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Eargo is a No Go

Jonathan Heller says selloff on criminal probe leaves too many unknowns.

Jonathan Heller is big on “double-net” stocks, but he’ll take a pass on one formerly outperforming company.

‘Recently, I dug up a surprise within one of my deeper-value screens, in particular, "double-nets,” Heller wrote recently on Real Money. “That's a homegrown search for companies trading at between one- and two- times net current asset value, or NCAV. That's a relatively low multiple of net current assets, and over the years this universe of companies has been fertile hunting ground for acquisition candidates.”

The company that showed up on Heller’s screen is Eargo Inc.  (EAR) , which has seen its share price slide significantly after some downbeat news.

“I was surprised to see recent high-flyer Eargo Inc. appear on the double-net list, trading at just 1.75x NCAV,” Heller said. “The hearing aid company went public at $18 a share less than a year ago, closed its first day of trading at $33.68, then rose to nearly $77 by early February of this year as Eargo briefly attained cult-stock status. It has been downhill ever since, due primarily to mixed earnings results, and shares were trading in the low $20’s last week.”

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Then a bombshell hit EAR last week, sending the stock spiraling downward.

“Eargo disclosed in an 8-K filing that it had been informed "that it is the target of a criminal investigation by the U.S. Department of Justice (the "DOJ") related to insurance reimbursement claims the Company has submitted on behalf of its customers covered by federal employee health plans,” Heller said. “That news sent shares down 68% last Thursday; they closed Tuesday at $6.84.”

With an investigation in play, Eargo will not be providing guidance for this fiscal year, and analysts covering the name have been downgrading it and reducing price targets. That’s a major red flag for Heller.

“As much as I like to dumpster dive for companies that the market may have overly punished, there is simply too much uncertainty in the case of EAR,” he said. “There are not enough details available to figure out where this situation is headed, how long the investigation will take and what the outcome will be. This is a case where the fundamentals, namely the extremely cheap valuation in terms of NCAV, are trumped by the circumstances. There is simply too much uncertainty here for my blood, at this point, anyway.”

“This is one time where investors need to be careful of not falling into the mindset that the stock is cheap simply because it once traded for $75 and now trades for less than $7,” he added.

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