In a year of busted IPOs, including debuts from Uber and LyftSmileDirectClub (NASDAQ:SDC) has been one of the biggest disappointments.

Shares of the teledentistry company, which sells teeth aligners online, sold for $23 in the company's September IPO, but lost nearly two-thirds of their value since then, trading under $8 today. Part of that collapse may be bad timing: SmileDirectClub's IPO came just as WeWork was unraveling. But investors also seem to be skeptical of the company's valuation and its future growth potential. Let's take a look at what SmileDirectClub has to offer investors to determine if the stock is a buy today.

A pair clear dental aligners

Image source: SmileDirectClub

The value proposition

Founded in 2014, SmileDirectClub grew quickly to reach $423.2 million in revenue last year. The company's mission is to use teledentistry technology to democratize orthodontics and disrupt the traditional orthodontist visit process through a more affordable, fast, and accessible model. According to SmileDirectClub, its procedure costs $1,895, compared to between $5,000 and $8,000 for traditional orthodontics, and it has served 700,000 customers thus far. 

Since its creation, SmileDirectClub has put up impressive growth, with revenue up 190% last year. However, its growth rate has decelerated significantly since then. After revenue jumped 113% in the first half of 2019, it increased by 50.6% to $180.2 million. The company's guidance for the fourth quarter implies revenue growth of about 56%.

The teledentistry company is also unprofitable. For this year, the company expects to lose between $73 and $80 million on an adjusted EBITDA basis, and it had a net loss of $74.8 million last year. The company spends most of its revenue on marketing, a sign of expensive customer acquisition costs, as sales and marketing expenses have made up 61.5% of its revenue through the first three quarters of the year, a higher rate than a year ago. But the company has high gross margins, at 77.4% through the first three quarters of the year, evidence that the cost of making the product itself is relatively slim.

Management believes the company has a global market opportunity of 500 million people and $945 billion, and has just begun expanding internationally into Europe, Canada, and Australia. In the U.S., it sees a total addressable market of 124 million people, or $234 billion. It claims that 85% of people have malocclusion, or misaligned teeth, yet less than 1% get treatment for it annually. Worth $3 billion, the company's closest publicly traded competitor is Align Technology (NASDAQ:ALGN), maker of the Invisalign teeth aligner, which is valued at $21 billion.

Align was actually an early supplier and investor in SmileDirectClub, and at one time held a 19% stake in SmileDirectClub, but the two companies have since drifted apart. Last year, Align said it wouldn't renew a supply agreement with SmileDirectClub, and the two companies fell into a legal spat. SmileDirectClub won an arbitration decision over Align earlier this year that forced Align to close 12 stores in violation of a non-compete clause. 

Risks facing SmileDirectClub

Short sellers have already lined up against SmileDirectClub, as is often the case with poorly performing IPO stocks. In fact, 26% of the stock's float is sold short, and the company was slammed in a short-seller report by Hindenburg Research, alleging that it is "carelessly cutting corners in a field of specialized medicine, putting customer safety at risk."

Indeed, the American Dental Association and other such bodies have filed complaints against SmileDirectClub, meaning the company faces distinct legal and regulatory risks.

As a business, the company's biggest challenges appear to be its lack of profitability and high customer acquisition costs, which reached $1,237 per customer in the third quarter. Since SmileDirectClub's product is meant for one-time use, the company relies on new customers to drive its business, so its marketing costs will likely continue to be high unless some of those expenses can be replaced by free marketing, like word-of-mouth or the media. The need for the company to find new customers also explains why its revenue growth could continue to fade, especially if customers begin to worry about the kind of potential safety risks the ADA alleges.

Finally, investors must remember that SmileDirectClub's estimate of the total addressable market is made up of one-time payments, not annual revenue. According to IBIS World, the orthodontics market in the U.S. is $11.7 billion in annual spending, and growing in the low single digits. Align Technology had $1.97 billion in sales last year and is highly profitable, and unlike SmileDirectClub's aligners, the Invisalign is sold through orthodontists. In its most recent quarter, it shipped 385,000 aligners. SmileDirectClub will want to keep those figures in mind as a benchmark.

At the end of this year, Align's supply agreement with SDC is set to end. In 2018, SmileDirectClub paid Align $42.8 million for aligners and digital imaging equipment, but CEO David Katzman reassured investors on the latest earnings call, pointing out that the company manufactured 100% of its own aligners in-house in the third quarter.

Is SmileDirectClub a buy?

SmileDirectClub's high revenue growth is attractive, as is the company's valuation on a price-to-sales basis. After the post-IPO sell-off, it trades at a P/S of just four based on this year's expected revenue. Align Technology, by comparison, trades at a P/S of 9.2, though its high profit margin explains its valuation.

However, the teledentistry company faces considerable risks, and it's unclear that its model, which is dependent on heavy marketing spending, can turn profitable. Consumer product companies like GoPro and Fitbit that are also reliant on one-time purchases have also seen high sales growth out of the gate, only to fizzle out a few years later. Though SmileDirectClub competes in a different industry, it faces some of the same challenges.

Risk-seeking investors may want to take a chance on SmileDirectClub following the sell-off -- its disruptive potential is intriguing, and Align has certainly been a big winner on the market. However, I can't call the stock a buy, at least until its customer acquisition costs show significant improvement. Until then the company won't have a reasonable chance to turn profitable.