Tuesday, March 13, 2007

Eyelogic Part 1--Overview

Eyelogic (EYE.A on the Toronto Venture Exchange) is my most exciting current holding, accounting for approximately 9% of my personal portfolio. I have owned the name for over a year, and have compiled a good deal of research on the name. This is likely to be one of several postings. To summarize, this is a tiny ($5M US) market cap company with a potentially disruptive technology, growing at about 40% per year with a P/E ratio of ~10, and a dividend yield of 6%. It is extremely illiquid, and is suitable only for small investors with long time horizons and relatively small accounts. I view this as a private equity purchase, and do not plan on selling anytime soon. I believe this stock has the potential to increase 10 to 20 fold if its technology catches on. It is currently the most attractive risk/reward play I see in the market.

The company makes an automated refraction system, which is a fancy way of saying that they have developed a device capable of taking an accurate measure of the prescription of glasses needed by a patient. To explain how big a break-through this is, let me first provide some detail on the eyecare industry.

Overview of the Eyecare Industry
Eyecare is provided mainly by optometrists, who specialize in health of the eye. They provide a host of eye related services, including glasses prescriptions, eye check-ups, lasic surgery, treatment of cataracts, and other ailments of the eye. Though there are many ailments on the eye, the most common reason people go to the optometrist is to get a new prescription. It is estimated that nearly 90% of visits to the optometrists are for this reason.

Anyhow who has ever gotten their prescription taken can tell you how much of a joke this process appears to be. The optometrist flips a switch, asks you to compare two options, and continues to do so until the correct prescription is found. He is, 90% of the time, a glorified machinist. This knock on optometrists is not new news. Witness 1800-contacts battle with the optometrists. Most optometrists refuse to give prescriptions for contacts, instead making the customer order through them (with hefty margins going to the optometrist). 1800-contacts has spent millions battling optometrists unions, and will likely continue doing so in the future.

Unsurprisingly, the optometrists view Eyelogic and its system as a huge threat. In the fall of 2006, they pursuaded the board of Canada to classify the eyelogic system as a class 2 instead of class 1 device. This forced Eyelogic to suspend sales in Canada, until they received the additional certification (which was received in late February). A cursory view of internet message boards will also show you some resentment on behalf of the optometrists.

Anyhow, if a good system to automate the prescription process was developed, it is clear why the optometrists would be scared. Luckily, Eyelogic has a partner in their battle, in a way 1800-contacts does not:

The Optician
Opticians specialize in sales of products for the eye, mainly glasses. They have always fought the optometrist for business, as many optometrists sell glasses in their own office, providing a lucrative additional revenue stream. Many opticians have gone a similar route, bringing in their own optometrists strictly for the purpose of driving eyecare sales. Unlike the optometrist, the optician views the prescription process as a hassle. They see it as a vechile for eye care sales, not as a lucrative revenue stream (which is why this service is usually heavily discounted in most optical stores). They would love a machine that would automate the process, and drive more people to their stores instead of to optometrists. The union of opticians in Canada has lobied on behalf of systems like eyelogic, and should be a strong ally in the battle going forward.

The Market
The eyecare and prescription market is a multi-billion dollar business. According to a 2004 labor bureau report, there are over 34,000 optometrists in the US alone. Additionally, increases in computer usage, and jobs requiring computer usage, are likely to take a toll on most people's vision, requiring increasing visits for eyeglass prescription in the future. Currently, it is estimated that about 30-40% of the population has myopia, most of whom require glasses or contact lenses. In addition to thousands of optometrists worlwide, there are also hundreds of thousands of opticians who sell eyecare products to the public. Though Eyelogic has no hard numbers on the penetration of autorefractors, it is estimated to be very low (<10%). Adoption has been slow, as optometrists have largely shunned the service (it would admitting that there is no skill involved in 90% of what they do, and would negate them to specialists for more serious issues). Opticians have adopted the service more rapidly, but are still adopting relatively slowly.

According to Mark McDonald, COO of Eyelogic, there are several companies in the marketplace. Many have tried (and failed) to spend millions on high powered marketing campaigns and low-cost machines to encorage rapid adoption, but none has worked thus far. Eyelogic has taken a measured approach to growing the market, and anticipates the market to continue to expand slowly in the future, until mass adoption by a couple large optical chains or mass retailers (e.g. Costco, Wal-mart) tips the scale.

There are 3-4 companies that make this equipment. Eyelogic is the leader in the Canadian market, and sells worldwide through its distribution agreements. There are also 2-3 japanese companies that make flashier, albeit less functional products then eyelogic. Demarc, a large provider of optical equipment in the US, is the leader in the US market, though has faced similar adoption challenges as eyelogic has faced in Canada.

Next-->a review of eyelogic's operations, financials, and growth potential...

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