A global leader in the radiation oncology segment, Varian Medical Systems (NYSE:VAR) is now striving hard to transform itself from a product company to an integrated human-centered cancer treatment provider. And the long-term strategy of the company is to expand its addressable market size from $7.3 billion in 2017 to $12.3 billion by the year 2022 by focusing on patient-centered care coordination. This will ultimately result in meaningful footprint expansion for Varian Medical Systems, not only in new segments but also in new geographies.
I strongly believe that today, Varian Medical Systems is in a sweet spot, all set to capitalize on existing as well as new opportunities in radiation oncology segment, in both developed and developing economies. The target price of $130, set by Barrington Research in January 2018, seems more reflective of the true potential of this stock.
While the company's current share price may not be a very attractive entry point, it is definitely a point where you want existing investors to hold on to this stock to enjoy some nice returns in the coming months.
In this article, I will be explaining my hypothesis for recommending Varian Medical Systems as a hold opportunity for 2018, in greater detail.
The global radiation therapy market seems to be picking up, growing at 4.5% (linked above) in the 12 trailing months from October 2016 to September 2017, and Varian Medical Systems is well placed to capitalize on this opportunity. The company boasted of an installed base of 7,876 linac units (linked above) at end of Q1 2018 and expects to grow this number to 10,000 by the year 2022. The company also plans to expand its annually treated patient base from 3 million to 6 million (linked above).
There are many growth drivers in the oncology segment that can prove favorable for Varian Medical Systems in achieving its long-term target. The increasing aging population in emerging markets, rising incidence of cancer, and relative under-penetration of radiotherapy in these markets is a key short-term growth driver for Varian Medical Systems. In developed markets, it is mostly the aging installed base, around 1,000 systems over 10 years old (linked above) in USA alone, that is fueling the company's replacement business. Coupled with these drivers, is Varian's winning strategy comprising of innovative hardware and software products and services for care continuum that is playing pivotal role in strengthening the company's position in the radiation oncology market.
Varian Medical Systems has already been witness to strong growth trends in Asia Pacific market, which includes Japan, China, and other geographies in south-east Asia. In China, the company has been seeing rapid uptake for its Edge product as well as Aria software.
Approved by the FDA in June 2017, Halcyon system is an image-guided volumetric intensity-modulated radiotherapy or IMRT device, designed to provide cost-effective cancer services across the world. Halcyon has also received CE mark from European regulatory authorities. The company has managed to secure around 62 orders for this device across the world (linked above), of which, 40% arise from greenfield sites.
What has been differentiating this linac device from bunch of other devices in the market, is its small footprint and cost effectiveness, all done without compromising on quality. So, the small size will be playing a pivotal role in placing Halcyon in developed markets of USA and Western Europe, where almost 90% to 95% of the demand is from the replacement segment (linked above). Here, Halcyon is being positioned to replace the aging linac devices, including around 2,000 cobalt devices (linked above), Tomotherapy devices, as well as Siemens devices. Unlike TruBeam which was too big, Halcyon's small size, capable of fitting in older vaults, is the key differentiator in this case. Then again, the advanced capabilities such as kilovoltage cone CT imaging in Halcyon will enable Varian to pursue higher-priced opportunities in developed markets.
Halcyon's small size has also reduced construction time required to construct new vaults, in case of greenfield orders. Additionally, the device reduces per patient treatment time to almost half of that required with previous devices and hence, also improves overall throughput. Then again, unlike older devices which would require almost 31 button clicks, Halcyon requires only 9 clicks for functioning. The reduced amount of human intervention implies reduced probability of wrong decisions, thereby, improving quality as well as safety for patients.
Here, we have mostly concentrated on the evolution of Halcyon's growth trajectory in developed markets. But it is the emerging markets, where lies most of the accounts that have never deployed radiotherapy before. Out of the 62 orders placed till date for Halcyon (linked above), almost 40% has been from emerging markets. And with 90% of these orders (linked above) from those accounts that never had a linac device, company is making a big difference in this underpenetrated segment in future years.
Going beyond Halcyon's current capabilities, Varian is also planning to imbibe adaptive radioactive therapy, one that changes with patients and tumors, in the Halcyon system. This involves multi-modal imaging technology at the point of care, iterative cone-beam CT for appropriate dose distribution, and accurate dosage delivery.
Going beyond products, Varian Medical Systems has developed a HyperArc, an end-to-end solution that when combined with potential of TrueBeam® and Eclipse™ platforms, is capable of providing advanced high definition intracranial radiosurgery solution. We now have people upgrading their TrueBeam and Eclipse installed base to the new HyperArc solution, which costs almost $1.0 million (linked above). For new systems, the cost per HyperArc solution is almost $2.5 million (linked above). The company has managed to secure almost 57 orders for HyperArc (linked above), since its launch in late 2016.
In addition to the large installed base that can be upgraded with HyperArc, Varian is also targeting a large opportunity in product and service margin segment, associated with HyperArc. Combining all the factors with the rapidly rising prevalence of brain cancer patients and subsequent demand for stereotactic radiosurgery solutions, HyperArc is expected to prove to be a revenue opportunity of around $300 million for Varian by year 2022.
Varian Medical Systems offers a host of software solutions, aiming to help the dosimetrist and clinician create the most optimal treatment plan for patients. Prominent amongst these is Eclipse, which had a strong franchise of around 3,900 independent customers in mid 2017 (linked above). The recently launched knowledge-based software, RapidPlan, has also witnessed almost doubling of installed base in Q1 2018 as compared to Q1 2017.
Varian Medical Systems is now focusing on getting orders for upgrading the installed Eclipse base with HyperArc solution and RapidPlan software. Today, Eclipse software comes with multi-criteria optimization capability, which can work with RapidPlan to create flexible and optimal customized treatment plans. Further, Varian has also introduced a graphics processing unit in Eclipse, to improve calculation efficiency and thereby, productivity of the radiation technology. All these changes and upgrades in the treatment planning systems present an incremental revenue opportunity of around $250 million (linked above) for the company, by the year 2022.
Beyond the treatment planning software, Varian Medical Systems also offers workflow management and decision support software such as ARIA, InSightive, Velocity, and 360 Oncology, in a relatively underpenetrated global market. So ARIA and the various localized versions that are being developed for foreign markets help customers to better comply with healthcare regulations in those specific geographies. InSightive works in combination with ARIA to provide financial and clinical analytics capabilities to customers.
360 Oncology can prove to be a major opportunity for Varian Medical Systems in the yet underpenetrated cancer care coordination segment. This market is worth more than $1.0 billion (linked above), and every 100 new customers for 360 Oncology effectively represent a revenue opportunity of around $20 million. 360 Oncology is enabling digitization and thereby, simplifying the working of the multi-disciplinary tumor board. Further, it is also enhancing the degree of patient engagement and finally, emerging as integrated system for cancer patient care.
In Q1 2018, Varian Medical Systems' longitudinal cancer imaging software, Velocity, reported double digit growth on YoY basis. This software plays a pivotal role as a tool in determining effectiveness of treatment and monitoring of cancer patients, based on images obtained from disparate sources.
Already a leader in proton therapy segment, Varian Medical Systems has recently launched the ProBeam Compact proton therapy, which is more efficient in targeting tumors and having less impact on the neighbouring tissues as compared to other external beam systems. The company is also preparing to leverage the huge underserved market opportunity for proton therapy in the Chinese market.
Varian Medical Systems has also made its foray in the rapidly growing interventional oncology segment, by acquiring radioembolization leader and Australia-based Sirtex. This company has added SIR-Spheres Y-90 resin microspheres, a targeted internal radiation therapy, already used in around 1,040 centers in 40 countries across the world, to treat certain inoperable liver cancers. This deal has been priced at around $1.3 billion (linked above).
Although a global leader in proton therapy segment, Varian Medical Systems is anticipating both revenue and margin volatility for this business in coming quarters, since the company is currently ramping up its operational base. Then again, the competition in this segment from companies such as Sumitomo, Ion Beam Applications (OTCPK:IOBCF), Hitachi (OTCPK:HTHIY), and Mevion Medical Systems is rising rapidly, and hence Varian will have to continue to invest heavily for maintaining its leadership position. Hence, we can expect margins to remain low for the company's proton therapy business in coming quarters.
In the context of the entire radiation oncology segment, Varian Medical Systems is competing with major electronics players such as Philips (PHG) and Siemens (OTCPK:SIEGY) as well as with niche radiation oncology companies such as Accuray (ARAY) and Elekta (OTCPK:EKTAY). Increasing competition implies continued pricing pressures for Varian Medical Systems in future quarters.
Varian Medical Systems is currently trading at a PE multiple of 28.46x, which is definitely not cheap considering that the average PE multiple for the radiation therapy industry is 17.2x. This valuation can be justified by the strong business fundamentals and robust growth prospects. The company has total debt close to $340.0 million and total cash worth $836.6 million on its balance sheet. Varian Medical Systems also had net operating cash flow close to $495.9 million at the end of 2017.
In this context, the company's strong balance sheet can help Varian to return shareholder value either through dividends or share repurchases.
Considering all these aspects together, I believe that retail investors should definitely consider Varian Medical Systems as a robust investment opportunity in FY 2018.
This article was written by
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.