A Great Investment Opportunity, or Not So Sure?

Syneron investors would rather forget the last two days of 2005, when a downgraded recommendation from the CIBC investment house sent the share tumbling 19 percent, thereby wiping out almost a full year's worth of gains. The downgrade, from "outperform" to "sector perform," took investors by surprise, because just two months ago, CIBC had raised its target price for Syneron shares from $52 to $62. The CIBC move caused the share price to fall from a mid-December peak of $46, representing a market value of $1.27 billion, to $31.80, representing a market value of only $877 million.

What happened over the last two months to make CIBC change its mind so sharply?

CIBC attributed the downgrade to a survey of distributors of Syneron products, from which it concluded that the company, which makes equipment for non-surgical aesthetic treatments based on light and laser technology, would have trouble meeting analysts' fourth-quarter sales forecasts of about $29 million. This, combined with what it termed a history of sharp fluctuations in profitability in this industry, caused it to prefer a more "conservative" forecast for 2006.

In fact, it cut its 2006 growth forecast for Syneron almost in half - from 52 percent, representing sales of $137 million, to 29 percent, or sales of $116 million. This translates into more than $10 million in lost profits.

But while many investors were surprised by CIBC's move, some said that there had been warning signs - specifically, the resignation of CEO Moshe Mizrahy in early November.

When he left the company, Mizrahy asked the U.S. Securities and Exchange Commission for permission to dump all his holdings in Syneron - some 1.3 million shares, then worth about $53 million. "Mizrahy was a successful CEO who brought Syneron achievements, and his moves did not express great confidence in the company," noted one investor.

Mizrahy, who founded Syneron together with company chairman Shimon Eckhouse, did not explain his reasons for leaving; but according to Eckhouse, the decision was mutual.

"He's a short-distance runner, and at this stage, Syneron is already a big company that needs a CEO with a different management style appropriate to the company's new phase - a CEO with substantial management experience, who also understands mergers and acquisitions," Eckhouse said.

However, Eckhouse had trouble providing a convincing explanation for Mizrahy's subsequent resignation from Syneron's board of directors in mid-December, and it seems likely that he was simply shown the door. This interpretation is bolstered by the fact that Mizrahy's replacement, chief financial officer David Schlachet, had never before been signaled as Mizrahy's heir and had never dealt with running the company's operations.

But whether Mizrahy's departure ultimately proves good or bad for the company, Syneron's greatest asset remains its gross profitability. In 2004, its gross profit totaled 88 percent of revenues; and in the first nine months of 2005, it totaled 87 percent. For a medical equipment maker, such gross profitability is extraordinary. It also outstrips that of Syneron's seven major competitors, whose gross profits range from 74 to 44 percent of revenues.

Such high profitability could be the result of high sale prices, low production costs or both. According to Eckhouse, Syneron's prices are higher than average, though not the highest on the market. He attributes its extraordinary profitability to Syneron's proprietary ELOS (electro-optical synergy) technology, which lowers production costs. All Syneron products are made in Israel.

The slower sales-growth forecast by CIBC could also have two explanations - fewer products sold, or lower prices. Yet CIBC is still predicting gross profitability of 85 percent for Syneron next year, indicating that it does not foresee significantly lower prices; thus it evidently expects fewer products to be sold than it had originally predicted.

Syneron's current market value reflects a price-earnings ratio of 19. This is not particularly high for a company that expects to report 70 percent growth this year; rather, it reflects investors' fears about Syneron's future performance. For anyone who considers these fears unfounded, the current price is thus a great investment opportunity. Others, however, will prefer to wait and see.