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TSO3 Inc.

Frederic Tremblay, CFA, Analyst

  • TSO3 appears poised to gain market share in the existing low-temperature sterilization market with its best-in-class technology.
  • Increasing commercialization and sales efforts in support of distributor Getinge should boost deliveries of units.
  • TSO3 is currently in the early stages of implementing a razor-and-blades model where installations of the STERIZONE VP4 sterilizer would drive recurring revenue from high-margin proprietary consumables.

TSO3 is an innovative Québec-based company whose activities consist of R&D, production, assembly and sale of low-temperature sterilization processes and related consumables supplies, as well as accessories for heat- and moisture-sensitive medical devices. The company's main product is the STERIZONE VP4, a low-temperature sterilization system designed to sterilize a large number and wide range of compatible reusable medical devices using one preset cycle.

The STERIZONE VP4 is cleared by the Food and Drug Administration (FDA) and, in our view, possesses key advantages vs incumbent systems that should enable it to capture a significant share of the ~US$450m worldwide annual sterilizer replacement market (~40% of which is in the US).

In late 2015, TSO3 signed an exclusive distribution agreement with Getinge, a global leader in infection control solutions. Recently, management indicated that 50 units have been delivered to end users by Getinge as of the end of the third quarter (3Q17). TSO3 expects to end the year at ~70 deliveries, thanks to a busy 4Q17 and steps taken to accelerate progress (such as providing additional support to Getinge and incorporating advancements to the STERIZONE VP4 that should make installations faster and easier). We will closely monitor execution, as having a solid base of installed units in hospitals is key to driving future recurring revenue from high-margin proprietary consumables. With strong execution, we believe the company can unlock significant value for shareholders.

In addition, TSO3 continues to pursue its submission to the FDA for terminal sterilization of duodenoscopes and recently responded to the FDA's request for additional information. Assuming that the FDA does not make another meaningful request for additional information, we believe a final decision from the FDA could be announced before the end of the month or in early 2018. Approval of this extended claim would be an important catalyst. While TSO3's VP4 sterilizers are gaining traction in central sterilization departments, we believe approval for the extended claim on duodenoscopes would accelerate penetration of TSO3's product in the untapped gastrointestinal (GI) market, where endoscopes, and duodenoscopes in particular, have been linked to outbreaks of multidrug-resistant bacteria (superbugs).

In this context, we believe an approved sterilization technology could displace the current process (ie high-level disinfection) in the GI market. FDA approval would make the VP4 sterilizer the first and only validated sterilizer technology in the US with a cleared label claim for the terminal sterilization of duodenoscopes (note that TSO3 already possesses duodenoscope clearance in Canada and Europe).

Our C$4.00 target is based on a discounted cash flow analysis using a 12% weighted average cost of capital, 2% terminal growth rate, 4x terminal EV/sales multiple and C$1.27/US$1 exchange rate. We have a Buy–Above-average Risk rating on TSO3.

The author

Frederic Tremblay

Frederic Tremblay

CFA, Analyst