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Wednesday, July 12, 2006

Syneron Medical: Falling Revenue Should Only Be Temporary

Saul Sterman submits: Our outlook on the medical equipment sector is for the most part neutral with the notable exception being the cosmetic surgery stocks. Contrary to the oversupply situation that prevails in the cardiology, orthopedics and drug-eluting coronary stents categories, robust demand for cosmetic surgery – primarily facial aesthetics and breast enhancement – should yield excellent returns well into 2007.

Note that refractive surgery is not included. Our research points to a possible ominous (evil eye) problem in this area, specifically for LASIK type procedures which could dwarf the recent problems encountered by Bausch & Lomb (BOL).

Covered in this five part analysis are:

Syneron Medical (ELOS) – designs, develops and markets aesthetic medical products currently relying heavily on FotoFacial RF skin treatment and developing a dental laser line of products.

Candela Corp. (CLZR) – designs, develops and manufactures aesthetic laser systems currently replacing the VBeam system with the more advanced Pulsed Dye Laser [PDL] Platform.

Cutera (CUTR) - designs, develops and manufactures aesthetic laser systems and other light-based equipment.

Laserscope (LSCP) – designs, develops and manufactures surgical and aesthetic laser systems and related surgical equipment.

Palomar Medical Technologies (PMTI) – researches and develops laser systems primarily for hair removal and to a lesser extent other cosmetic applications.

Syneron Medical (ELOS) is our pick out of the five companies competing in this arena. There is compelling rationale for the markets beating down the stock by as much as 34% over the past year. Yet in-depth analysis yields the basis for our prediction that this trend will end.

As far as the recent price decline goes, there are two factors. First and foremost are revenue (in millions) and EPS. Though revenue for Q1 2006 was up to 23.74 from Q1 2005 of 18.51, it is flat from Q4 2005 and down from Q3 2005 = 25.03.

On the surface, earnings is of greater concern. Earnings per share are down from Q3 2005 on lower sales. EPS are substantially lower for Q1 2006 = 0.32 in comparison with Q4 2005 = 0.43 on comparable revenue!

The second (minor) factor is that Syneron is an Israeli company. Recently the market has been eyeing Israeli companies with a tad of suspicion. Mercury (MERQ) marked the beginning (definitely justifiable), and recently ECI and Teva have been hit – ‘for fundamental reasons’.

The whole picture tells a totally different story.

On the earnings front, Syneron has increased its expenditures on marketing and research & development.

Marketing expenses related to the entry into the Chinese market in partnership with Miracle Laser should decrease as a percentage of goods sold — as revenues increase. We expect to see positive results from the Chinese market already in Q3.

The R&D agreement with Light Instruments Ltd. will take a toll on earnings a while longer. Once the development of the dental laser system is completed, R&D investment should return to 7% of revenue. In addition to revenue and profits that the new laser line would generate, the lower R&D expenditures should add 1.5 to 2 million to the bottom line.

On the revenue front, Syneron has recently unveiled a new line of products for skin tightening, hair removal and non-ablative (skin) photo rejuvenation systems. Historically, the cosmetic laser industry experiences wild swings when new products are introduced.

Regarding the second (minor) factor – well, Wall Street tends to ‘re-favor’ sectors and groups as soon as one company outperforms its peers in a given group. We don’t think that there is any real concern regarding the financial statements of Syneron or of ECI nor Teva for that matter.

Syneron protects its proprietary technology with 4 issued patents and has 13 additional patents pending approval. This enables the company to outsource manufacturing, thus reducing overhead and inventory charges.

We estimate 2006 EPS at $1.89 and have a target price of $31.50. The current trailing PE ratio is 14, well below the competition.

The remaining four companies have their strengths and weaknesses, however at present we feel that they are fully valued and do not present an compelling investment opportunity. We will make do for now with posting the respective PEs:

ELOS = 14, CLZR = 24, CUTR = 23, LSCP = 35, PMTI = 40

Obviously this is not the complete picture for the four musketeers and we will be covering them in the near future.

This is an ongoing analysis posted in five parts to be continued next week.

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