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By Satya Prakash

Intuitive Surgical (ISRG) designs, manufactures, and markets a robotic surgical system that helps surgeons perform complex surgeries. For the past few quarters, the company is facing a declining demand for its flagship product, "da Vinci Surgical Systems." The company attributed the decline in sales to the cost cutting measures adopted by leading hospitals due to the Affordable Care Act. However, there are other issues, like concerns over the system's cost benefit and ongoing litigations, which are negatively affecting the system's sales. The plaintiffs are patients who underwent surgery that used a da Vinci System.

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da Vinci Surgical System

The da Vinci Surgical System is a robotic surgical system that is designed to facilitate complex surgery using a minimally invasive approach. The system is divided into four components, a surgeon console, patient-side cart, EndoWrist instruments, and high-definition vision system. The system is primarily used for prostate gland surgery, cardiac valve repair, and gynecological surgical procedures.

Performance in latest quarter
On October 17, 2013, Intuitive Surgical reported its third quarter results, which were disappointing. The company witnessed a revenue decline of 13.74% compared to the second quarter 2013 and a 7% decline compared to the same quarter of 2012. The company generates revenue both from the sales of da Vinci Surgical Systems as well as from the accessories and service for already sold units. In the third quarter ended in September 2013, Intuitive Surgical sold only 101 da Vinci Surgical System units, while 143 units were sold in the June quarter, a decline of 29.3% quarter over quarter.

What's going wrong?

The company has cited the Affordable Care as the key reason behind the declining sales, but there are other reasons like the product cost, negative publicity, and ongoing litigation that are also responsible for the decline in product sales.

  • Product cost and negative publicity:

The cost of one da Vinci Surgical System is between $1.5 million and $2.2 million, which is a significant initial capital expenditure for hospitals. Looking at the changing medical insurance market, hospitals are reluctant to make an investment of $2 million.

There has been negative publicity for robotic surgery on big medical platforms claiming that the robotic surgery isn't a better alternative to conventional surgery and that it is far more costly for patients. According to the American Congress of Obstetricians and Gynecologists:

There is no good data proving that robotic hysterectomy is even as good as-let alone better-than existing, and far less costly, minimally invasive alternatives.

Also, according to a report published in The Journal of the American Medical Association:

The median total cost for laparoscopic hysterectomy was $6,679 (IQR, $5,197-$8,673) compared with $8,868 (IQR, $6,787-$11,830) for robotic-assisted hysterectomy.

  • Litigation:

In the latest 10-Q filing for the September quarter, Intuitive Surgical reported 50 individual product liability lawsuits by plaintiffs who claim that they sustained a variety of personal injuries and, in some cases, deaths were claimed to be a result of surgical procedures that used the da Vinci Surgical System. The litigation has also raised questions about the quality of training provided to doctors before they use new equipment on patients.

  • Affordable Care Act:

The Affordable Care Act, widely known as "Obamacare," aims to increase the quality and affordability of health insurance, lower the uninsured rate by expanding public and private insurance coverage, and reduce the costs of healthcare for individuals and the government. Due to the enforcement of the new act, the enrollment in the U.S. government's Medicare is rapidly increasing. This is compelling hospitals to cut costs, because under the Medicare program, the government reimburses hospitals at a fixed rate based on the diagnosis, which doesn't differ between a robotic surgery or conventional surgery. The cost of robotic surgery is higher than conventional surgery, so hospitals are at a risk of under recovery from the mass insurer. Therefore, hospitals are avoiding the capital expenditure on a system that has a cheaper alternative available.

We believe that the increasing concern over the product cost, cost benefits for patients, efficacy, and ongoing litigation will make it difficult for the company to market the system, affecting product sales.

Competitors

There is no direct competitor in the market for the da Vinci surgical instrument; however, competitors are eager to offer an alternative to capture a share in the $5 billion annual market. Titan Medical's Amadeus systems, the University of Washington's Raven Surgical Robot, and the ARAKNES project are in the development stages and could prove to be strong competitors for Intuitive Surgical.

There are a few specialty robots in the market offering specific surgeries from companies like MAKO Surgical (MAKO), which offers a robot for orthopedic surgery. MAKO Surgical's stock has given a return of 135.07% in the last three months. On September 24, 2013, the medical device maker Stryker (SYK) announced the acquisition of MAKO for $30 per share. Stryker is paying a huge amount for the deal, around 13 times of this year's sales. After the deal, Stryker's President and Chief Executive Kevin A. Lobo said:

Our combined expertise offers the potential to simplify joint reconstruction procedures, reduce variability and enhance the surgeon and patient experience.

MAKO's shares surged 82%, to $29.50, after the acquisition announcement.

Another company in the market that offers a specialty surgical robot is Accuray Incorporated (ARAY). It offers radio-surgery and radiation therapy systems for the treatment of tumors in the human body. Its flagship product, CyberKnife system, automatically tracks, detects, and corrects the tumor in a patient's body. Accuray Incorporated has given a stock return of 22.22% in the last three months.

Stock Performance

ISRG Chart

ISRG data by YCharts

In the last six months, Intuitive Surgical's stock declined about 24%, which is mainly attributed to the declining revenue in the last few quarters. As the insurance market is changing in the U.S. due to the Affordable Care Act, hospitals are reluctant to make big capital expenditures, which is directly impacting the da Vinci System's sales. The Intuitive Surgical stock is currently hovering at its 52-week low price, reflecting the negative sentiments for the stock among the investors. To boost the investors' sentiments, the company has provided clinical evidence to prove the da Vinci System's advantages. We believe the effort will help it support its stock price for a limited period, but in the long run, the company's revenue generation capability is the only way to support the stock price.

Conclusion

Over the last three quarters, Intuitive Surgical has witnessed a consecutive decline in its revenue. The issues like high product cost, cost benefits of da Vinci for patients, its efficacy, ongoing litigation, and the Affordable Care Act's effect on hospitals' spending, all raise concerns over the marketability of the product. Hence, we recommend investors to hold their positions, and not make any new positions.

Disclaimer: Fusion Research is a team of equity analysts. This article was written by one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: How To Play Intuitive