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  Theragenics is a study in contrasts

BENJ GALLANDER and BEN STADELMANN

Wednesday, December 15, 2010

With global investors fixated on the potential contagion of the European debt crisis, an article concerning an Atlanta-based biotechnology small cap, Theragenics, could be construed by some as a form of escapism. To which we reply, "Sure, why not?"

This is our second go-around with this stock. We purchased it for the Contra portfolio in 2004 at a price of $5.11. Back then, the company was primarily manufacturing its radiation treatment for prostate cancer. With that therapy losing ground to alternatives, the company chose to forgo more investment in R&D, and diversified by buying two companies in the medical products field.

We felt they overpaid, and were skeptical about revenue growth and the newly debt-laden balance sheet. Also, we'd had some disappointments with biotech companies, so it made sense for us to take a tax loss to offset gains on the position. It was sold in 2006 at $3.24.

Since that time, Theragenics has meandered through some trials and tribulations, but its surgical products division has shown revenue growth for every quarter throughout the past two years. In 2009, revenue came in at a record $78.3 million, with net income of $3 million. That's quite a turnaround from 2004, when the firm lost $8 million on sales of $33.3 million.

Even with the recession and issues regarding U.S. healthcare reform, consolidated revenue for the first nine months of 2010 was $61.5 million, an increase of 3 percent over the 2009 period. Though 2010 should be another record year for sales, operating income in the surgical products division is down on thinner margins, primarily due to some unusual items. Startup costs for a manufacturing facility, a new software system, and legal expenses have all dinged the bottom line.

Third-quarter revenue for the old prostate cancer segment was notably higher year over year, which hasn't happened in five years. This legacy business has been sinking steadily, but agreements with new distributors seem to have increased market share. By no means does the company anticipate growth in this type of procedure, but they are looking to be one of the remaining players holding a bigger piece of a slowly shrinking pie.

The balance sheet has also changed from six years ago. The cash reserve of $40 million as of the end of September is still decent, but now there is long-term debt of $27.8 million. When we did our initial due diligence, there was none. With the remainder of expansion expenses to be finalized in the fourth quarter, debt reduction can move up on the list of priorities.

On the face of it, the timing of this buy in June was less than ideal and out of character for our contrarian methodology. We knew Theragenics was involved in several disruptive actions that would affect their short-term results. But we took advantage of the fact that it was being removed from the S&P SmallCap 600 index. When this happens, index funds must sell their shares. For a relatively lightly traded stock like Theragenics, the price gets hammered, as supply temporarily swamps demand. A position was picked up for the Vice-President's portfolio at a great price of $1.10.

A relatively easy company to understand, owning Theragenics doesn't leave us feeling straitjacketed. It has two distinct business segments and an uncomplicated balance sheet. The surgical products business is the engine of growth, but the recession is still affecting customer decisions, and quarterly results may still be volatile going forward. Biotech is clearly an out-of-favour sector, making it more attractive for a contrarian's stage. Though Theragenics' share price has appreciated close to the suggested buy limit of $1.50, we note that a NYSE listing requires it stay over $1. With some major issues now settled for the company, and the hope of an improved healthcare environment, the sell target range of $3.50-$4.50 seems quite reasonable.


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