Intuitive Surgical (NASDAQ:ISRG) recently caught my attention again. The maker of the da Vinci® Surgical System has experienced a tumultuous week or more of trading leading up to and following a preliminary announcement of fourth quarter and full year earnings. I fully expect the actual earnings release to catalyze even more volatility.
It just so happened that ahead of the recent volatility, I noticed that the latest issue of Obstetrics & Gynecology (January, 2014, volume 123, Number 1) from the American College of Obstetricians and Gynecologists (ACOG) included four articles dealing with robotic surgery. I became motivated to slog through these articles to explore whether ISRG was worth more than some short-term trading. That is, I wondered whether last year's plunge in the stock represented a unique buying opportunity. After reading these articles and reviewing some of the citations, I am convinced that ISRG is indeed a buy on the dip kind of stock.
The state of the research into the efficacy, efficiency, and profitability of robotic surgery appears to still be in its infancy. For example, the da Vinci was approved by the FDA for gynecological surgery in 2005. A lot of important learning remains on-going. The research on robotic surgery can demonstrate conflicting conclusions with the smallest of differences in assumptions. My overall impression from the collection I read is that there is plenty of reason to believe that robotic surgery is here to stay and will only improve over time. Bumps along the way with regulatory regimes and technology adoption should be expected. To the extent they negatively impact the stock, they likely generate buying opportunities. For reference here are monthly and daily views of ISRG's stock.
The rocket ship has notably slowed since all-time highs in 2012
The stock is showing signs of stabilization since last summer's collapse
The valuation on the stock is high but not "exorbitant" if ISRG remains a growth company: forward P/E of 25.7, P/S of 6.9, P/B of 4.8. I was a bit surprised to see that short interest is only 5.4% of the float as of December 31, 2013 a full 6 months after ISRG's devastating earnings warning last summer. The amount of shares short have bounced around 2M since then with no trend upward or downward. Analysts are split with 8 strong buy, 5 hold, and 4 strong sell ratings.
Intuitive Surgical issued its earnings warning on July 8, 2013. The warning included the following explanation of a slowdown in benign gynecologic procedures:
The slowdown in benign gynecologic procedures reflected a number of factors including, but not limited to, reduced hospital admissions and a trend by payers toward encouraging conservative management and treatment in outpatient settings.
This slowdown contributed to softness in U.S. sales. ISRG reported full results 10 days later, and the stock dropped significantly again. In another 11 days, the company announced a $779M increase to its existing share repurchase program - no doubt a bit surprised at the on-going selling in the stock. This move brought the total size of the repurchase program to $1.5B of which $500M was allocated to "accelerated" repurchase activity. At the end of the second quarter, 2013, ISRG held $3.0B in cash, cash equivalents, and investments. In its last earnings report, October 17th, ISRG listed $2.5B of cash, cash equivalents, and investments. As promised, the company was very aggressive in repurchasing stock in the third quarter: "$694 million in cash was used to repurchase approximately 1.74 million shares of Intuitive Surgical's common stock in the third quarter of 2013 at an average price of $398.87 per share." No doubt, this aggressive accumulation has helped stabilize the stock as shown in the charts above.
My interest in reading the Obstetrics & Gynecology articles only grew seeing that ISRG fingered a slowdown in benign gynecologic procedures as a prime culprit in the company's current change of fortunes. Those articles are as follows (all articles can be found on the website for Obstertrics & Gynecology, January 2014 issue):
- Robotics in Benign Gynecologic Surgery: Where Should We Go? (editorial by John F. Steenge, MD and Jon I. Einarsson, MD, PhD)
- Robotics in Gynecology: Is the Glass Half Empty of Half Full? (editorial by Arnold P. Advincula, MD, FACS)
- Robotic Compared with Laparoscopic Sacrocolpopexy: A Randomized Controlled Trial (original research by Jennifer T. Anger, MD, MPH; Elizabeth R. Mueller, MD, MSME; Christopher Tarnay, MD; Bridget Smith, PhD; Kevin Stroupe, PhD; Amy Rosenman, MD; Linda Brubaker, MD, MS; Catherine Bresee, MS; and Kimberly Kenton, MD, MS)
- Milestones to Optimal Adoption of Robotic Technology in Gynecology (current commentary by Pranjal H. Desai, MD; Jeff F. Lin, MD; and Brian M. Slomovitz, MD)
The original research was the most difficult to get through for a layperson like myself, but I believe I understand what I need to know from the research. The other articles were very digestible. The editorials referenced the other two articles and provided additional insight.
Steege and Einarsson are skeptics. They claim "…the potential advantages of robotic assistance in laparoscopy, while initially appealing, have not been borne out by subsequent research and clinical reports…the case for recommending robotic assistance in the vast majority of laparoscopic surgeries has yet to be made." They further warn that "…in the absence of demonstrable clinical benefit, advocacy of the robot in benign gynecological cases becomes unsupportable" because there is an increasing push to incentivize doctors who are financially efficient while delivering quality health care.
For an example of this push, you can review "Can Hospitals Save Money By Making Doctors Squirm?" (December 19, 2013). In this podcast, Planet Money explains how Obamacare has motivated healthcare providers to take a much closer look at the cost of delivering their services through a series of voluntary experiments across the country. In one Akron, Ohio hospital, a consultant moderates a discussion amongst heart surgeons and anesthesiologists to compare and contrast costs on a doctor-by-doctor basis. The idea is that bundled payments, or lump sum payments, from Medicare for a given procedure will motivate a focus on cost. The consultant at Akron demonstrated "behaviors change" if physicians are shown the costs of their services AND how they compare to other physicians. Doctors tend to be competitive and detest poor rankings.
So, in this environment, the costs of using a robot for surgery are being scrutinized more than ever.
Steege and Einarsson go on to conclude that "physicians and their patients would be better served by restoring balance in training programs to avoid dependence on the robot and by training programs for practicing gynecologists who have sufficient surgical volume to maintain and enhance their skills." Their preference for minimally invasive surgery using conventional laparoscopy over robotics could not be clearer.
Advincula is more charitable toward robotic surgery's potential in gynecology. He acknowledges the current controversy and concerns regarding "…longer operative times, increased costs, and complications given comparable clinical outcomes when compared with conventional laparoscopy." He is critical of the methods used in the Anger et al study that suggest that robotic surgery is more expensive. However, in concluding that the glass is half full for robotic surgery, he references an ill-timed editorial in 1992 that called conventional laparoscopy a "gimmick." Eighteen years later, the editor reversed himself.
While Steege and Einarsson think it is a moot exercise to construct a model of technology adoption for robotic surgery in gynecology, I found the article on this topic the most interesting of the bunch (my own research background was partially related to this topic but in a manufacturing setting). To set the stage, Desai et al provide a brief review of the mixed results found in various studies of the upsides and downsides of robotic surgery when compared to the surgical alternatives. The definitive positives are described in minimally invasive hysterectomies, endometrial cancer, and gynecology oncology. Despite the success stories, widespread adoption is hindered by long learning curves and cost. The authors have created a 5-step milestone plan to help overcome these challenges:
- Team building (the cornerstone of a robotics program)
- Culture of safety
- Learning curve
- Quality of life
- Business perspective
These principles can be applied to any technology adoption program. When applied to robotic surgery, it provides a great reminder of the potential future and strong reasons to look at short-term troubles for ISRG as buying opportunities.
These milestones are all connected in some way by learning, the accumulation of knowledge, and effective application of expertise. Robotic surgery places more importance on teamwork given the multiple of components: "bedside robot and instruments, tower, and surgeon console." A surgeon needs a team motivated to learn given "the technical complexity involved in robotic high-risk gynecologic and gynecologic oncologic procedures is no less than cardiac surgery…" A strong learning environment contributes to a strong culture of safety that includes "recognition of the inevitability of errors, incorporation of nonpunitive error reporting and analysis systems, commitment to transparent discussion of and open learning from errors, and proactive identification of latent threats." These are all common-sense principles that of course apply in many, if not most, work environments, especially ones coping with high levels of risk. On the learning curve, the authors main point is to propose a different method of assessment (using a cumulative sum curve rather than discretized statistical methods).
Ultimately, any new medical procedure must improve health outcomes. Quality-adjusted life-years (QALYs) is a commonly used measure. Unfortunately, there are no studies "assessing QALY or cost-utility ratio for robotic technology pertaining to benign or malignant gynecologic conditions." Clearly, there is a huge hurdle here.
The authors also suggest moving from a business model reliant on long-term strategies to a strategy based on transient advantage. Competitive advantage is very dynamic and hospital administrators must be ready to adjust on an on-going basis. This principle was the most fuzzy of the five because the authors did not provide examples of how hospitals compete with each other through technology adoption. Instead, the authors focus on how to manage costs and revenue through the phases of the learning curve. I consider this management an inter-company dynamic not an intra-company one.
Finally, the original research using a randomized controlled trial attempted to answer a call from the National Institutes of Health to study the comparative effectiveness of robotic surgery.
Here is the challenge (Word doc - I could not determine the specific date, but it seems to be around 2009):
05-EB-104* Comparative Effectiveness of Robotic Surgery - Compared to standard invasive surgical procedures, minimally-invasive robotic surgical procedures have the potential to provide a safer and more precise treatment for a variety of conditions including prostate cancer. Comparison of robotic procedures with standard invasive treatments should demonstrate the comparative effectiveness and comparative cost of robotic interventions for the clinical treatment of disease.
The authors cite a lack of comparative cost studies, indicating that past cost studies "have used retrospective data or disease simulation models in which the investigator makes assumptions regarding costs and outcomes to compare robotic, open, and laparoscopic procedures." This study used a randomized controlled trial. The trial randomized 78 women on the day of surgery (after consent) with a near 50/50 split between laparoscopic and robotic procedures for sacrocolpopexy used for treating pelvic organ prolapse (think of it like a female hernia where internal organs drop into the pelvic area).
I think the most problematic methodological choice was the experience requirement for surgeons (Advincula references this as well). Surgeons had a minimum experience of 10 procedures for each method. However, the study did not control for the range of experience with the different procedures, instead claiming that "all study surgeons were skilled in both robotic and laparoscopic sacrocolpopexy." They do acknowledge the possibility of an experience deficit for robotic surgery relative to laparoscopic procedures. It is possible that Anger et al did not think this difference was important enough because they found "…a relatively small increase in operative time in the robotic group (24.4 minutes)" that did not generate extra costs. This finding runs counter to other studies including one referenced by Advincula: "Impact of robotic operative efficiency on profitability" (Geller EJ, Matthews CA. Am J Obstet Gynecol 2013;209:20.e1-5). I briefly discuss this article further below.
The results of the trial were mixed to somewhat discouraging. The robotic procedure cost more because of maintenance and purchase costs, had higher operating room times, and higher pain scores in the first week post-surgery. The differences in pain scores did "diminish" by two weeks, and at 6 months there were no differences in clinical outcomes. The authors also acknowledge that "robotic technology has made laparoscopic sacrocolpopexy a more feasible procedure for many pelvic surgeons because the improved dexterity of the robot and precision of instruments" facilitate easier suturing. There may also be benefits from lower blood loss from the surgery. Still, a better outcome for this research would be at least a demonstration of clear and distinct improvement of medical outcomes: such a demonstration is the primary way to justify the costs.
The article in the American Journal of Obstetrics and Gynecology called "Impact of robotic operative efficiency on profitability" pre-dates the aforementioned articles and is one of the retrospective studies criticized by Anger et al. This paper examines the revenue and cost side of robotic surgery. For me, here is one of the most telling quotes of the paper:
Operative time predicts operative cost more than any other factor. The studies that have shown cost equivalence, or cost savings, of robotic-assisted procedures compared with standard laparoscopy all demonstrate equal or shorter operative times in the robotic group.
This study was conducted in a special location: the Computer and Robotic Enhanced Surgery (CARES) Center at the University of North Carolina at Chapel Hill (UNC). So, the results are examples of the possibilities in a specialized, dedicated setting that has gone through, for example, the five milestones described by Desai et al. The study cut across all surgical subspecialties at CARES. The retrospective examined data from 1295 robotic cases, 105 distinct robotic procedures, 9 surgical specialties, 29 surgeons, and 2 ISRG da Vinci Si surgical systems spanning July, 2009 to June, 2011. All but two specialties were profitable in the first year of the study. The non-profitable specialties, urogynecology and pediatric surgery, became profitable in the second year through the reduction of case performance times.
Most fascinating to me was to see the large variability in profitability based on insurance carrier. The study found a significant correlation between insurance carrier and profitability, but I could not verify that the variability in operating income was not distorted by differences in mix of types of procedures. I assume these impacts are properly controlled only because elsewhere in the study variability in profitability by procedure was flagged as driven by the mix of insurance carrier payments. Note also that reimbursement rates did not change much across the two years of study.
- Blue Cross Blue Shield ($3428/case)
- State health plan ($3172/case)
- Managed care ($2043/case)
- Other commercial ($1928/case)
- Other ($124/case)
- Medicare (-$269/case)
- Medicaid (-$1573/case)
- Self-pay (-$8148/case)
It was no surprise to see that Medicare, Medicaid, and self-pay performed the worst and were all money-losers. Note that the estimates of operating income did not include the initial purchase cost of the robot as it is common practice to spread such costs across all surgical procedures in hospital accounting. The authors also note that it is possible indirect costs were not allocated across cases correctly.
My main take-away is that robotic surgery can be profitable and can sustain a specialized program at a medical center. Another telling finding was that CARES "…demonstrated that specifically for sacrocolpopexy, a reduction in case time to 179 minutes achieved profitability." In Anger et al, surgeons achieved an average case time of 202.8 minutes for robotic surgery versus 178.4 for laparoscopy. The difference in the studies suggests that, as I intimated earlier, it is possible robotic procedures were disadvantaged by an experience deficit relative to laparoscopy. The authors provide the following guide to explain how CARES is able to achieve its excellence in operative efficiency. Note the consistency of these characteristics with the five milestones discussed earlier (all quotes direct from the paper):
- A consistent and coordinated robotics nursing and surgical technician team
- Appropriate packaging of necessary surgical instrumentation
- Experienced console surgeons
- A formalized robotics training program for residents and fellows to maximize hands-on and simulation skill drills (shortens the learning curve)
- Some flexible block time in scheduling
- A policy of open access within 2 weeks of any unscheduled robot access for all surgical specialties
- A dedicated robotics program coordinator who analyzes trends in utilization and adjusts assigned block time accordingly.
The articles I referenced here are a small part of an ever-growing body of work studying the impact of robotic surgery. Overall, these articles, including their rich set of references and citations, demonstrate to me that the field of study of the efficiency, efficacy, and value of robotic surgery remains a wide-open field. There seems to be enough evidence to suggest that the future remains promising even as several areas of caution and skepticism continue to receive attention and get addressed. At the right price, perhaps at current levels (depending on what ISRG has to say this week?), ISRG is a great way to invest in this future. If benign gynecology is what ISRG's weak point looks like, then I can only imagine the compelling stories being told from its stronger points.
Be careful out there!
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ISRG, over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.