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Vital Signs Inc (VITL) is a small healthcare supplies company, operating from of its global headquarters in New Jersey. The rich history of this company dates back to the early 1970s, when the Terence Wall used $46K of his own money to start an anesthesia supply company, which has grown steadily over the past three decades. Today, Vital Signs operates in four main categories (covered in more depth later in the next paragraph) selling over $200M annually, but the fundamentals of the company have not wavered from the original intent of the founder. The company is still heavily owned by insiders (over 40% according to last report), is free of long-term debt, and does not grow more than its infrastructure can handle. This strategy has brought much success to its founders and early shareholders, but throughout this article I will make a case as to why VITL has a tremendous amount of upside potential according to its current valuation.

The four main business segments of Vital Signs are Anesthesia products, Respiratory/ Critical Care, Sleep Disorder/ Apnea, and Interventional Cardiology/ Radiology. Anesthesia is the largest business segment as well as the original operation, which provides single use products such as air masks, breathing circuits, CO2 sampling lines, and others, to the anesthesia lab. The Critical Care business uses its large sales force to sell syringes, manual resuscitators, and blood pressure equipment, and many other items. The Sleep disorder business operates sleep centers all over the United States, including its most famous centers at hospitals at Johns Hopkins, Duke, and the University of Maryland. The Interventional Card/Rad business provides precision equipment that enables access to the respiratory system.

There are demographic and legislative factors that will prove this will be an incredibly successful company in the coming decade. Current reports indicate that between 20 and 40 million Americans suffer from sleep disorder, and it has been proven by studies that sleep apnea and excessive snoring is linked to congestive heart failure, high blood pressure, diabetes, and even depression. Vital Signs will be a perfect place to invest for the long term, and affluent Americans continue to age and demand high quality healthcare. Even though VITL operates 56 sleep apnea centers in the US, the CEO is very active in acquiring smaller sleep labs, and he has stated that in the future that he will continue to aggressively pursue both organic and acquired growth. Currently, over 75% of VITL’s revenues come from domestic sales, a ratio which Mr. Wall is looking to decrease in favor of taking advantage of aging populations in Europe and Asia. A key point here is that VITL uses cash flow from operations to fund this growth. By keeping long term debt off the books, VITL is able to hedge itself against the current environment of rising interest rates, and should be able to deliver better margins that its peers.

On the legal side, key developments are shaping up that will play a role in pushing more and more business towards the anesthesia and critical care business segments. Recently, states are requiring hospitals to publish infection rates of their patients. Currently 19 states require full disclosure about what infections each patient came into the hospital with and what they left with. Most industry experts expect this number to increase, as well as the spending on single use healthcare equipment. Again, VITL stands tall in this segment, with strong position in breathing circuits (50% share of the domestic market), manual resuscitators (25% share), and others. As state governments continue to tighten on hospitals, Vital Signs will receive a windfall. I look for this to start becoming a major factor in early 2008.

Despite the healthy long term outlook, is now the right time to begin accumulating a position in Vital Signs? Again, I see several clear indicators that indeed it is. According a comparables analysis and an inside look at the companies strategy, VITL is well positioned to take advantage of both short term and long term opportunities. The companies included in this study are Respironics (RESP), Telflex (NYSE:TFX), Baxter (NYSE:BAX), Boston Scientific (NYSE:BSX) and Alcon (NYSE:ACL).

In this comparison of other companies within the medical instruments and supplies industry, the trend seems to be healthy margins, double digit growth, plenty of cash reserves. VITL has been able to outperform its competitors most every category, except for top line growth. I believe this is why the PE ratio slightly trails the likes of Respironics, Boston Scientific and Alcon, however, given the factors I mentioned above, the market will soon realize that VITL should command a premium. In addition to the exceptional margins and valuations, the cash flows that VITL generates also deserves a premium.

VITL

The second reason that VITL is poised to make a move this year comes from a change in the operational strategy in the sleep apnea centers. In the past Vital Signs has supplied the diagnostic equipment to the sleep disorder labs, but they have not been in the preventative equipment business. However, they will now supply this equipment to each patient who visits the sleep labs, instead of referring them to another producer. According to conservative estimates, this strategic change will result in an extra $5M of operating profit per year. When added to VITL’s $30M of 2007 Op Profit, we can indeed see how big of an increase this is.

In conclusion, I see the fiscal year of 2007 being very robust for Vital Signs, and this will be more than reflected in the stock price. Strategic changes, market changes, and growth opportunities will all combine to drive this stock to a premium valuation. In the long term, Vital Signs will continue to take advantage of legislation, demographic changes and international expansion to grow this company into an unprecedented place over the next decades.

VITL 1-yr chart

VITL 1-yr chart

Disclosure: none

Source: Vital Signs: Healthy for the Long Term