers. It would be interesting to get a break down of these 2
markets.

Matthew Goodman (Praetorian Capital)

posted 4 months ago - 10/12/2011 at08:44PM

Do you believe this story is as appealing as when you first wrote it up? any changes to note? have you averaged
down?

Shaun Noll, CFA (Stirling Capital Management)

posted 4 months ago - 10/12/2011 at 08:58PM

not sure about Ryan but certainly still looks interesting to me and I bought a little today, nice to see some small

jnjsidjjrjDuj^c^sjssj^

short interest ticking up slightly though (although still very low)

Ryan Morris (Meson Capital Partners)

posted 4 months ago - 10/14/2011 at04:i9PM

Sorry for the delay - I think it's more attractive now than ever, down 2/3rds from when they did a PIPE 2 years ago
now! I've been buying a bit on the way down but other things have also gone down so it's not isolated.

This quarter will provide some more information I think, last Q looked bad from a short term POV as they have spent
a lot on advertising and haven't had the corresponding revenue growth but there can be quite a bit of lag (6-12 mos) between ad spend and the start of revenue from it, so I think it's fair to judge them on an annual basis but 12Q's is too short. Will know if I am wrong and Mark L has lost his touch in a couple Q's...

Example Position: LBMH

a Liberator Medical sells recurring use medical products using direct advertising. Founded and 1/3 owned by Mark Liberatore who created
and sold Liberty Medical - currently a $600M+ business.
a

Revenue is growing by 30%+/year, currently trades near IX sales, comps

all at 2X sales with minimal growth.

trades at 6X PE.
a

Net Income distorted because of advertising expense treatment, pro forma

9$QS0* * le^Ju ^*z^*f<dL |e^ ~\).(t7

Revenue is virtually most recurring form possible (medical projects that are required permanently - ex catheters, paid for by Medicare)

Minimal Medicare price reduction risk, focused on dominating smaller markets that wouldn't move the needle for Medicare to cut expenses.
Stock has declined 35% YTD despite revenue continuing to increase. Business is counter-cyclical because advertising expenses decline in recession due to less competition.

~rjj ^