What’s Cabot Small-Cap Confidential’s “Stock of the Decade?”

What was pitched as the "$20 biotech stock to hit $48" last Summer is now being touted as the next 1,000% gainer and their "Stock of the Decade"

This note about a Cabot Small-Cap Confidential teaser first ran in the Friday File in the Summer of 2013, and the stock is up about 25% since then but is now being pitched as Cabot’s “Stock of the Decade”.

What follows was published on June 21, 2013 and has not been updated or revised:

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I thought you might enjoy a quick look at a teaser ad for one of Thomas Garrity’s picks from Cabot Small-Cap Confidential — they’re promoting this pretty actively right now as a “$20 biotech stock to hit $48,” as their innovative medical device gets approval to treat a much larger number of patients.

So what is it? Here’s the tease:

“$20 Biotech Stock to Hit $48

“All thanks to its revolutionary medical devices system that already delivered 140% gains to date….

“This Could Be an Easier Double Than The 974% Gains We Made In Monster Beverage”

They describe their strategy/philosophy of stock-picking thusly:

“Here at Cabot Small-Cap Confidential, we have found that the secret to profitable investing is to invest in game-changing technologies that not only stand in the path of growth but revolutionize entire industries.

“The reasons these companies have been so lucrative for us is they (1) change the way an entire industry does business and (2) have proprietary technologies that right from the beginning give them such a monopoly-like market share that few competitors can ever catch up.”

And tell us that this gives you a chance to invest in stocks that might be the next Priceline.com, Netflix, or Apple, to name a few of the examples they throw out.

Then we start to get details:

“Just like Monster Beverage’s breakthrough natural drink products revolutionized the beverage industry, this small-cap medical juggernaut is doing the same thing for the treatment of heart disease.

“With heart disease the leading cause of death for both men and women, this is one medical stock on a growth trajectory that could easily surpass the big profits we made in Monster Beverage.

“What makes me say so?

“Because this company’s treatment for Peripheral Arterial Disease (PAD), which will affect one in 20 Americans in their lifetime, could make heart angioplasty obsolete.”

OK, so that’s a nice big market — what’s the technology that’s shaking things up, and that has already driven the shares of this stock to more than double, with more (so they say) to come?

“Unlike angioplasty, which uses a metal mesh to inflate and stretch traumatized arteries to clear arterial blockages, this company’s treatment is like using a plumber’s snake to unclog your drain.

“Just like a plumber’s snake, it also uses a spinning drill-bit to sand plaque from arterial walls. Without getting too technical, it does this in a way that significantly minimizes the rise of trauma and ischemia.

“Since the company received FDA clearance to market this product, its stock price has risen an incredible 116% while its revenues have increased 24% quarterly.

“Now that its arterial-cleaning solution has been proven for treating PAD, the company is in the final phases of having its arterial blocking products approved for treating Coronary Artery Disease (CAD), which is the most common form of heart disease and costs the United States more than $100 billion each year.”

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Doesn’t that sound just lovely? A plumber’s snake squirming around inside your arteries? Yeeks. And better yet, the trade name used to be the Diamondback, with “Viperwire” accessories. It seems like they’ve moved on to the next generation of the core product under the “Stealth 360” trade name (the stealth is electric, the diamondback was pneumatic), but this is basically a wire that goes into the vessel and has a small diamond-coated lump on it — very technical term, I know — that spins around in the artery to essentially sand away the plaque from artery walls, including hardened plaque that’s otherwise very difficult to remove with other treatments.

And yes, the company is Cardiovascular Systems, Inc (CSII). And they do have a device that’s being used — successfully, as far as I can tell — to treat Peripheral Arterial Disease (PAD), and has been for several years. The pneumatic Diamonback version was approved back in 2007 and the newer Stealth electric one in 2011, so this is not a brand new treatment. Revenue is continuing to grow thanks to the continuing adoption of the technology, more sales in more labs and hospitals that increase usage, but it’s only growing by perhaps 20% or so, year over year. That would be great for most companies, particularly if you have a nice fat gross margin like CSII does on their devices and accessories (75% or so gross profit from those sales) … but for a $500 million company that’s generating $20-30 million in revenue per quarter and spending more than that on their sales force rampup, administrative costs, and clinical studies for the expanded use of the device, it’s not enough.

So what investors are banking on, including those who ponied up to add more shares in the secondary offering they did to raise cash this Spring (at $17.50, FYI, it’s around $20 now), is that they will both continue this steady growth trend in sales for PAD treatments and get approval to market the device for the apparently much larger market of Coronary Artery Disease (CAD). From their last quarterly release indications seem to be that the trials are going well for this label expansion, and they’re still forecasting substantial investments in the sales force to ramp up for that new indication, but at this valuation I expect they’d be in trouble if they’re denied access to the CAD market. They say CAD approval would get them into a $1.5 billion market, so even a small piece of it would be meaningful for a company with annual sales of currently only $80 million or so … but without that, they’d have to make a financial decision.

The downside, financially, is that if they can’t get into CAD or other new markets and are just going to have to focus on taking more market share in PAD, a market where they’ve had a presence for six years now, then creating a cash flowing company from the current 15-20% annual revenue growth would mean essentially cutting the R&D budget at least in half and cutting probably 15% from their SG&A budget to break even. If they did that then there’s a reasonable chance for the growth to turn into profits. Even if they double revenue over a couple years, though, and keep a strong gross marg