Another quarter and another disappointment for Boston Scientific (NYSE:BSX). With a new caretaker CEO at the reins, but only for a year, it an open question as to whether investors can reasonably expect any near-term progress. While there are some bright spots deep in the pipeline, it is going to take many years for them to bear fruit, and BSX will find itself having to battle for share amidst established competition. All in all, this is an investment that requires a great deal of faith - and hope and faith are seldom great partners to have in an investment.
Another Disappointing Quarter
Boston Scientific reported that sales declined 6% on a constant currency basis, with core revenue (that is, excluding divested lines) down 3%. The company's interventional cardiology segment (which includes drug-coated stents) saw revenue fall 4%, while the CRM business (which includes pacemakers and ICDs) fell 12%. Neuromodulation (up 6%) and peripheral intervention (up 4%) weren't bad, but endoscopy (up 6%) is about as close to good news as there was for the quarter. But that business contributes only about 16% of total revenue.
Profitability was worryingly weak. Gross margin slid almost four full points, and reported operating income fell nearly one-third. Even adjusting out the myriad charges does not leave a very pretty picture – adjusted operating income fell 22%.
Where's The Momentum?
Admittedly, the CRM market is not very healthy or easy right now – doctors over-implanted the devices in years past, many practitioners are awaiting new guidance on patient selection, and a DOJ investigation over ICD reimbursement has hospitals nervous and playing more conservatively. Still, an 11% drop (including currency benefits) is unacceptable – either the market is truly terrible (and St. Jude (NYSE:STJ) is a rock star) or BSX continues to bleed share.
Speaking of share, management seemed to boast of “maintaining” market share in drug-coated stents. Considering that Johnson & Johnson (NYSE:JNJ) has given up on that market and pulled out, why is management bragging when stent sales growth was just 2%? Granted, Abbott (NYSE:ABT) only delivered about 3% reported growth (and negative constant currency growth), but I'm not sure what BSX thinks it's celebrating.
On a more positive note, businesses like peripheral intervention and endoscopy are showing more life, as is neuromodulation. Even here it is possible to nitpick. JNJ's endoscopy results were pretty decent, as were Stryker's (NYSE:SYK), and it seems reasonable to think that Covidien (NYSE:COV) will show good growth as well – so BSX isn't really standing out. Likewise with neuromodulation – growth is better than no growth, but St. Jude is doing better, and Medtronic is doing about the same.
No Easy Way Out
Unfortunately, there are no quick and easy answers for Boston Scientific management. Former CEO Elliott's efforts to expand the company's sales efforts in emerging markets were commendable, but Medtronic, JNJ, and others are there as well.
Moreover, it does not look like BSX should be all that appealing to a buyer. JNJ would perhaps be the most likely candidate, but JNJ struggles to do well with the acquisition of successful companies, so JNJ shareholders should shudder to think of the baggage and disruptions from a fixer-upper like BSX. Along similar lines, it would seem unlikely that General Electric (NYSE:GE) would want to enter the market for individual devices (as opposed to the “big iron” that it already sells) with a company that is lagging and lacking momentum. Consider this as well – any company that would be interested in BSX (whether JNJ, Abbott, Danaher (NYSE:DHR) or whoever), would likely at least consider St. Jude, and while St. Jude is about 50% larger (in market cap terms), it's at least 50% better.
New Management And A New Pipeline
There has been a fair bit of turnover in the executive suite at Boston Scientific, and that cannot be helping the recovery process. Elliott switched out a lot of senior management in his tenure, and now the company is looking at a year of a caretaker CEO before Mike Mahoney takes over. What's more, while some analysts seem excited that BSX was able to land Mahoney from JNJ, investors should remember that he ran JNJ's device business and did not do a world-beating job of it (though perhaps he was limited in doing so by the CEO and/or board of directors).
Still, it is not as though the cupboard is bare here. BSX is lagging in transcatheter heart valves, atrial fibrillation and other growth markets, but at least they have credible candidates in the clinic. Likewise, the transition to the Promus Element (a drug-coated stent where BSX will keep 100% of the profits) should help improve margins. Unfortunately, though, BSX is likely going to have to play the hand it currently holds – there is too much debt on the balance sheet and too little value in the stock to hope for any deals that will lead to near-term transformation.
The Bottom Line – What's Hope Worth?
BSX might be the ultimate “could” stock. With a few successful clinical trials, a more vibrant U.S. health care market, and some internal efficiency improvements, Boston Scientific could be a good turnaround stock. After all, there is ample money to be made even as the #3 CRM company and the #2 stent company. With so many other health care stocks trading at such appealing valuations, though, investors really need to ask themselves whether a perennial disappointment like BSX is the way go, or whether they should pick shares of a company with more positive momentum.