Reasons Abound to Like Intuitive Surgeries

When Intuitive Surgical (ISRG) traded at a PS of 10 and a P/E of 75, I opined that ISRG is worth a look if the P/E drops to below 25. Much like Cisco’s (CSCO) fall from grace that was brief, back in 1994, CSCO went up in value fifty fold after that [from 1993 to 2000]. While Cisco from the 1990’s is similar to ISRG today, the differences are huge too.

For starters, ISRG has a competitive edge over any offering from Medtronic (MDT) or JNJ - who remain ISRG’s biggest rivals that can out-spend or buy out ISRG. Intuitive Surgicals’ daVinci is protected by hundreds of patents in the fields of electrical, mechanical and fluid engineering; and has created a new genre of minimally invasive robot-assisted surgery (MIRAS).

ISRG’s marketing pitch is without equal. If you are a guy in need of a prostatectomy, and want to not visit the John one too many times at night, and want a chance to please your partner - you have three times the odds that you would - if your surgeon chooses the daVinci [as opposed to open surgery].

Per ISRG’s own estimates, the daVinci has a 70+% penetration in the prostatectomy market. In the biggest market [250K hysterectomies/year], their penetration is 14%. I think that in the one thousand large hospitals in the US, ISRG can sell a maximum of one each on average. Sure, some will buy a couple, or even more, but the company’s stated 80% penetration goal - with 2.5 robots/large hospital is in my opinion too optimistic. Their estimates on the international hospital market is pessimistic. If Intuitive can gain acceptance into a wider range of surgical procedures, the number of daVinci procedures could triple from a base of 85,000 in 2007 - by 2012.

When a surgeon uses a daVinci to perform a surgery, the machine consumes $2000 to $3000 worth of consumables. This currently represents 50% of ISRG’s revenues, and the gross margins for robots and consumables is similar. In these days when there are very few “economic moats” up for grabs, Intuitive Surgicals for sure has built for itself [and its investors] at least a moderate sized moat [Morningstar thinks that ISRG has a narrow moat, but I beg to differ]. I think that Intuitive’s ability to convince other minimally invasive [laparoscopic] surgeries to migrate to daVinci assisted procedures will become important after the initial install phase that ISRG is in as of now.

The company has also convinced hospitals in Santa Clara and Santa Cruz counties to air TV ads that promote robot-assisted surgery, and the benefits from MIRAS - short hospital stays, quick recovery, less pain, and smaller incisions. So, hospitals are spending their marketing budgets - promoting the fact that they use daVinci [good for ISRG].

But, the most important reason why I am picking ISRG is valuation. At $100/share, there are 39 Million outstanding shares of ISRG - pegging the market value at close to $4 Billion. The company has no debt, and cash in hand of $900 Million. The company earned $5.12/share fully diluted in 2008 [un-audited results].

ISRG’s guidance has been traditionally very conservative, and most of the growth in 2009 will be from services and instruments and accessories. In fact, Q4-2008 system sales were $114 Million - down from $126 Million in Q3-2008. While Q1 and Q2 of 2009’s comparisons over 2008 will be relatively “easy”, ISRG will have a more difficult time posting numbers like it did in the past.

The bottom-line: If we assume that ISRG will grow by 15% this year [company's understated estimate], the stock looks cheap at the current quote of a little over $100/share - keeping in mind that almost a quarter of the valuation is in cash. Add to this ISRG’s unassailable position as the king of MIRAS. Additionally, the company is very well managed, and fiscally sound, and does not need to raise capital - as all of their growth can be [and is] funded by operating cash flow. I’d opine that the floor on this stock is a TTM P/E of 15 - or $75/share. Assuming a growth rate in double digits, and operating margins in the low 30’s [it is currently around 38%], ISRG could get to and past the high that it hit in the last twelve months [$357/share] by the end of 2011. The only scenario in which it could remain at the current level - is if growth grinds down to single digits and if margins drop to the low 20’s.

Disclosures: No positions in ISRG. Long JNJ.

Comments

[EconoMarcus:]

While I've been eying ISRG as well for quite some time (and was lucky enough to get an initial small portion at $87.78) don't forget that its chart doesn't look too healthy yet. As long as it's still trending down and while the whole market as well seems to be poised to reach new lows I wouldn't buy too much. Not yet. (And for trading there are better stocks than ISRG.)

Jan 30 10:09 PM

[bambooman:]

After all of that analysis and commentary about ISRG, I find it rather ironic that you disclose no holdings in ISRG, but in JNJ.

Feb 01 03:01 PM

[bambooman:]

Would like to add though that there's some great ideas in here. Personally think that now is the time to be loading up on proven leaders throughout various industries - ISRG is certainly in that category.

Feb 01 03:10 PM