Robotic Surgery: Meet Intuitive Surgical

In 1985 the PUMA 560 was released and was used to place a needle for a brain biopsy using Computed Topography guidance.  Many at first were quite skeptical, but it was a very exciting time for the healthcare medical industry. The long-term outlook looked promising; however, with a brand new concept coming into the market, were patients willing to leave their lives up to computers?  When Intuitive Surgical (NASDAQ:ISRG) came into the space and began marketing their brand new da Vinci Surgical System, minds were quickly changed.

History of Intuitive Surgical

From the launch of the PUMA 560 in 1985 up until 1999, there was not any extremely effective robotic surgical instruments available in the market. Then, Intuitive constructed and released the da Vinci Surgical System and the market was filled with excitement.  Today, ISRG stands strong as the global technology leader in robotic assisted minimally invasive surgery, or MIS.

So what is this da Vinci I am continuously mentioning?  First, we’ll have a closer look on how it came to the market.

• 1980’s- original prototype was developed at the former Stanford Research Institute under contract to the U.S. Army (initial interest in developing battlefield surgery remotely, then commercial use became the priority)
• 1995- Intuitive Surgical was founded in order to test this theory
• 1999- first launched in January
• 2000- da Vinci became the first robotic surgical system cleared by the FDA for general laparoscopic surgery
• 2000->Present- FDA has cleared it for thoracoscopic (chest) surgery, cardiac, urologic, and gynecologic procedures

Valuation

When looking at the numbers for ISRG, your eyes will immediately tune to the high multiple that you must pay as an investor.  With a Trailing P/E of 58.46x and a Forward P/E of 38.35x, the multiples are quite high, but historically we have observed compression.  According to Zacks, the Long-Term Growth Rate is 31.70% . However, is this an appropriate premium for continuous innovation in the field of robotic surgery solutions? Personally, I think so, but such possible gains come with a high risk.  Their ratios are quite impressive with trailing ROA and ROE of 16.69% and 20.84% respectively.  It is also Important to note that they have 0 Debt on their books.  The margins also speak for themselves.  Lack of competition combined with the Intuitive’s model itself yields an impressive high margin business.

We’ll take a closer look at their margins as of June 2008:

• Gross Margin-Product: 73.6%
• Operating Margin: 35.7%
• SG&A Margin: 26.2%
• R&D Margin: 9.3%

Ok, so ISRG is not an old company, and the da Vinci has not been in the market for too long, but is that the only reason why the margins have been so high and haven’t really trailed off? No.  They have brought down their SG&A Margin from 29.7% in 2005 to its current state and expanded their Gross Margin-Product from 69.7% in 2005 to the current numbers mentioned above.  I truly do not expect these margins to decrease too much going forward because they are continuously expanding their sales of the da Vinci and bringing it into larger markets.  For example, a few summers ago I worked at a hospital in Scranton, PA with a population of over 70,000 people. There were 3 hospitals in the area that were packed tightly near one another, and medical professionals in the areas were extremely excited about the recent purchase of the da Vinci. This brings forth no limits for expansion of ISRG, since Scranton is located conveniently close to New York and Philadelphia, every major hospital will/have rushed to purchase ISRG’s great product and it will be a staple in hospitals around the world.

Market is Tough to Enter

Robotic surgical players are Intuitive Surgical and….?  That’s right. There really are not any true competitors to ISRG that will have a detrimental effect on their company. One thing helping ISRG is that they have “the deepest and broadest intellectual property portfolio of all the surgical robot companies” according to an Oppenheimer research report on September 2nd, 2008.

Risks

There are a few risks you may take as an investor if you do decide to scoop up some shares of ISRG.  Obviously, if you are a value investor, you probably have not read up to this point. ISRG is a growth story and will remain as one going forward.  Investors have/will continue to pay a high multiple for their shares. A slight risk to the stock is foreign exchange risk.  According to their 10-Q, international sales were only about 11% of total revenue for the three months ended June 30, 2008. Since rates have been held at 2% by the Fed, and the dollar has made a run against the Euro in the last couple months. This is not too much of a risk going forward, but foreign currency fluctuations are a slight concern. Another risk is any litigation brought forth by another company trying to steal their market share. This most likely will not hurt the company too much because as briefly mentioned above, they have obtained patent and copyright protection through strategic acquisitions where they take over and discontinue marketing of products that challenge their current products.

Conclusion

If you can stomach some short term losses, I feel that Intuitive Surgical is still a $300+ stock long-term.  They have touched above $350 and within the last year have traded from $212 up to $353.  The margins will remain high, intellectual property will remain dominant, and their business model is the best in robotic surgery.

-Ryan Savitz

Disclosure: None.

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