ISRG - Intuitive Surgical

[lucasnascimento]

Intuitive is a global technology leader in minimally invasive robotic-assisted surgery (MIS). The Company's da Vinci® Surgical System enables surgeons to operate minimally invasively through a few small incisions or the belly button from a nearby ergonomic console. The da Vinci System features a magnified 3D HD vision system and tiny wristed instruments that bend and rotate far greater than the human hand. As a result of this technology, da Vinci enables surgeons to operate with enhanced vision, precision and control.

 

The idea of robotic surgery started with a project in the 90's, with the need to get US Army folks to receive surgery remotely. Current Intuitive CEO Gary Guthart (in Intuitive since 1995, CEO since 2007) participated in the project.

 

The company makes money selling i) the Da Vinci System (30% sales), ii) instruments and acessories (52% sales, usually each instrument has a cap of 10x rounds of use) and iii) services (18% sales) (surgeon training, maintenance etc.).

 

System cost: 600k-2M USD

Cost per procedure:~1.8k per procedure

Service cost per year: ~100k

 

Big numbers (USD, GAAP, FY17):

Market Cap: 58.1B

Sales: 3,1B; Gross Profit: 2.2B (70% margin); EBIT: 1.05B (33.7% margin); Net Income: 660mn (21% margin, normalized ~25%)

6M procedures since inception. FY17: 644k US (15% growth), 233k OUS (23% growth)

Installed base of systems: 4400 installed (65% in the US)

CFO margin: 36%; Capex/sales: 6%, normalized 3%; FCF margin: 30%

Zero debt (net cash)

 

Razor-blade business model: ~70% sales are recurring

High switching costs: Surgeon trained to use the system is highly unlikely to change to another

Monopoly: no relevant competitor + first mover advantage; More relevant competitors are coming by 2020 after delayed plans to come earlier (JNJ/Google, MDT/Mazor) but they tend to focus on procedures in which ISRG doesn't focus; ISRG view that as a positive to increase MIS TAM

Economics: MIS surgery increases efficacy (most non-robotic surgeries offers high risks of complications), reduces invasiveness (less scars, less damage to other muscles/organs etc), reduces patient recovery times in hospital, etc. (13K legacy clinical evidence reports on cost reduction and customer value enhancement recorded; 2.5K of which released last year)

 

Barriers to entry:

Regulatory approvals, which have specifics in each country/state and type of procedure (much clinical evidence needed)

High expertise, technology and human talent

Stickiness with surgeons

 

It's difficult to quantify the total addressable market, but a simple way to look at it is that 33M inpatient under anesthesia procedures are performed each year in the US, compared to ISRG 644k procedures in the US.The opportunity is huge not only in the US but outside.

 

Stock soared since last year in part bc of accelerating growth and because of share repurchases.

 

Currently not long because of valuation. ISRG seems expensive at ~50x P/FCF fwd and ~60x P/E fwd, but not so if compared with Align Tech and some software companies. What do you think?

 

 

 

[cameronfen]

I'm interested, but it's only growing 15-20% a year.  What's is the incremental ROIC/ROE in your opinion? (I assume it's high i.e. ravorblade model but how much capital does incremental growth require?).  What's the split between ARPU growth and volume growth?  In particular what's the pricing power look like 5-10 years down the road.  How sustainable is growth?  It's going to take 6 years to grow into a 16x P/E  at that a 20% pace.  Is that a good bet?  Seems like you have to be reasonably sure it can continue to grow at that rate which may be iffy considering growth before this quarter was 15%ish and only this quarter did it shoot up to 25%.  My two cents after two seconds of digging. 

 

 

[Jurgis]

ISRG has always been expensive. There always has been questions about addressable market, growth, etc. Not saying it's a buy or that I have answers.

 

It's yet another stock that I have bought and held briefly in the past, sold at some gain instead of holding long term for huge gains. No position right now.

[rkbabang]

ISRG has always been expensive. There always has been questions about addressable market, growth, etc. Not saying it's a buy or that I have answers.

 

It's yet another stock that I have bought and held briefly in the past, sold at some gain instead of holding long term for huge gains. No position right now.

 

I did the same.  I bought in 2006 and sold in 2012 for what I thought was a nice gain.  Stupid.

 

[johnny]

I think there is not nearly enough attention here given to the addressable market question. Just mentioning how many surgeries are done nationally and walking away may be worse than not discussing it at all, because you're anchoring on a totally impossible number.

 

What percentage of those surgeries are being done in areas where the total operational volume could never economically justify a Da Vinci machine? What percentage of the remainder are operations for which the Da Vinci isn't even a plausible device??

 

Then, once you get past that, how much of the marginal demand for Da Vinci machines is motivated primarily by the fact that high-volume surgical centers see the machine primarily as a way of doubling the amount they get to bill per procedure? How far out are you willing to project with confidence that such billing gamesmanship is going to be the order of the day in the US healthcare system? 20x revenue confident?

 

Those 90% gross margin consumables? I wonder at what installed-base some third party will be awfully tempted to try selling their own generic Da Vinci compatible needle drivers at 66% off. Granted, surgeons are total psychopaths that will insist that they can feel the difference between the $1,000 needle driver and the $3,000 one, but luckily it seems like the medical system is largely becoming more and more controlled by a different breed of spreadsheet-oriented psychopath who enjoys telling the surgeons to fuck themselves. So I don't know if I think the future is so bright.

 

I'd be curious to know what anybody flirting with going long on this name thinks is the probability of the US having a single-payer or medicare-for-all type arrangement in the next 10, 20 years. I suspect the Da Vinci is going to be one of the relative losers in the fight for healthcare dollars, once healthcare dollars get truly scarce.

 

 

EDIT: I don't think I'm correct in how I represented the billing implications of operating with a Da Vinci, but I believe it's fair to say that the ultimate result (goosed demand created by poorly crafted financial incentives that push institutions to acquire equipment for economic, rather than therapeutic reasons) is the same. Things like Medicare grants for the capital costs, things like hospitals "competing" for patients that are idiots and want their prostate to be cut out by Data from Star Trek because he seems like a reliable guy, etc.

[BPCAP]

Earnings out.  Lots of open field for the company, but my main concern about the company (other than price controls) is their stock comp.  seems like hedge fund fees.

[peterHK]

I took a long look at them about 2 months ago and had the following thoughts:

 

MDT/JNJ are getting into soft tissue surgery and in a very big way. Each, particularly MDT has potential to materially underprice their robots (MDT has said this is their plan) in an effort to rapidly gain market share.

 

ISRG has had an effective monopoly on their market for like a decade, and while they'll keep good market share, my sense is management isn't taking competition seriously enough. I've found their answers to it on conference calls sort of lazy/not well thought through. So, my worry here is that the other bigger players figure out a way to erode some of the economics of ISRG's business through things like what MDT is planning to do which is basically give the hospitals the capital equipment for free, and then just have consumable revenues, or have the capital equipment pay itself off through the consumables. That's a lot easier for a hospital to digest than blowing $2mn on a new robot.

 

Second, they've said there are like 5 million applicable surgeries for DaVinci done each year (I can't remember the source, it was one of their conference calls). Each robot platform basically does a surgery type (it's sort of like AI where there's not a singularity, but little AI's that each do their own thing), although my sense was DaVinci could do the most. From what I read (and I might be mistaken) to actually get that 33 million person TAM, you need ISRG to basically invent a new robot. Doable, but does one want to bank on that especially with other players now quickly getting into the soft tissue game?

 

When I modeled it out with applicable surgeries growing 5% a year from 5mn today, I had to assume ISRG got 50% market share after 15 years with some degradation in pricing (~-2% per year) to justify a $440 stock, let alone a $525 stock. I dont' like doing 15 year DCF's, and I don't like assuming a player gets 50% market share to justify the current price.

 

When you look at the economics of this business (ROTC/ROIC, high margin, high recurring revenue, low capex, outside of the capital equipment, not cyclical), it is phenomenal, and not just a little phenomenal, like "this is one of the best businesses ever" phenomenal. That's initially what made me interested, I ultimately couldn't get comfortable with the mix of a TAM that was sort of hard to define and figure out, and a management that, to me, seemed lazy after having a monopoly for a decade.

 

[glorysk87]

I took a long look at them about 2 months ago and had the following thoughts:

 

MDT/JNJ are getting into soft tissue surgery and in a very big way. Each, particularly MDT has potential to materially underprice their robots (MDT has said this is their plan) in an effort to rapidly gain market share.

 

ISRG has had an effective monopoly on their market for like a decade, and while they'll keep good market share, my sense is management isn't taking competition seriously enough. I've found their answers to it on conference calls sort of lazy/not well thought through. So, my worry here is that the other bigger players figure out a way to erode some of the economics of ISRG's business through things like what MDT is planning to do which is basically give the hospitals the capital equipment for free, and then just have consumable revenues, or have the capital equipment pay itself off through the consumables. That's a lot easier for a hospital to digest than blowing $2mn on a new robot.

 

Second, they've said there are like 5 million applicable surgeries for DaVinci done each year (I can't remember the source, it was one of their conference calls). Each robot platform basically does a surgery type (it's sort of like AI where there's not a singularity, but little AI's that each do their own thing), although my sense was DaVinci could do the most. From what I read (and I might be mistaken) to actually get that 33 million person TAM, you need ISRG to basically invent a new robot. Doable, but does one want to bank on that especially with other players now quickly getting into the soft tissue game?

 

When I modeled it out with applicable surgeries growing 5% a year from 5mn today, I had to assume ISRG got 50% market share after 15 years with some degradation in pricing (~-2% per year) to justify a $440 stock, let alone a $525 stock. I dont' like doing 15 year DCF's, and I don't like assuming a player gets 50% market share to justify the current price.

 

When you look at the economics of this business (ROTC/ROIC, high margin, high recurring revenue, low capex, outside of the capital equipment, not cyclical), it is phenomenal, and not just a little phenomenal, like "this is one of the best businesses ever" phenomenal. That's initially what made me interested, I ultimately couldn't get comfortable with the mix of a TAM that was sort of hard to define and figure out, and a management that, to me, seemed lazy after having a monopoly for a decade.

 

I mostly agree with you here re: valuation, but wanted to point a few things out in terms of competitive positioning.

 

I think ISRG is more defensive to new entrants than one might think.  There are a few layers that new competitors need to pierce in order to gain real adoption of their platforms.

 

First, the platform needs regulatory approval for each type of surgery (in each country!). This is not a fast process, so this alone will prevent rapid adoption of new systems.

 

Second, ISRG has created a very large and robust training ecosystem for surgeons to learn the DaVinci system. They have a dedicated program for learning technical skills on the systems as well as a network of surgeon proctors who train surgeons by directly assisting them on their early surgeries. They also have a formal credentialing program in place with continuing development programs to keep surgeons up to date on the platform.  The company already has over 40,000 surgeons trained on the DaVinci platform - so hospitals that already have DaVinci systems are very unlikely to adopt a new system since in all likelihood their surgeons are already trained on the Davinci (and that's setting aside the financial investment in the systems themselves). Hospitals that don't have a robotic platform are also much more likely to buy a DaVinci rather than a competing system since most of the surgeons on staff or prospective hires likely already have DaVinci training.

 

Third, while it's true that there will be new systems hitting the market from competitors, they are extremely far behind in terms of the technology. ISRG has already shifted their focus towards future endeavors like efficient single port access, incredibly impressive UI overlays that detect and label the patients anatomy in the surgeons viewport in real time, and other AI developments. These are things that again will take a lot of time and money for competitors to replicate.

[peterHK]

I took a long look at them about 2 months ago and had the following thoughts:

 

MDT/JNJ are getting into soft tissue surgery and in a very big way. Each, particularly MDT has potential to materially underprice their robots (MDT has said this is their plan) in an effort to rapidly gain market share.

 

ISRG has had an effective monopoly on their market for like a decade, and while they'll keep good market share, my sense is management isn't taking competition seriously enough. I've found their answers to it on conference calls sort of lazy/not well thought through. So, my worry here is that the other bigger players figure out a way to erode some of the economics of ISRG's business through things like what MDT is planning to do which is basically give the hospitals the capital equipment for free, and then just have consumable revenues, or have the capital equipment pay itself off through the consumables. That's a lot easier for a hospital to digest than blowing $2mn on a new robot.

 

Second, they've said there are like 5 million applicable surgeries for DaVinci done each year (I can't remember the source, it was one of their conference calls). Each robot platform basically does a surgery type (it's sort of like AI where there's not a singularity, but little AI's that each do their own thing), although my sense was DaVinci could do the most. From what I read (and I might be mistaken) to actually get that 33 million person TAM, you need ISRG to basically invent a new robot. Doable, but does one want to bank on that especially with other players now quickly getting into the soft tissue game?

 

When I modeled it out with applicable surgeries growing 5% a year from 5mn today, I had to assume ISRG got 50% market share after 15 years with some degradation in pricing (~-2% per year) to justify a $440 stock, let alone a $525 stock. I dont' like doing 15 year DCF's, and I don't like assuming a player gets 50% market share to justify the current price.

 

When you look at the economics of this business (ROTC/ROIC, high margin, high recurring revenue, low capex, outside of the capital equipment, not cyclical), it is phenomenal, and not just a little phenomenal, like "this is one of the best businesses ever" phenomenal. That's initially what made me interested, I ultimately couldn't get comfortable with the mix of a TAM that was sort of hard to define and figure out, and a management that, to me, seemed lazy after having a monopoly for a decade.

 

I mostly agree with you here re: valuation, but wanted to point a few things out in terms of competitive positioning.

 

I think ISRG is more defensive to new entrants than one might think.  There are a few layers that new competitors need to pierce in order to gain real adoption of their platforms.

 

First, the platform needs regulatory approval for each type of surgery (in each country!). This is not a fast process, so this alone will prevent rapid adoption of new systems.

 

Second, ISRG has created a very large and robust training ecosystem for surgeons to learn the DaVinci system. They have a dedicated program for learning technical skills on the systems as well as a network of surgeon proctors who train surgeons by directly assisting them on their early surgeries. They also have a formal credentialing program in place with continuing development programs to keep surgeons up to date on the platform.  The company already has over 40,000 surgeons trained on the DaVinci platform - so hospitals that already have DaVinci systems are very unlikely to adopt a new system since in all likelihood their surgeons are already trained on the Davinci (and that's setting aside the financial investment in the systems themselves). Hospitals that don't have a robotic platform are also much more likely to buy a DaVinci rather than a competing system since most of the surgeons on staff or prospective hires likely already have DaVinci training.

 

Third, while it's true that there will be new systems hitting the market from competitors, they are extremely far behind in terms of the technology. ISRG has already shifted their focus towards future endeavors like efficient single port access, incredibly impressive UI overlays that detect and label the patients anatomy in the surgeons viewport in real time, and other AI developments. These are things that again will take a lot of time and money for competitors to replicate.

 

I think ISRG's installed base is safe, but for the stock to work you have to be right on growth. That's where competition threatens the stock: if competitors are able to steal growth share and you see ISRG's growth stall, the stock is going to be punished.

 

Regarding technology, I'm not sure we know that because to my knowledge MDT's platform hasn't been made public yet and JNJ's is still in development. I don't think we're in a position to say that ISRG is that far ahead.