The seemingly never-ending road to recovery just got a little longer for Boston Scientific (BSX). Although this long-struggling med-tech name has been making some progress in restructuring its businesses and cost structure, fourth quarter earnings highlight that growth and competition are still pressing worries. Though BSX has a fairly deep pipeline, patient investors ought to ask themselves if the company will be able to gain and hold real share in these emerging growth markets.
Q4 Earnings Show Blemishes On The Crown Jewels
Boston Scientific reported that total revenue declined 8% in constant currency terms this quarter, with 5% erosion in the core businesses. Not only was this more than 3% below the average estimate, it was beneath the bottom of the range.
Worse yet, the company was weakest in its largest and most significant businesses. Cardiac rhythm management sales were down 15% (missing estimates by more than 5%) and ICD sales were down 18% - much worse than the recently-reported results at St Jude (STJ) and strongly suggestive that BSX continues to cede share to St Jude and Medtronic (MDT).
The story with stent sales was not substantially better. Total stent revenue was down 7% (missing estimates) and drug-coated stent sales fell 6%. With Abbott's (ABT) worldwide stent sales falling about 1% for the same quarter, BSX was clearly weakening further ahead of its much-anticipated Promus Element launch.
Other businesses were basically okay. Endoscopy, neuromodulation, and peripheral were all in line with expectations and pretty consistent. That said, it looks like rivals like Covidien (COV) and Bard (BCR) are gaining in peripheral and neither are losing quite as much share in soft tissue as feared (and perhaps Johnson & Johnson (JNJ) is gaining).
Not All Bad News
If there's good news in the quarter, it's that BSX did pretty well with its profits despite the revenue shortfall. The company's gross margin of 64.3% and though down from last year, was up sequentially and pretty respectable vis a vis analyst estimates. Operating income did fall 22% on an adjusted basis, and though the adjusted operating margin was perhaps a little light, it wasn't worryingly so. Said differently, the cost structure of BSX is not the company's biggest worry today.
Is That The Cavalry Coming … Or Mister Ed?
Boston Scientific shareholders pretty much have no choice but to hope that the company's pipeline really delivers on its potential. The good news is that the company has several lucrative shots on goal, though investors need to have some concern for the quality of the competition.
Promus Element should help Boston Scientific gain share on Medtronic and Abbott in drug-coated stents, though expect the rivals to heavily market against the concerns about longitudinal stent compression with the Promus. Still, doctors tend to like to check these things out for themselves, so expect the BSX stent to get a fair shot. Although this will be a more profitable product for BSX (no need to split profits with Abbott), the time in sunshine may be limited if Abbott can get its bioabsorbable stent on the market in due course (and assuming the data is good).
Other markets like atrial fibrillation, hypertension, transcatheter heart valves, and left atrial appendage devices could all be worth hundreds of millions. The trouble, though, is in BSX's time to market and product differentiation. Almost everybody (Medtronic, JNJ, St. Jude, and AtriCure (ATRC) has its hat in the a-fib ring and there is also the risk that new drugs from companies like JNJ (Xarelto) or Pfizer (PFE) (Eliquis) will shrink the market (these drugs don't cure a-fib, but do reduce the risks of stroke).
Likewise, the same large four companies are targeting renal denervation as a treatment for hypertension. It's potentially a $10 billion-plus market, but Medtronic already seems to have a leg up. Looking at minimally invasive heart valve replacement, here too there is a large market opportunity that BSX can address with its Sadra acquisition, but it looks like BSX will enter the market (2016) well behind Edwards Lifesciences (EW) and Medtronic, and perhaps St. Jude as well.
Even one of BSX's most promising markets, left atrial appendage closure, won't be exclusive. Boston Scientific got great technology with the Atritech acquisition, but St. Jude and Medtronic are coming as well and BSX will have to split the market - though several hundreds of millions in incremental sale is hardly just a consolation prize.
Going From Buy To Build To Bought Out?
It's worth noting that most of BSX's growth potential is to come from technologies acquired in deals over the past couple of years. Said differently, BSX's internal R&D productivity has not been great. Promus Element is a good stent, but the company risks falling further and further behind St. Jude and Medtronic in CRM due to a lack of exciting new products. Longer term, it's simply not sustainable to keep buying growth.
On the flip side, might someone step up and buy BSX for its own? Medtronic and St. Jude couldn't do it with the antitrust concerns and pipeline redundancies, but JNJ could be interested in the business if they believe there's hope for resuscitating the CRM line. Chances are, though, that if BSX gets a bid it will be one that's off the board right now - a private equity company, perhaps, or a company like General Electric (GE) looking to expand into implantable device-based medicine.
The Bottom Line
Is Boston Scientific stock cheap? If you believe that they can stem the losses in CRM, reignite the stent business, keep the other businesses growing, and develop this pipeline, then the answer is "yes". The problem, though, is that trusting BSX to get its house in order over the past few years has been like entrusting small children to a dingo-run daycare.
There absolutely is a time and place to buy BSX, but I would suggest it's when the company has proven that CRM and stents are under control. Will that mean leaving money on the table? Since analysts are perpetually looking for turnarounds, the answer is probably "yes", but it's a question of risk and reward.
Execute on the existing business opportunities and bring that pipeline to fruition, and BSX is worth something in the high single digits. But if management cannot stabilize CRM and stents, holding BSX will give investors a lot of papercuts over and over again.