Newsletter Value Investor Insight carried an interview May 30th with Troy Capital's Alex Troy, whose fund has returned an average of 23.6% annually net of fees since inception in March 2003, versus 15.8% for the S&P 500, according to Value Investor Insight. Here's the excerpt from the interview in which he discusses Boston Scientific (BSX), which was trading at $15.43 at the time of the interview (current price here):
Your first specific idea, Boston Scientific (BSX), surely qualifies as out-of-favor.
AT: There are certainly plenty of well known reasons to put this in the too-hard. pile. Recent studies have shown drug therapy or bare-metal stents to be as efficacious in certain situations as the company’s drug-eluting Taxus stents. Meanwhile, Abbott Labs is coming out with its new Xience stent, armed with plenty of research about its superior efficacy.
Boston Scientific has also had some problems with the F.D.A. over pacemaker manufacturing problems inherited from Guidant and because of facilities-management problems that have delayed the launch of the next-generation Taxus Liberte stent.
There’s litigation with Johnson & Johnson over patent infringement and the company just had to increase reserves for patient claims due to damaged pacemakers. On top of all that, the defibrillator market they entered by buying Guidant slowed down sharply right after the acquisition.
Other that that, everything seems fine!
AT: But there are also plenty of reasons to imagine things getting much better. On the regulatory side, the pacemaker manufacturing problem has been resolved and the problems delaying the Taxus Liberte launch will be – the issue there is largely over record keeping. The defibrillator market is recovering and growing at double-digit rates again.
Management also was smart to license from Abbott the right to sell a version of the Xience stent. It won’t be as profitable as selling Taxus stents, but it will prove very valuable if the Xience technology starts to take significant market share. Even with a very difficult start, I think management did the right thing in outbidding J&J to buy Guidant and make the company far less reliant on the Taxus business. People complain that they paid too much for it, but that’s irrelevant – I just care how much it’s worth going forward.
Talk about the potential you see coming out of the merger with Guidant.
AT: I basically see four ways to win here that I don’t think the market is pricing into the stock.
First, all the high-profile problems have obscured the fact that almost half of the company’s projected $8.4 billion in revenue this year will come from products other than the core stent and defibrillator businesses. That other revenue comes from a wide range of established and growing product lines. One they’ve highlighted is the endosurgery business, which manufactures surgical tools that make less-invasive incisions and which they plan to take public at around 4x revenues, using the proceeds to pay down debt. There are several other businesses with similarly excellent prospects and our sum-of-the-parts value of all the nonstent and non-defibrillator businesses comes to about $11.50 per share, 75% of the current market price.
A second way to win is for Guidant to increase its market share in the recovering defibrillator market, from its current 25% share to the 30% it has traditionally enjoyed. Third, we believe the studies out there suggesting drug-eluting stents are no more effective than alternatives are backwards-looking and that there’s an excellent chance the next-generation of stents like Xience and Taxus Liberte will reestablish the advantages of drug eluting stents.
Finally, the company has considerable opportunity to cut costs. Historically, selling, general and administrative costs have been around 47% of sales. It’s now running about 52%, and I see no reason they can’t take another $400-500 million out through things like salesforce reduction, systems integration and facilities rationalization.
What upside do you see for the shares, now trading around $15.50?
AT: If the drug-eluting stent business stabilizes, SG&A is reduced and the company can recapture its historical defibrillator market share, we think by 2009 that it can earn $1.10 per share. At a 20x multiple, appropriate given the rate at which they’re growing, we think a fair expectation for the stock price is in the low- to mid-$20s.
Are you ascribing any value to the company’s development pipeline?
AT: No. Everything we’re valuing is generating revenue and established in the market today. They have many interesting products in the pipeline, for which we don’t feel we’re paying anything – given the company’s track record, that should be conservative.