Monday, July 28, 2008

Barron's Cover Story on Intuitive Surgical (ISRG)

Quite a comprehensive story via Barron's on Intuitive Surgical (ISRG) - worth a read. Touches on a complaint I've been voicing of late - how few true growth opportunities there are outside the now hated commodity complex... which means one must "really pay up" for other growth opportunities.

Specific to ISRG the question has always been, one past the "saturation point" with the prostate market, what are the new growth opportunities? Once growth slows in a momentum growth stock, the resulting affect in your portfolio is usually quite painful. But again, as other countries grow in wealth, this could become quite the international story as a phase II of its growth cycle. Yet the question is what exactly is the amount of robots that could be placed worldwide? The answer will determine how long this remains a hyper growth company.
  • At 322 each, the shares now go for more than 75 times trailing 12-month earnings, giving Intuitive one of the handsomest multiples in the Standard & Poor's 500. That multiple reflects the alacrity with which surgeons have adopted the company's da Vinci robot, a four-armed marvel the doctor controls from an operating-room console. Patients have less bleeding and scarring, and can get back on their feet without a long, expensive hospital stay.
  • But Intuitive's volatile and pricey shares also bespeak the desperation of investors mobbing a quality growth story in a lousy economy and stock market. That momentum mob seems heedless of how suddenly this expensive stock could become a victim of the robot's success.
  • About 40% of the country's large hospitals already have at least one da Vinci robot. When Intuitive (ticker: ISRG) finishes placing its robots, it will see a falloff in the systems sales that have contributed more than half of its revenue.
  • Sales of disposable instruments and accessories for each operation will continue, but the growth rate of those revenues will also decline once the da Vinci gets its share of the relatively fixed number of surgical procedures performed each year.
  • In its report last week, Intuitive allowed that procedure growth has slowed for the kind of robotic prostate surgery that I had last fall. The robot took seven years to garner the majority of the 90,000 prostate procedures conducted annually.
  • Robotics is gaining share more quickly in the rather larger market for hysterectomies and other surgeries performed by gynecologists. But after that, there are only a handful of remaining high-volume procedures in the U.S. and abroad.
  • What stock multiple investors would put on such steady-state earnings is harder to predict. Shares of profitable medical-device makers that saturated their markets, like coronary-stent maker Boston Scientific (BSX), have settled into earnings multiples in the high teens. Even if that earnings arithmetic proves too stingy, Intuitive shares could fall by at least 25% once most people get their surgery robotically, as I did.
  • The company and its fans say growth is far from slacking. "We don't think we are anywhere near saturation in anything," says Intuitive's vice president of finance, Benjamin Gong.
  • da Vinci procedures have burgeoned. About 55,000 fellows around the world went under the da Vinci in 2007. With other kinds of da Vinci surgeries, there were a total of 85,000 robotic operations last year, an increase from 2006 of almost 75%
  • That demand drives hospitals to invest in robot systems. The worldwide installed base of da Vinci robots grew 42% last year, to almost 800, with about 600 of those in North America. A system sells for more than $1.3 million. The hospital pays another $135,000 a year for service and support. Each procedure consumes $1,500 to $2,000 in disposable instruments and accessories.
  • Gross margins on both systems and consumables are 70%. Operating margins are almost 35%, and if you add back noncash charges for stock options, cash margins from operations approach 45%.
  • The thousand largest hospitals in the U.S. (those with more than 325 beds) should be good for three systems each, says the company. The next thousand hospitals could have one da Vinci apiece. Hospitals in the rest of the world could buy 2,000 more, Intuitive says, for a worldwide total of 6,000 robots. Through June, the company had sold 946 da Vincis worldwide, so Intuitive thinks it has penetrated only 15% of the hospital market.
  • THE COMPANY'S MEASURE OF THE MARKET FOR ROBOTS may be far too optimistic. Jose J. Haresco, an analyst at Merriman Curhan Ford in San Francisco, thinks there's room for about 1,800 da Vinci robots in the U.S. and 600 more abroad. Intuitive's dream of three robots in every big hospital isn't yet supported by the evidence.
  • Finance V.P. Ben Gong, and bulls like Deutsche Bank's Tao Levy, are quick to change the subject to hysterectomies. There are an estimated 600,000 performed in the U.S. each year. Many of these procedures already qualify as minimally invasive; gynecologists pioneered surgery through laparoscopic key-hole incisions. Yet Intuitive thinks surgeons could use the da Vinci for about 250,000 complex hysterectomies currently done with open incisions.

[Jul 23: Healthcare Companies Starting with the Letter 'I' Outperform]
[Feb 1: Intuitive Surgical Very Impressive]

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