Semler Scientific: A Deep Dive
Not many people have heard the name Semler Scientific. It trades on the OTC markets, barely qualifies as a small-cap stock, and rarely has a daily trading volume greater than 1,000 shares. I actually saw it only trade 14 times in a single day. Compare that to Tesla, which has 40 million+ shares traded on the regular. Talk about price discovery am I right.
I believe Semler Scientific can be a serial compounder over the next decade. That’s a bold statement, especially because this is my first foray into the small-cap, non-NYSE/Nasdaq territory. But I wouldn’t stray away from my typical $1-$25 billion business if I didn’t have high conviction. And I have plenty of it with this stock.
Below I’m going to outline my investing case for owning Semler (ticker: SMLR) by going through my six-step investing research process. The process is pretty basic, and probably not dissimilar to what you go through if you’re a bottom-up, growth-oriented investor like myself.
Alright, let’s get to it. First up, the basic financials.
Basic Financials/What they Do
As of this writing, Semler has a market cap of $335 million. For the trailing 12 months, the company brought in $29.5 million in revenue, giving them a P/S ratio of 11.3 (latest earnings can be found here). That seems mighty steep for a healthcare company, so let’s dig in a little deeper to see if a double-digit sales ratio makes sense.
Over the last nine months sales grew 52%, and last quarter they grew 60%. In the latest quarter, Semler’s EBIT (earnings before interest and tax) was $3.1 million, giving them an EBIT margin of 34%. That is an awfully strong margin number for a high-growth company.
We’ll take a deeper dive into the financials later, but at first glance, there seem to be no initial red flags for the business, especially with this clean looking balance sheet:
Semler Scientific’s balance sheet, Q3 2019
Okay, next up, what does Semler Scientific do?
It’s pretty simple. Semler developed, got FDA approval, and now manufactures a healthcare device to identify chronic disease. Their stated mission is “to develop, manufacture and market innovative proprietary products and services that assist our customers in evaluating and treating chronic diseases.”
As you can see, the company has a broad mission statement (every company is changing the world nowadays, just ask WeWork and Uber). However, right now they just sell one product called QuantaFlo. They sell this product to insurance providers and physicians across the United States.
QuantaFlo is a 4-minute blood flow test (pictured below). It helps doctors identify peripheral artery disease, a commonly untreated vascular disease of the legs/other extremities. Think of it as a quicker, easier, and more accurate blood flow reader.
Semler’s customers pay to license its proprietary software. Last quarter, 66.8% of sales came from fixed software license arrangements, while 29% came from variable license arrangements. The rest of their revenue came from equipment sales.
So, as you can see, Semler brings in the majority of its revenue through software applications, which is why they have such high EBIT margins.
Do I Understand the Business?
Next up, a relatively simple step. I believe I understand Semler’s business model because:
None of the technology is overly complicated
They only have one product right now
That product is easy to understand
Sometimes this step involves a lot of personal debate, asking questions like “Do I want to spend the time and learn about this business?” and “Could I ever become an expert in this industry?” When researching Semler, I found no red flags, so it was an easy decision to move on to the next step.
Do They Have any Competitive Advantages?
As stated in Semler’s 10-k, their primary competition is the traditional ABI blood pressure cuff that I bet you are all familiar with.
A traditional blood pressure cuff.
From an industry-level perspective, Semler has no competitive advantages. The traditional players are larger, have more financial resources, and more pricing power. But they also have one thing that has killed incumbents time and time again: the innovator’s dilemma.
What is the innovator’s dilemma? Well, the exact definition is highly debated, but the outcome is that most incumbents fail to disrupt themselves because of how profitable their current products are. I see something similar happening with blood flow measurement products.
Could Semler’s competition, given a few years for regulatory approval, come up with a comparable device to Quantaflo? Sure they could. But as of today (and this is according to the 10-k again), there are no direct “digital ABI” products that compete with them.
This is strange because study after study (most sponsored by Semler, so take it with a grain of salt) have shown Quantaflo is the most accurate measure of vascular problems on the market.
Semler has been able to grow its revenue by 50%+ annually without sacrificing profitability. That wouldn’t be possible if they had an inferior product.
Note: If you want to listen to me opine on Semler, we did a fundamental analysis show on them a month ago. There was also an Industry Focus show discussing them if you want to get some other opinions on the company.
For this section, I want to look at Semler’s suppliers, customers, and competition since those three relationships will have the greatest impact on their business prospects.
The competition, as stated above, are the traditional analog blood pressure readers. One argument you could make for these devices over Quantaflo is they occupy more “mindshare” with doctors/patients and are the first thing people visualize when they think about blood flow tests. However, since Quantaflo has been proven to be more accurate and efficient than any of these devices, I am confident they can continue to win a bigger share of the PAD market.
Next up: suppliers. Since you need hardware (see the above pictures) to use Quantaflo, you’d think a decent portion of their revenue would come from that. But that isn’t the case. Out of the almost $9 million in third-quarter revenue brought in by the company, less than $300,000 was hardware sales. So, even if they get squeezed by a supplier or have to spend upwards of 50% on materials for one reason or another, Semler’s bottom line will not be meaningfully impacted.
The one thing I do have a concern about is Semler’s customers. Last quarter, Semler’s three largest customers made up 47%, 15.7%, and 12.4% of revenue. That is a ton of revenue concentration. They don’t specifically say who these customers are, but they are likely the giant healthcare providers in the United States. If these customers, especially the 47% one, chose to leave Semler, that could be devastating to revenue growth and would likely severely impact its valuation.
That being said, I see no reason why any of these large customers would leave Semler. Switching out Quantaflo would involve large costs and, if the product is as good as advertised, why would they even consider it? The risk of losing these customers is always there, but I don’t think it is a high one.
Vetting of Management
Semler’s CEO is Douglas Murphy-Chutorian M.D. Chutorian is Stanford educated, an experienced healthcare entrepreneur and executive, and has guided over 50 products through regulatory approval. Knowing that he has experience as a business leader and healthcare professional gives me the confidence he can lead the technical and business side of Semler Scientific. One note though, he did have a stroke a few months back (should have used Quantaflo!), but he is back to working full-time now according to the company.
Scrolling through the rest of the executive team, I see some other medical professionals with tons of experience in the healthcare industry. Since the company is so small, there isn’t much to research publicly, but from what I found there are no red flags.
Glassdoor only has 4 reviews, so not really any statistical significance there, but the company had a 4.4-star rating, which is positive.
Lastly, with management, it is always good to look at conference call transcripts to see how the executive team thinks publicly about the company. There wasn’t anything specific to note, but just that there were no red flags (I use that term a lot, but it is important) when reading what management had to say.
Is There a Way They Beat the Market?
I don’t want to sound too bullish, but I think Semler can definitely beat the market over the next five years. The company is guiding for margin expansion and has a huge opportunity ahead of it.
Using the TTM revenue of $29.5 million as a baseline, let’s assume Semler can grow sales of Quantaflo by 30% over the next five years (a conservative estimate, given the market opportunity and historical growth). That would give them $109 million in sales in five years. Assuming an average EBIT multiple of 25 and an EBIT margin of 37% (remember, expansion), Semler would have a market cap of $1 billion, which is 3x of what it trades at today.
And this doesn’t even take into consideration new product offerings the company has basically guaranteed will be coming down the line in the near future. New products will likely eat into their profit margins, and actually have to be good ideas, but if they have anywhere near the margin profile of Quantaflo Wall Street will eat it up.
Okay, I know I sound super bullish on Semler Scientific (I am, and plan to buy shares shortly). Just know that no company is ever flawless and that investing in small-cap healthcare stocks comes with known risks. But with that risk, you get some big-time potential.
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.