My Bullish Thesis

Unique Founding/Family Ownership

Jordan Katzman and Alex Fenkell founded Smile Direct Club ("SDC") in 2014. Jordan and Alex met at a summer camp when they were 13 years old due to the fact that they both wore metal braces. They came up with the idea for SDC in their 20's while reminiscing about their childhood and thinking about a less embarrassing way to straighten teeth.

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David Katzman, Jordan's father, funded the company via his investment group. Jordan's uncle, Steven Katzman, is also the company's chief operating officer. Together, the Katzman family owns more than 65% of the business's voting power. Thats a lot of Katzmans.. let's get that straight.

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Jordan Katzman - Founder

David Katzman - Father

Steven Katzman - Uncle

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CEO (David Katzman)

David Katzman is the founder and Managing Partner of Camelot Venture Group, a private investment group. He has served as a member of the board for Sharper Image, Simplex Healthcare (a diabetic supply company), ePrize (an online promotions company), CleanRest (bedding), and Quicken Loans (an online mortgage company).

 

He was also Vice Chairman of the Cleveland Cavaliers and Managing Partner of sports graphics company "Fathead". As CEO, David Katzman brings extensive experience in business leadership, investment, and in finance. Also, perhaps knowing several celebrities in the basketball industry could bring high profile sponsorship and advertisement opportunities.

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The Bull Thesis

Fresh IPO at an Intriguing Valuation

Smile Direct Club IPO'd on September 12, 2020 for about $20 per share. Shortly after, the company dropped to about $8 per share before spiking up to $14 then dropping again to under $4 per share as a result of the COVID-19 pandemic. Although the share price has recovered to about $11 per share this is still well below its IPO pricing.

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Small Company with a Large Market Opportunity

There are several competitors in the clear aligners market but the two largest providers of clear aligner products are Align Technology (ticker "ALGN") and SDC. ALGN is the more established company with a market capacity of approximately $42 B while SDC is much newer and provides similar services but trades at a market capacity of about $1.4 B. I believe that SDC has the potential to grow into as large of a company as ALGN if not larger.

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This means that SDC has the potential to be worth approximately $300 per share one day. That would be a 3,000% return on investment.

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Cheap

Traditional Braces - The average cost is approximately $5-6k, but some individuals might pay as little as $3k or as much as $10k.

 

SDC's Method - Clear aligners and nighttime clear aligners cost approximately $2k or $90 per month. Historically, one of the largest barriers to getting braces has been their price.

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Convenient

Traditional Braces - In order to get braces you need to go to an orthodontist's office and have them attach metal brackets to your teeth, then insert wires through the brackets and over time slowly tighten the wires in order to adjust the teeth into the proper position. Depending on your situation, this process can take anywhere from 18 months to 3 years.

 

SDC's Method - SDC sends you an $18 impression kit in the mail for which you can get a rebate. Then they send you your clear aligners which are see-through and for most people the straightening process takes 4-6 months.

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Industry Disrupting Company

Manufacturers of clear aligners are disrupting providers of traditional metal braces by reducing the cost of getting braces by over 50%. Also, clear aligners are more convenient, less invasive, and typically look better, and it is a faster process than metal braces. If a person had the option to choose, why would anybody pay more for less convenience, more invasiveness, for a process that takes longer? However, that being said, clear aligners are not an option for everyone. See below.

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The Bear Thesis

**Disclaimer** because of the existence of the Hindenburg (short-seller) Research Report the bear thesis is a little longer. There are several significant concerns here but take it for what it is. Short-sellers often publish these lengthy reports to try and stir up fear and hurt the companies that they hold short positions in.

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Hindenburg Research Report

On October 4, 2019, well known short-seller Hindenburg Research published a lengthy and unsurprisingly overwhelmingly negative research report alleging that SDC is "selling a dangerous product that cuts corners instead of actually disrupting the orthodontics industry." The Hindenburg Report predicts an 85% decrease in the share-price.

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• The report states that several of SDC's business practices have been made illegal by Alabama and Georgia and that 36 State complaints have been filed against SDC that the company is operating as a dentist without proper licensing.

• The report cites 1,200 Better Business Bureau complaints and a class action lawsuit.

• The report states that SDC has a habit of accepting candidates for clear aligners that are denied by other companies and that SDC's orthodontists "crank out" 75 to 100 cases per day from their phones.

• The report mentions that SDC requires customers to sign legal release forms stating that they won't post negative online reviews or complain to regulators and in exchange the company will provide a refund.

• The report also goes on to mention that there are several online reviews of SDC customers who state that their impression molds got stuck and needed to pry the molds free from their mouths themselves.

• The report also mentions that in 2017, the company sued an orthodontist who posted a YouTube video questioning the safety of the company's approach. The case was settled.

• The report also mentions what can only be described as unethical business practices pointing to the fact that CEO, David Katzman, sold a plane worth $3.4 MM to the company a month before its IPO.

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Increasing Debt and Decreasing Cash on Balance Sheet

In Q3 of 2019, SDC had $547.6 MM on their balance sheet with only $219.4 MM worth of debt. Fast-forward to Q3 of 2020 and the company's cash balance has shrunk to $373 MM with $415 MM worth of debt. That is not great news. However, the picture is not quite as bad as it seems because at least $100 MM on the company's balance sheet in Q3 of 2019 was set aside for anticipated IPO costs. Still, decreasing cash on the balance sheet and increasing debt is a trend that need to be watched. However, I believe that the long term outlook on the company remains intact.

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Not an Option for Everyone

Not everyone's dental situation allows for the use of clear aligners. After you send in your impression kit, it is given to an orthodontist who makes an assessment of whether or not clear aligners are right for you. The determination depends on the factors listed below:

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1. Severity of your cases - severe teeth crookedness or severe jaw issues may be better handled by braces or other orthodontic treatment.

2. Overall Dental Hygiene - advanced gum disease could disqualify you from being a good candidate for clear aligners.

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Competition

• Uniform Teeth

• Orthly

• Candid

• Smile Love

• SnapCorrect

• Byte

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None of the above mentioned names are large players in the clear aligner industry, but all of them were established shortly after SDC's founding in 2014.

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Conclusion

This is a high risk high potential reward stock. There are a lot of red flags! For such a young company they have a lot of lawsuits filed against them. I think the risk/reward falls slightly in favor of SDC, but this isn't a stock you would want to put your whole portfolio in.