Boston Scientific: 'Liberte' Stent Provides Upside Potential

Boston Scientific Corporation (BSX) engages in the development, manufacture, and marketing of medical devices that are used in various interventional medical specialties worldwide. The company offers its products in three groups: Cardiovascular, Endosurgery, and Neuromodulation. The Cardiovascular group consists of drug-eluting and bare-metal stents, coronary revascularization products, Intraluminal ultrasound imaging catheters and systems, Embolic protection system, peripheral and neurovascular interventions, electrophysiology devices, and cardiac rhythm management devices.

The Endosurgery group includes esophageal, gastric, and duodenal intervention products; colorectal, pancreatico-biliary, and pulmonary intervention devices; and products for urinary tract intervention and bladder disease, prostate intervention, pelvic floor reconstruction and urinary incontinence, gynecology, and oncology.

The Neuromodulation group comprises Precision Spinal Cord Stimulation system for the treatment of chronic pain of the lower back and legs, and HiResolution 90K Cochlear Implant system to restore hearing to the profoundly deaf. Boston Scientific Corporation markets its products through direct sales force, and a network of distributors and dealers. The company was founded in 1979 and is headquartered in Natick, Massachusetts.

Financial Results

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Boston Scientific has been digesting an acquisition of epic proportions from over a year ago. Many may recall BSX’s successful cash and stock bid for Guidant in 2007, as they came in and scooped the company away from a rival medical equipment maker. The resulting acquisition was one of the largest in financial history, topping $20 billion and basically leaving BSX’s balance sheet with a significant multi-billion dollar “goodwill” asset, a huge float of 1.5 billion shares, and a healthy dose of acquisition-related debt. Current debt levels for the combined company are just over $8 billion in long-term debt, roughly equivalent to their annual revenues.

As this acquisition is digested, we believe BSX has the opportunity for balance sheet improvement as well as an avenue to build important margin improvements to their currently anemic bottom line. Current estimates are for the company to earn between 50 and 60 cents per share next year, and a similar amount into 2009. We see marginal opportunity for improvement of their cost to carry the $8 billion in debt they’ve built up, given current low interest rates. The capital markets may provide some cost savings if the debt were to be renegotiated or rolled over, however we believe those improvements might be minor in the scheme of earnings.

A bigger opportunity for BSX likely resides in its new “Liberte” stent, which received a preliminary approval letter in mid-March from the FDA. BSX Management expects a more formal approval of this stent system in the near future. BSX already offers two platforms of drug eluting stents, including the TAXUS stent and the Promus product, known as the “XIENCE” from Abbott Labs. Promus is a private-labeled stent system manufactured by Abbott Labs (ABT) and distributed by Boston Scientific, which is coated with a different drug than the TAXUS system. BSX is the only company with two separate stent platforms in the market.

Trading near their current book value of $10 per share, we see some value in BSX shares, which we would like to buy now and hold for a long-term appreciation.

Over the course of the holding period, we would look to write covered calls against these shares to extract a few dollars in premium income. Currently BSX pays no dividend.

Investment Recommendation

We recommend that investors accumulate Boston Scientific shares at or below $12.80 per share, and write the August $15 calls for at least $0.60. This gives a target exit price of $15 per share, reflecting a $2.20 per share, or 17% increase. The call premium of $0.60 over the $12.80 “buy” price of BSX gives you a static return of 4.7%. Combined, (if you’re called away at $15 on the shares) you would have a return of 21.7%, which is not a bad return for 138 days until August’s options expiration.

On the downside, if BSX declines past $12.20, you would begin to experience unrealized losses on the position. You would get to keep the $0.60 option premium when those options expire, but a holder of BSX shares would lose $0.60 or more on the shares once the price declined below $12.20 (not including commissions), so that is the break-even level, and those are your known risk / return parameters. You may want to have a sell stop in place at $11.00 to $11.20 to limit your losses to about 10%.

Please note: Options trades all involve a high degree of risk and the potential to lose some or all of your investment. These recommendations are general in nature, and you should consult your own financial professional who is familiar with your situation as to the appropriateness of these trade ideas.

Disclosure: Analyst has no position in BSX stock or options.

Comments

[Pj568]

The Guidant acquisition was in April of 06, not 07 so they've had two years to integrate and reap the benefits. I find it ironic that ABT (their support partner in the acquisition) has incurred around a 50% write-down on the BSX stock it received while BSX has yet to recognize an impairment charge pertaining to its acquisition costs. Maybe the acquisition was a big success and the rest of their business fell apart, or maybe not and there remain significant adjustments yet to be recognized?

[dat]

As noted before, GDT acquisition was in '06, not '07.
Other clarifications to your article -
- Part of Advanced Bionics, including the HiResolution 90K Cochlear Implant system to restore hearing to the profoundly deaf, was sold back to Alfred Mann January, '08.
- Liberte' can't be approved until the warning letter for legacy BSX is lifted. FDA inspected in February. It may be some time yet before the warning letter is lifted and that should have been noted in your article.
- The $10 per share book value you noted is nearly entirely goodwill.