Medical device manufacturer Boston Scientific (BSX) is a gift that just keeps on giving for a financial writer. With a long history of recalls, controversies, strategic shifts, and promising new technologies, to say nothing of a free cash history that reminds one of the Rocky Mountains, there is almost always something to say about Boston Scientific. While investors seem relieved that Boston Scientific reported a basically in-line quarter, the underlying results show that there's still a lot of work left to make this into a truly competitive company.
Low Expectations Key To A "Good" Quarter
Boston Scientific's quarter was good in the sense that expectations and reality have finally synced up, but the results weren't so good in absolute terms.
Revenue fell 3% this quarter, with CRM revenue falling another 11% and cardiovascular revenue falling 2% leading the decline. Neuromodulation was a relative bright spot (up 8%) and endosurgery did alright (up 4%).
Boston Scientific also did a little better than expected on its operating items. Gross margin slipped about a point, but actually surpassed most sell-side estimates. BSX outspent expectations on SG&A, but made up some of it with lower R&D spending. All in all, operating income fell 29%, but still exceeded expectations.
No Joy In CRM Yet
Boston Scientific's performance in CRM, particularly ICDs, is going to remain a talking point. Remember, Guidant was the #2 player when Boston Scientific bought them, but St. Jude Medical (STJ) has since surpassed them and BSX is struggling to regain momentum.
US CRM sales were down 14% this quarter, worse than St. Jude's (-7%) performance (and Medtronic (MDT) won't report for a while). ICD revenue fell 12% (St. Jude's fell 2%), indicating that BSX continues to lose share despite some controversy with St. Jude's leads.
BSX isn't giving up the ship yet. Earlier in the quarter, the company exercised its option to buy Cameron Health - a small development-stage company with a leadless sub-q ICD about to go in front of the FDA. Data on this device has been mixed, but there's a definite niche out there (maybe 10%-15% of the present ICD market) for patients who can't, for whatever reasons, tolerate the transvenous leads that conventional ICDs require.
The purchase price was relatively modest - $150 million up front, another $150 million on approval, and up to $1.05 billion in revenue-tied milestones. This could be an interesting first-mover product, though I find it a little ironic that Boston Scientific is moving this technology forward when faulty ICD leads is one of the seemingly few problems that the company has not had.
Mixed Messages In Other Businesses
The drug-coated stent market continues to be a tough one; while the revenue declines reported by BSX and Abbott Labs (ABT) look similar, Abbott had on-the-ground growth as much of the decline in reported revenue was tied to the disappearance of BSX royalties. Said differently, Abbott and Medtronic appear to be chipping away at Boston Scientific's drug-coated stent share.
While neuromodulation was up, it was up less than St. Jude's and a lot of the future growth of this business seems pinned on high-risk/high-reward opportunities like deep brain stimulation. Endosurgery was mixed, with 4% overall growth. Boston Scientific did a little better than Stryker (SYK) in endoscopy, but weakness in urology/gynecology was disappointing.
A Better Future … If Management Can Deliver
A big part of what gives hope to this story is the fact that Boston Scientific has an interesting pipeline. The biggest caveat here, though, is that BSX won't be first to market in many of these markets (unless competitors see trial failures).
Boston Scientific will likely be fourth to market in transcatheter heart valves (with Sadra), with no particular product advantages (unlike St. Jude) that suggest it will grab real share from Medtronic or Edwards Lifesciences (EW). Likewise, while Boston Scientific is developing its own renal denervation approach, this is going to be a crowded market where Medtronic and St. Jude also appear to be meaningfully ahead.
Elsewhere, the company is also hoping to enter the LAA closure market and become a bigger player in atrial fibrilation; a market that Medtronic, St. Jude, Johnson & Johnson (JNJ), and Atricure (ATRC) are also targeting. The company's bronchial thermoplasty product for asthma (Alair) is already on the market and could be a winner with time.
The Bottom Line
I wish I could be more positive on Boston Scientific, but the company's history is against it. What's more, while the company has some real opportunities in its pipeline, the company also has real risks to existing businesses (including CRM, drug-coated stents, and intravascular imaging). Worse still, the company has had to buy a lot of that promise with M&A and that isn't a sustainable model for this company.
All of that said, modest revenue growth assumptions (just 2% compounded from 2011 through 2017) and improved, but still below-peer, cash flow conversion suggests these shares are undervalued. Fair value could well be above $8, but investors need to understand that this bargain comes at the cost of a great deal more risk than with many of its peers.