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We downgrade our recommendation on Masimo Corp. (NASDAQ:MASI), a leader in the pulse oximetry monitoring equipment industry, to Neutral. While fourth-quarter fiscal 2010 earnings beat the Zacks Consensus Estimate, we believe that Masimo’s valuation already reflects its robust growth prospects. As a result, the stock is expected to offer limited upside potential in the near-to-medium term.

Masimo’s products enjoy large potential market size. Its Signal Extraction Technology (“SET”) offering may help it become a dominant global player in the pulse oximetry market. Masimo pursues organic growth, which it bolsters with tuck-in acquisitions. The company entered the brain function monitoring market by acquiring SEDLine.

Rapid product development continues to be a key area of focus. For example, Masimo’s SpHb is the first non-invasive and continuous hemoglobin monitoring technology to receive the U.S. Food and Drug Administration (“FDA”) clearance. In second-quarter fiscal 2010, Masimo announced that it got clearance from the FDA for its Pronto-7, a handheld device intended for fast and non-invasive spot check testing of hemoglobin, as well as the measurement of pulse rate and other parameters.

The addition of non-invasive parameters is expected to act as a long-term barrier to entry and drive substantial growth. The expanded pulse oximetry utilization into non-critical care areas of hospital represents another growth driver. Shipments have been growing at a steady rate fueled by new contracts. Moreover, recurring revenues, from sale of consumables, are increasing at a brisk pace. The renewal of the royalty agreement with Covidien (NYSE:COV) is a positive factor.

However, competition is intense and Masimo partly depends upon its Original Equipment Manufacturers (“OEM”) partners for sales. The company needs to innovate at a rapid pace and keep introducing new products. This is more challenging keeping in mind that Masimo’s competitors are large in size with deep pockets for funding sizeable R&D programs.

Masimo’s sales have traditionally been marked by client concentration. Loss of major hospital contracts could dent the company’s prospects.

In conclusion, we believe that Masimo’s current valuation reflects high short-term expectations from its hemoglobin monitoring and other technologies. However, in reality, uptake of the hemoglobin monitoring device may be uneven, at least in the initial stages.

Source: Masimo Downgraded to Neutral