Young Robots Lenny And Mona All Grown Up Now, But Intuitive Surgical Is No Cost Cutter

| About: Intuitive Surgical, (ISRG)

Publicly funded research that eventually led to the development of the da Vinci Surgical System was performed in the late 1980s at non-profit research institute SRI International with funding in the 1990s funding from the National Institutes of Health and the US Department of Defense which was interested in the potential to allow surgeons to operate remotely on soldiers wounded on the battlefield.

In 1994, Dr. Frederic Moll and John Freund acquired an option to acquire SRI's intellectual property and incorporated a new company that became Intuitive Surgical Devices, Inc. (NASDAQ:ISRG).

The company refined the SRI System into prototypes known originally as Lenny after the young Leonardo da Vinci, and Mona, for his masterwork the Mona Lisa.

The final version of the prototype was nicknamed the da Vinci Surgical System, and the name stuck when the system was eventually commercialized. After further testing, Intuitive Surgical began marketing this system in Europe in 1999, while awaiting FDA approval in the United States.

Shortly before going public, Intuitive Surgical was sued for patent infringement by Computer Motion, Inc, its chief rival. The uncertainty created by the litigation between the companies was a drag on each company's growth and in 2003, Intuitive Surgical and Computer Motion agreed to merge, thus ending the litigation between them.

The da Vinci Surgical System is a robotic surgical system. The system is controlled by a surgeon from a console. It is commonly used for prostatectomies and increasingly for cardiac valve repair, gall bladder surgery and gynecologic procedures.

The da Vinci System consists of a surgeon's console and a patient-side cart with four interactive robotic arms controlled from the console.
Three of the arms are for tools that hold objects, act as a scalpel, scissors, or electro-cautery instruments. The fourth arm is for an tiny camera with two lenses that can go right inside the body and give the surgeon a full stereoscopic view.

The surgeon sits at the console and looks through two eye holes at a 3-D image of the procedure, meanwhile maneuvering the arms with two hand and foot controllers.

By providing surgeons with a better view, steadier hands, and the ability to perform surgery while sitting down, da Vinci Surgical System makes it possible for surgeons to perform surgery for certain procedures through keyhole incisions.

The advantage to the patient is that there is less cutting, less bleeding, and less pain after the surgery, and thus a quicker recovery.

However there are also some disadvantages. While the use of robots to assemble cars speeds up production, reduces demand for humans, and makes 24-hour production possible, there are no such economies of scale in the world of human surgery and surgical robots may be slower than their human competition.

A da Vinci Surgical System costs approximately $1.75 million. In addition, there are maintenance contracts plus expenditures for instruments used during surgery and some critics have pointed out that hospitals have a hard time recovering the cost and that there is limited evidence that the patients really do better.

Insurance companies and Medicare do not pay any more money for a robotic procedure.

On the other hand, as more surgeons are being trained on da Vinci systems from the outset of their careers, the installed base of da Vinci enable surgeons is growing, and there is little serious doubt that the procedures it enables are better for some patients, especially the obese--an ever growing market segment.

One advantage to da Vinci may well be its ability to extend safe surgical options to more individuals.

So what about the stock?

As we see from the chart above the stock has soared since early 2011 and the P/E ratio is a massive 42.20, implying that healthy revenue growth is expected for several years to come--or that the stock is overbought.

The most recent earnings report was good and the stock beat earnings and hit a new all time high, but at the same time in the conference call for the 2011 last quarter earnings announcement last month, there were hints of dark clouds forming over Europe. The company said:

During the first quarter, we sold 140 da Vinci systems: 105 in the United States, 14 into Europe and 21 into rest of world markets. As part of the 140 system sales, 19 standard da Vinci Systems and 27 da Vinci S Systems were traded in for credit against sales for new da Vinci Si Systems.

We had a net 94 system additions to the installed base during the quarter, which brings to 2,226 the accumulative number of da Vinci systems worldwide, 1,615 in the United States, 379 in Europe and 232 in rest of world markets...

While our overall international system sales were strong, our Q1 EU system sales were somewhat disappointing and below historical trends.

With the uncertainty hanging over the future financing of health care in the US, questions about the sustainability of Medicare at current levels, and terrific financial pressures on the government financed health systems of Europe, it would seem logical to be cautious about the short term growth of Intuitive Surgical. The company is expanding into South Korea, which seems to be an important growth market.

The company has a great product, great technology and, importantly, established links with the medical and regulatory communities in the US and Europe, and it also seems logical to think that robotic surgery has a long term future, and indeed that hand-held surgical instruments will eventually go the way of the buggy whip--but maybe not yet.

I would look to open a small partial position if the investor is looking for a stock with a very long term future with a view to increasing on dips, or selling puts 25% below the current price provided the investor really wants to own the stock.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ISRG over the next 72 hours.

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