David Lentz

GE's Dismal Earnings a Warning for Other Medical Device Companies

Looking back at the last quarter's presentations by ISRG and ARAY, I was struck by the fact that the actual numeric trends presented, were not all that much different (or so it seems to me, YMMV).

But the great gulf between the two as received in the marketplace was entirely in the skill of their presenters.

It seems unavoidable that hospitals will face (or are facing) strong pressures to contain capital spending in the face of a recession, and that a company whose PE of 90 (!!!) would be extremely unlikely to be able to avoid the same multiple compression that the rest of the market is working through, regardless of whether their earnings decline or not.

Only the most fervent true believers would think that the earnings of ISRG will continue to grow through this economic calamity in a manner sufficient to sustain a PE of 90 while the credit markets are imploding and unemployment is rising.

A hint: unemployment says something about corporate finances, and in the end, corporate finances are almost entirely what supports hospitals, as Medicare is a money-losing proposition, and individual insurance money flows are trivial in comparison to employer sponsored health insurance. Unemployed people are much more likely to postpone surgery until they have insurance coverage -- even if it kills them.

All this says absolutely nothing about the quality of ISRG, or whether they are likely to see competition for their (very) expensive devices, either from other medical equipment companies or from the pharmaceutical/biotech industry (e.g., if there were an better nonsurgical treatment for cancer, esp. prostate cancer, ISRG would be impacted severely) -- all that is being said is that ISRG (and all other medical equipment companies) faces some serious headwinds that have more to do with the investing public's valuations than any part of their business. GE's medical equipment business is just another barometer of how strong those headwinds are likely to be.

Full disclosure: I hold some ISRG puts (that I am losing my shirt on, as to date, the market disagrees with me about the near-term course of ISRG's valuation).