Company – Resmed develops products and techniques for the testing and treatment of sleep apnea and other sleep related illnesses. Their main products are masks users wear overnight that prevent the airway from closing during sleep. The masks have the increased benefit of significantly reducing snoring.
Summary – RMD has experienced earnings growth over the past five years well in excess of R&D and capex spending growth. The company is not cheap compared to other similar sized high growth healthcare companies but I believe it deserves a significant premium for three reasons. First, its products act to extend the functional working life of users allowing them to recoup retirement money lost during the recession and at the same time increase tax receipts for the federal government. The economic incentive is there for individuals, the government, and employers to use and cover Resmed’s products respectively. Secondly, Resmed treats an illness that historically has suffered from a lack of awareness which has only in the past few years begun to spread. Because most of those affected are unaware they suffer from sleep apnea, the potential market is unquantifiable. Obesity, the main cause of sleep apnea, is also the pervasive physical attribute of America’s working class. Finally Resmed has only one significant competitor and users generally decide between the two based on subjective preferences rather than fundamental issues of quality.
Negatives and risk factors – One of Resmed’s top insiders, Chris Roberts, sold 87% of his shares on May 20 when the stock was trading close to $70. It is also my view that in the coming year we will see a wave of bolt-on acquisitions in the industry as healthcare companies gear up for the baby-boom retirement wave. One of Resmed’s smaller competitors could potentially be bought out giving them the resources to better compete and fundamentally alter the currently investor friendly industry concentration. The increasing awareness of sleep apnea may also be a double-edged sword as larger companies increase spending on R&D geared towards the disorder. The creation of a less cumbersome treatment could seriously hurt Resmed’s growth prospects.Valuation – Resmed is currently trading at 15 times TEV/EBITDA, 27% below the acquisition price paid by Philips for Resmed’s main competitor Respironics in Dec 2007. Respironics was purchased at a 64% premium to trailing EBITDA. While the market has weakened significantly since Dec 2007, Philip’s investment thesis has worked out and so the risk for a potential Resmed acquirer has been significantly reduced and the company could now potentially be purchased buy a buyout firm as well as a larger medical equipment company. These two opposing forces lead me to believe that a fair acquisition price for Resmed is at least 40% above its current value. Resmed is now financially secure enough to significantly increase spending on developing awareness. I believe the return on such investment will be greater than previous R&D given the difficulty of potential users to diagnose the cause of problems associated with sleep apnea. Given Resmed’s dominant position in the industry, continually increasing return on investment, history of earnings beats, and Resmed’s suitability as a takeover candidate, I believe ResMed is a great addition to any long term portfolio.
Disclosure: Long RMD