ShockWave Medical (NASDAQ: SWAV) investors have had a turbulent ride since the company's initial public offering in March.
The stock nearly tripled in its first three months. Since then, though, shares have been cut in half.
Volatility is nothing new for young, small-cap companies, especially for ones like ShockWave, a medical device maker using new technology to treat heart disease. Still, sustained volatility can leave even the most experienced investors wondering: Is this a good time to buy ShockWave, or is there more trouble to come?
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What the company does
ShockWave treats artery disease, a buildup of plaque in blood vessel walls. For decades, doctors have used a procedure known as an angioplasty, where a balloon is inserted into the artery and then inflated to clear it of blockages.
However, angioplasty is more difficult and riskier in arteries with severe lesions that have calcified and hardened. ShockWave's technology, known as intravascular lithotripsy (IVL), aims to address that problem.
Like angioplasty, ShockWave's catheter has a balloon attached. But instead of scraping away calcium, which can damage the artery and risk patient complications, the balloon emits ultrasonic waves (lithotripsy) that break the calcium. (It's the same treatment that has been used to blast kidney stones for years.) The IVL technology has benefits for patients (no damage to soft tissue), doctors (a relatively familiar procedure), and hospitals (it's less expensive), according to the company.
ShockWave treats peripheral artery disease (PAD), which affects vessels carrying blood to the body's extremities, in the United States and Europe. It has begun treating coronary artery disease (CAD), which affects vessels supplying blood to the heart, in Europe and is in clinical trials for approval in the United States and Japan. The company also is working to address aortic stenosis, a narrowing of the heart's aortic valve. The company estimates its addressable markets for PAD as $1.7 billion, CAD as $2 billion and aortic stenosis at $3 billion. Right now, the company has only begun tapping those markets. PAD treatments have been approved in the United States and Europe. CAD has been approved in Europe, with U.S. approval expected in 2021; and the company is developing a catheter to treat aortic stenosis.
Considering that ShockWave had only $12.3 million in 2018 revenue, it's apparent that the company has a large growth runway.
The rise and fall
ShockWave issued its first earnings report on May 8. Revenue grew 450% year-over-year to $7.3 million, and the company forecast annual revenue of $33 million to $36 million for its first year as a public company.
Investors viewed the growth as a sign that ShockWave's IVL treatment was catching on, and the stock roared ahead. By June 10, the stock was up 166% from its opening day of trading. As a result, its market capitalization had surged to $1.8 billion -- 50 times the year's projected revenue, an extremely high valuation even for the fastest growing companies.
Wall Street must have noticed that valuation because investors suddenly reversed course. The company's share price began falling during July, accelerating when the market reacted negatively to the company's second-quarter report.
However, the second-quarter earnings seemed to reflect the same trends investors had reacted positively to in the previous quarter. Revenue surged 339% year over year and was up 38% sequentially. Management raised full-year revenue guidance, this time to a range of $38 million to $40 million. The forecasted annual growth, 218% at the mid-range, suggested that the company's IVL technology was continuing to gain acceptance. Wall Street's reaction this time? Shares slid 9 percent, and they've fallen faster in September.
Two short-term issues
ShockWave's shares have fallen sharply in September , fueled by two issues, both of which were noted in a Sept. 3 report released by Cliffside Research, which put a short-term $23 price target on shares.
First, was the lock-up period, which prevents company insiders from selling shares of their stock for a designated time after an initial public offering. ShockWave insiders had a 180-day lock-up period, and it expired Sept. 3. On the day of the Cliffside report, the first day insiders could sell, the stock dropped 12 percent on trading volume that was 10 times more than average.
Second, management raised the company's full-year revenue forecast in August, but analysts questioned whether growth would slow in the third quarter due to seasonality. (People don't want to have medical procedures during the summer vacation season.) Slowing growth would be a problem for a company that has such high expectations already baked into its share price. Management warned that it expected "some seasonality" but believed growth would pick up "significantly" in the fourth quarter.
Seasonality and insiders selling shares are both valid concerns that investors should consider. The company's share price could continue to fall in the near term, but both are short-term issues that won't make or break whether the company rewards shareholders over the next five years.
What's more important for the long term is whether doctors and hospitals adopt the IVL technology and whether the company can turn profitable. ShockWave's revenue growth provides signs that its technology is taking hold. The company also is getting more efficient. Gross margins were 59% in the second quarter, a significant gain from 48% a year earlier. That efficiency allows more revenue to be spent on operational expenses as the company tries to drive faster growth.
ShockWave also has a strong balance sheet, with $125 million in cash and investments. That should help the company avoid the need to issue more shares or debt to fund operations for about two years -- time to execute its strategy.
Despite the recent drop, ShockWave is still not cheap, with a price-to-sales ratio that's about 22 times 2019's revenue estimates. Analysts forecast $75 million in 2020 revenue, about 90% year-over-year growth. Expectations are high, and a slowdown in growth would be bad news for the share price.
There are legitimate, long-term risks investors should consider. Approval in clinical studies is not guaranteed; and even with regulatory approvals, the company must convince cardiologists and hospitals that its IVL technology is safe and effective.
Also, while revenue is rising, so are expenses. ShockWave lost $0.38 per share in the most recent quarter and has burned through $23.4 million in operating losses in the first six months of 2019. Profitability is likely years off as it spends heavily developing and marketing products.
Those types of risks aren't unique to ShockWave. Small, fast-growing companies often face similar challenges. That can lead to extreme volatility -- the kind that's been evident the last six months -- but it hasn't affected the company's long-term strategy.
For patient investors with a three- to five-year timeline, the company's recent decline could be an opportunity to consider buying shares.
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