Intuitive Surgical (ISRG) is a company with exceptionally strong growth potential whose stock has skyrocketed by about 25 times from its IPO in 2000. Any stock with such phenomenal appreciation will be under tremendous selling pressure and, with several negative developments lately, it is easy to understand the weakness that the ISRG stock has endured. The important question for long term investors is whether ISRG will continue its phenomenal growth in the years to come.
We revisit our investment thesis on the stock and carefully analyze the recent events surrounding the company. We come to the conclusion that the ISRG growth story remains intact and we see many years of strong share appreciation ahead.
ISRG's da Vinci Surgical System facilitates minimally invasive surgeries. There are 2,710 systems placed worldwide with 1,957 in the United States, 430 in Europe, and 323 in the rest of world markets. The procedure adoption has been concentrated in urology (mainly prostatectomy) and gynecology (mainly hysterectomy) but general surgery has seen strong ramping up in the last couple quarters. In the near to medium term, growth will be driven by continued procedure growth, particularly in general surgery, and by geographical expansion beyond the US, mainly into Japan. Recent events have cast some doubts on the growth prospect of the company, but we believe that the negativity is priced in the stock already.
In the long term, we believe that ISRG's fundamentals are not affected by the present distractions. We consider the da Vinci system a technology platform that enables surgeons to perform operations with ease and with more precision. It is still in a very early stage of adoption. We see it being developed for use in most major surgeries. We also see it being used not only in the minimally invasive setting, but also in remote surgery and even in traditional open surgery where it could assist surgeons to perform certain tasks more effectively. We see the da Vinci system eventually evolving into an essential tool where very few major surgical procedures would be done without its presence. This bold call is rooted in our belief that surgery is an area that can strongly benefit from but has yet to fully utilize the advancement of technology. ISRG is best positioned to meet this challenge. It will expand the coverage of the da Vinci robotic surgery by developing specialized tools (robotic arms) to meet specific procedural requirements. As the coverage becomes more prevalent, the cost will come down. A very important point for investors is that ISRG enjoys a very high barrier for entry with its technology, its mass acceptance, and the high safety concern for any potential competing product. It has in fact gained a nearly monopolistic position. We believe that this exceptionally strong fundamental is not nearly reflected in the current stock price.
- The company recently issued a notification alerting for potential micro-crack issues that can cause internal burns. This is troubling news that feeds in many reports of burn injuries. It will cost the company in product replacements and in litigation. However, we think this is a relatively minor technology/quality problem that would not jeopardize the FDA clearances. Its impact is likely to be limited to short term earnings.
- There has been a significant increase in patient litigation against the company. The case of Estate of Fred E. Taylor v. Intuitive Surgical Inc. is constantly reported in Bloomberg. We are not experts in law, but it's clear that nothing has been attributed to the fault of the da Vinci system. Therefore, no matter what the outcome of this or other litigation is, the impact will likely be a small dent to the balance sheet, possibly amounting to a few dollars per share, unless there is a punitive damage award which is obviously not likely.
- A recent study published in the Journal of the American Medical Association raises some doubts about cost/benefits of the da Vinci hysterectomy (dVH). This and the subsequent ACOG statement highlight the skepticism held by some within the medical community on the value of the da Vinci system, which in our opinion is more of a reflection of the struggle between surgeons who are trained on the traditional minimally invasive methods and those embracing the da Vinci technology. The headline finding of the study appears to be that dVH has a complication rate comparable to the laparoscopic surgery (5.5% vs. 5.3%) and thus offers no obvious benefits for an extra cost of around $2,000 on average. We think this headline itself is by no means a negative assessment for da Vinci because both the da Vinci surgery and the laparoscopic surgery are minimally invasive and should enjoy similar benefits in reduced complications. However, a closer examination of the data actually shows the results to be more favorable to da Vinci than what the headline would suggest. One obvious shortcoming of the study is its lack of correlation data between the complication rate and some important factors such as patient age and comorbidity. In this regard, the data shows that the da Vinci cohort has older age (9.2% over 60 vs. 5.7% ; 26.2% under 40 vs. 31.6%) and higher comorbidity scores (27.6% over 2 comorbidities vs. 22.8%; 42.8% no comorbidity vs. 48.5%). Another number that has not been widely reported is that fewer da Vinci patients require a hospital stay of more than 2 days (19.6% vs. 24.0%). We think a breakdown of the data by these patient groups would likely reveal a more interesting comparison on some difficult-to-treat patient groups. At the very least, we think the study validates one value proposition of da Vinci - that it allows a wider population of patients to enjoy the benefit of minimally invasive surgery.
- Another value proposition of da Vinci is the ease for surgeons to learn and use the technology when compared with its alternatives. Indeed, we think the best indication of the value/outcome of the da Vinci system is its adoption by surgeons. When a surgeon advises a patient on options available for a surgical procedure, it is in his/her best interest to recommend one that would result in the overall best outcome for the patient and it is reasonable to assume that the surgeon makes that recommendation based on his/her own experiences. It is thus an unfair criticism that da Vinci's success has been built on aggressive sale practices and consumer advertising, because neither could have a significant role to play in surgeons' recommendations and ultimately patients' choices. It is also a bit beyond a stretch of imagination to think that a patient would go against a surgeon's recommendation by demanding the da Vinci surgery. The consumer awareness provides at best some level of comfort to patients when making the robotic surgery selection. Thus we think that the surgeons have been and will continue to be the critical link in deciding the selection of a robotic surgery and it is clear that they are voting for the da Vinci technology.
In summary, we think the strong growth of ISRG is rooted in the values that it brings to patients and surgeons. The recent events surrounding ISRG may cause some setbacks in its short term earnings and balance sheet, but they will not slow the adoption trend of the da Vinci surgery and will not threaten its ultimate growth potential. If all goes well, ISRG stock may well be on its way to becoming a huge growth stock.