Intuitive Surgical, Inc. (ISRG)

I've seen one of the Da Vinci robots at work. It's weird at first, but the results don't lie. And the quicker healing time is true.

Therer are two tricky things about Intuitive Surgical as a stock:

1.) Valuing its P/E ratio. ISRG been all over the map in the past 10 years. And the current forward P/E of 56 seems too much.

2.) How much can we believe the analyst growth estimates? 36.8% in 5 years is a phenominal growth rate if a business can achieve it.

Still, doctors say they want the surgical robots that ISRG makes. Whether hospitals will pony up the big bucks for them is another question. There is still some question about insurance paying for them in surgery as well. If these concerns are resolved, then ISRG could go even higher than the estimates.

For ISRG to earn a 15% compunded annual return from the $286 per share level (which is probably where it will open on Tuesday May 27th), it will have to be worth at least $575 per share in five years. Which if the estimates are correct, it should not have a problem getting to that value.

Now for argument's sake, let's assume that the estimates are correct and the company grows its EPS at 36.8% for the next 5 years. We'll use a P/E of 40 because I don't trust P/E's of 50+ on any company, and I'm even hesitant to use 40. That put's today's sticker price at $400, if you want at least a 15% compunded annual return. So we're getting a 28.5% discount as of May 23rd.

Both Jon and Pete Najarian at OptionMonster.com & Fast Money love this business, and have their father as a doctor to help back them up on the medical side.

The technicals seem to vote against buying in now for a short-term trade:

1.) ISRG is below both its 10 day and 50 day moving averages
2.) The Slow Stoc. Oscill. is oversold and trending downward still, but it's nearing a point where it should turn
3.) The MACD 12-26-9 divergence is negative, and below 0.

The one short term reason to buy into this is the news from S&P that came late last week that ISRG is going to replace BSC in the S&P 500. That sent shares up $10 Friday, May 23rd.

Long term, this business seems like it's a buy to me. But I have a sneaking suspicion that the price may fall more before the next earnings report. Gut feeling, nothing else. Mr. Market is fickle as we well know.

Intuitive Surgical manufactures the DaVinci Surgical Robotic System (DVS). DVS enables Minimally Invasive Surgical (MIS) techniques to be used for complex surgeries. Since the DVS surgeries are performed through a series of small incisions rather than major openings in the body, patient outcomes are greatly improved.

The DVS System brings significant benefits to all stakeholders

Patients - No large scars, less trauma to the body, reduced risk of infection, usually eliminates need for bllod transufions, shorter hospital stays, faster and more complete recovery.

Hospitals - Perception of the hospital as having the latest medical breakthroughs, differentiation from competing hospitals, better track record of surgical outcomes, shortened recovery times enable better patient turnover, ability to attract and retain top surgeons.

Health Insurance Companies - Shorter hospitals stays, fewer complications and quicker return of patient function offset the higher surgical procedure cost.

Doctors - Expertise in robotic surgery and track record of superior outcomes enhance the surgeons standing in a particular specialty. The surgery console allows the surgeon to work in a comfortable seated position rather than standing hunched over the patient, reducing fatigue during long sugeries.

The Davinci Surgeon's Console is able to scale movements of the surgeon's hands so that a 1 inch movement of the surgeon's hand translates into a 1/4 inch movement of the surgical instrument. This allows for greater control while performing very precise movements. The system is also capable of filtering tremors in the surgeons hand movements. The surgeon views the procedure through a stereo laproscope with his hand in front of him giving the illusion of working within the patient's body. This 3D view and the natural feeling of the surgeon's hand movements on the controllers are responsible for the "Intuitive" Surgical name.

The DaVinci Surgical Systems sell for about $1.1 million on average, depending on regional and configuration variances. In Q306 they sold 46 systems (42 new, 4 refurbished) up from 30 in the same quarter of the prior year. This brought the total installed base to 509 systems worldwide with 10 hospitals having 3 units each and one having 4. Additional purchases of these expensive systems by existing customers demonstrates the undeniable value these systems bring to the hospital and surgeons.

New system sales growth is strong which is great. Even better is that recurring revenues (Maintenence and replacement parts) are growing even faster. Over time these recurring revenues are increasing as a percentage of sales. This will make future revenues and profits increasingly predictable. The company has international exposure with multiple sales in Europe and recently their first sale in China. They have barely begun to tap the US market with only a fraction of hospitals currenty owning even one machine. There is also strong growth potential as the number of procedures performed with the DVS increase.

Currently Prostatectomy (removal of the prostate) is the most common procedure. Due to the superior outcomes (faster and more likely return of continence and sexual function) the DVS system is expected to be used in an estimated 35% of all US Protatectomy procedures done in 2006. This is truly extrordinary because the DVS was only approved for use in this procedure in May 2001. The fastest growing procedure is hysterectomy. This market is estimated to be 5 times as large as the Protatectomy market and adoption is on a similar trajectory for Hysterectomy since it's approval in Apr 2005. Additionally the DVS is approved for a large number of other procedures where it provides similar noteworthy benefits. (Pediatric surgery, Cardio Revascularaization, etc)

The company is run very conservatively with no debt and a long term focus. The stock is currently selling for about $97 with a market cap of 3.6 Billion and a PE of about 38. A few weeks ago there was a rumor of a buyout offer from GE Medical for $150-$170. Personally I would consider that a dissapointment. It is a volitile stock and could even retreat to the mid 80s if the market slumps but I think this is a long term winner.

Having had personal experience with the DaVinci robotic system from ISRG 2 years ago when I had a robotically-assisted radical prostatectomy for prostate cancer which took only 90 minutes, resulted in a single over-night stay in the hospital with essentially no post-operative pain, a return to work three days after the surgery, and now two years later what looks like a complete cure with no significant residual problems with urinary incontinence or sexual dysfunction of any kind, I am a complete believer and, per Peter Lynch, also now a shareholder, in ISRG.

I expect and firmly believe that the many technical advantages of robotically assisted surgery will lead to the widespread adoption of the DaVinci system in the months and years to come as the surgical approach of choice in numerous areas where it is not routinely used currently.

This, of course, will result in enormous sales of the robotic systems to hospitals that wish to remain competitive and on the cutting edge(no pun intended), and ever increasing sales of support services and consumables a la the Gillette razor blade model.

The only question I have re: ISRG is how fast and to what extent it will grow and what the implications of this growth will be for the value of the stock. My opinion, based on personal experience and the many untapped opportunities that remain in the surgical world for minimally invasive surgery to be fully and beneficially implemented, is that the growth of the company and the value of the stock will be phenomenal for years to come.

Go ISRG! Help more and more patients have more effective and less traumatic surgery with better outcomes and you will make your shareholders very happy as you do.

One of my favorite companies and stocks. Robotic technology enabling surgeons to perform with more precision than they could with their own hands, cost-effective for hospitals since patients recover faster and need less bed time, and increasingly chosen BY patients as consumers who want a better surgical choice. Indications expanding from initial prostate surgery market to others like hysterectomies. Good growth rate. Well managed. High margins. I love the robot.

Here's a Fool.com piece I wrote about ISRG:

http://www.fool.com/investing/high-growth/2009/04/21/wonderful-company-but-is-the-price-fair.aspx

Wonderful Company, but Is the Price Fair?
Brian Richards
April 21, 2009

Years from now, when we think back to the Great Stock Market Implosion of '08-'09, we'll remember the epic falls from grace at Bear Stearns, Lehman Brothers, Fannie Mae and Freddie Mac, Intuitive Surgical (Nasdaq: ISRG), AIG, Citigroup, et al.

… Wait, Intuitive Surgical?

How has a company with a four-year annualized earnings growth rate of 72% ended up among the hardest-hit victims of the credit crunch and bear market? Since Jan. 1, 2008, Intuitive Surgical has lost 61% of its value (at one point it was down 74%!); by comparison, the bailed-out disaster that is Bank of America (NYSE: BAC) is down 78% over that same time period.

A crucial difference
While the stock charts of Intuitive Surgical and B of A trend the same direction, the comparisons stop there. Whereas the banks, homebuilders, and insurers have been hurt because of deep-rooted problems in their businesses and industries, Rule Breakers pick Intuitive Surgical is down for only one reason: its formerly sky-high valuation.

At the end of 2007, Intuitive sported a price-to-earnings ratio of 104.9. The Triple-Digit P/E Alarm never sounded, leaving investors battered as a result.

The underlying business, though, was and remains excellent. In fact, as I was contemplating the business models of some of the juggernauts of American capitalism, I kept coming back to this $4.8 billion surgical robot maker from California. It boasts:

*A product that disrupts and revolutionizes a dull industry. Shining example: Amazon.com (Nasdaq: AMZN) and bookselling.
*A market with high barriers to entry. Shining example: Amgen (Nasdaq: AMGN) in a biotechnology market that requires heavy R&D and patent protection.
*A near monopoly in its niche. Shining example: Microsoft (Nasdaq: MSFT) in software.
*Macro tailwinds in its industry. Shining example: ExxonMobil (NYSE: XOM) over the past hundred years, as the world industrialized and Americans took to their automobiles.
*Predictable, recurring revenue from a "razor blade" model. Shining example: Gillette (now a unit of Procter & Gamble (NYSE: PG)) and its, er, razor blade model -- sell the razor, and keep 'em buying the blades.

Imagine those traits combined in a single company:

*Disruptive product: The da Vinci robot benefits patients, doctors, hospitals, and insurers -- a rare win-win-win-win.
*High barriers: Intuitive owns or has use of more than 600 U.S. and foreign patents, as well as FDA approvals.
*Near monopoly: Intuitive acquired its closest competitor several years ago. At the end of 2008, the company had more than $200 million in free cash flow, but as my colleague Devon Rackle recently wrote, management indicated that "there was no other company it could acquire that would provide any strategic advantage." Intuitive's the only game in town for robot-assisted surgeries.
*Macro tailwinds: Americans spent $2.3 trillion on health care in 2007 -- 16% of GDP! The trend ever higher is clear, as 78 million baby boomers approach (or are in) retirement. Moreover, President Obama has made health care a priority for his administration, so the industry has full governmental support.
*Predictable revenue: Innovating, manufacturing, and selling the da Vinci systems is not inexpensive. But the beauty of Intuitive Surgical's business is that only about half its revenue comes from the one-time system sales. "Instruments and accessories" -- i.e., the razor blades -- accounted for a third of 2008 sales, while the fat-margin "service agreements" made up another 15%. Most importantly, these two segments were predicted to grow between 25% and 35% in 2009, while systems sales stay flat (not bad in this economy).

Apologies for all the bullet points
Fast growth in a strong industry ... with predictable, wide-margin recurring revenue. This business is simple -- you could draw the model on the back of an envelope -- yet dominant.

So it's easy to get excited about the company, as fellow Fool Anders Bylund did in January: "Intuitive Surgical's moat isn't just wide. It's filled with triflic acid and mutant carnivorous plesiosaurs, surrounded by electrified razor wire, and patrolled 24/7 by veterans of the French Foreign Legion. … This business fears no competitor and has no peers."

The right side of the SWOT ledger
Now it's time for a dash of cold water: There are weaknesses and threats to Intuitive Surgical's model. (And we can't afford to overlook that half of the SWOT -- strengths, weaknesses, opportunities, and threats -- model.)

Fools shouldn't overlook its position in an intensely regulated industry, where it must seek governmental approval from the FDA and protection for its patents. Intuitive also carries a big reputational risk: If one of its robots should ever prove defective, the company could not only face legal liabilities, but also suffer permanent damage to its brand and sterling reputation.

There's also the concern of outsiders entering the space: Deep-pocketed health-care conglomerates, upstart Rule Breakers taking aim at the market leader, or even lower-cost medicines that could achieve what only surgery can today.

The Foolish bottom line
Even with these potential threats, Intuitive Surgical has a wonderful business model and lots of room to run.

Warren Buffett has famously said, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

I believe Intuitive is a wonderful company. Prospective investors will have to decide whether 24.6 times earnings -- its current multiple -- constitutes a "fair price."

This is a once in a lifetime opportunity to buy a future rule maker in its early stages of development. The Da Vinci surgical system is making traditional surgery obsolete. In 20 years it may well be grounds for a malpractice suit to pick up a knife and cut into another human being free handed. Soon, most surgery will be performed with devices like this one. And Intuitive Surgical will get revenue from each procedure that is performed. You can buy a piece of that right now. At $120.00 a share it's a steal.

I think even those that are bullish about ISRG may be underestimating this one. Right now it's primarily being used for prostate, hysterectomy, and valve replacements...but that's just the tip of the iceberg. What happens when it starts to be used as often as possible to avoid the "open surgery"??? I think it's reasonable to expect this one to grow big time...and it's not unreasonable to think it may reach for the moon. P/E too high??? Hah!

Intuitive Surgical's DaVinci "robotic" surgical system is truly changing paradigms in surgery. The result for patients? The potential for minimal invasiveness (if/as appropriate) and unparalleled precision (no shaking/tremors) resulting in reduced complications. DaVinci can even compensate it's actions for the beating of a heart, which definitely improves survivability!

While it's all very well that a company benefits the human condition in patients, what about benefiting the investor? Here.....we've got a killer....and it's rolling up 60+% quarterly growth (yoy) in revenues and profits.

What is fueling this growth? Starting with the mundane,

1) Geographical growth across the United States and just starting international growth
2) Growing number of hospitals with multiple installations (Why would that be?...read on...)

3) Expanding number of surgical applications where DaVinci's advantages shine
4) "Razor and blade" business model....with the bonus of having a very profitable razor. Certain components (the blade analogy) are programmed to require regular replacement after a certain number of surgeries in order to function. This replacement market is the foundation of a large and rapidly growing annuity for the company.
5) On a related note, robots need replacement on approximately a seven year cycle.
6) Essentially no competition. In addition, any competing product would have to go through an FDA review before entering the market.

Lastly....and this is the killer:

7) We are seeing the development of a Virtuous Cycle for DaVinci. Hospitals (the direct customer) are actually advertising the advantages of DaVinci to the consumer, who, in turn, is demanding DaVinci from hospital systems....forcing wider application, new procedures, more multiple installations.....

Anecdotally, some surgeons see DaVinci as becoming THE standard in the procedures where it started.

Growth won't continue forever. I don't foresee having a DaVinci in every living room. But, given the fact that the limit is not even visible on the horizon (literally and figuratively), this company should be able to continue it's explosive growth at least through the next five year window.

The installed base of da Vinci robots is ggrowing as fast as Intuitive Surgical can build new ones. That in turn drives sales of consumables, to the point where that segment is just about passing the machinery sales now. And thanks to a deep patent portfolio, there is nary a competitor to be seen.

The only way to stop ISRG is to buy the whole thing. JNJ? Medtronics? Anybody? Otherwise, we're free to enjoy the benefits of unfettered market dominance on our own.

From Brian Richards:
Disruptive product: The da Vinci robot benefits patients, doctors, hospitals, and insurers -- a rare win-win-win-win.
High barriers: Intuitive owns or has use of more than 600 U.S. and foreign patents, as well as FDA approvals.
Near monopoly: Intuitive acquired its closest competitor several years ago. At the end of 2008, the company had more than $200 million in free cash flow, but as my colleague Devon Rackle recently wrote, management indicated that "there was no other company it could acquire that would provide any strategic advantage." Intuitive's the only game in town for robot-assisted surgeries.
Macro tailwinds: Americans spent $2.3 trillion on health care in 2007 -- 16% of GDP! The trend ever higher is clear, as 78 million baby boomers approach (or are in) retirement. Moreover, President Obama has made health care a priority for his administration, so the industry has full governmental support.
Predictable revenue: Innovating, manufacturing, and selling the da Vinci systems is not inexpensive. But the beauty of Intuitive Surgical's business is that only about half its revenue comes from the one-time system sales. "Instruments and accessories" -- i.e., the razor blades -- accounted for a third of 2008 sales, while the fat-margin "service agreements" made up another 15%. Most importantly, these two segments were predicted to grow between 25% and 35% in 2009, while systems sales stay flat (not bad in this economy).

CAPS is the screener for my investment newsletter picks.

I like this one (except the current P/E of 61), but here is my favorite part - "The Company markets its products through a direct sales force in the United States and parts of Europe. It has also entered into agreements with distributors in Australia, Canada, China, the Czech Republic, India, Italy, Japan, Korea, Romania, Saudi Arabia, Singapore, Spain, Taiwan, Turkey and the United Kingdom."

Medical costs are out of control. Hospitals want to make money. Our society has eating habits that lead to chronic diseases. Every well to-do family in the USA kids have grown up on computer games. Did you see the new Mercedes with only a joy stick? This robot will get people through the hospitals quicker. The patient gets a better operation. It is ?guestimated? it will take 5 years to get through the FDA approvals so this is a barrier to entry. I like that they have ?consumables? for each operation. This means a revenue stream if the world ever gets saturated with robots. It seems to me that this product should have explosive growth.

My first Motley Fool Rulebreakers stock purchase. Also, my first Trophy stock. I had a cost basis of $48 and sold the stock when it hit $125. I sold only enough shares to reclaim my initial investment, the rest of the shares I kept (since now I am playing with shares that I got for free and am playing with the house's money), calling them "trophies". When I look at my portfolio and see it filled with trophies, I feel warm and fuzzy all over... but I digress...

The ISRG 2Q07 conference call was obviously great fun if you are long the stock. They are selling these systems all over the world. Hospitals that have the basic daVinci system, are able to upgrade to higher definition imaging and extra robotic arms. The patented technology allows for a wide and deep moat around the brand, which means that it is extremely difficult to compete directly with the core business.

ISRG makes a product and embraces a technology where everyone comes out a winner. Patients benefit from more precise surgery with quicker and more complete healing. Doctors and hospitals attract more surgeries if they can perform them on these systems, and since the healing time is less and the surgeries more successful, they can service more patients in less time with less lawsuits brought on by botched surgeries, complications reulting from infections, etc. Managed care companies benefit from reduced hospital stays and better patient results.

I will say that I am still giddy from a nearly 50 POINT move in a single stock in a single day... But look at how many hospitals there are in the world and how many have daVinci systems (650+ worldwide). Some have added 2 or 3 ADDITIONAL systems. South Korea of all places has (I believe) 3 systems in one hospital.

The downside is that I remain waiting for a pull-back that may never come to buy shares in another account. I would have also liked the company to have announced a split on the conference call. Regardless, this stock remains a core holding for me, and I never would have heard about it without Motley Fool bringing it to my attention several years ago...

One of the most exciting companies to own because of its monopoly on the future of surgery. After making huge inroads into the prostate surgery market, they are now getting traction in the gynecological and cardiac arenas. Many hospitals now target advertise... specifically mentioning their minimally invasive treatment options using the Da Vinci Surgical System. And the company doesn't make money just on the units... they also generate revenue from selling the supplies and blades needed for every procedure. We are just at the beginning of the next gold standard for how surgery is performed. Twenty years from now, I'm betting that most surgery will be perfomed by robotics. And leading that pack will be ISRG.

Our country is in a real healthcare crisis. You can't survive without insurance, but unless you are employed full time or retired, getting it is incredibly expensive. Even when you have it, there are extra costs that add up over time. Costs remain high because with insurance paying them there is no incentive to lower them. But Insurers are publicly traded companies so they answer first not to their policy holders but to their share holders. So to keep costs down they are increasingly limiting what they are willing to pay for. Luckily, companies like Intuitive Surgical are not only advancing medical technology they are decreasing costs at the same time. The company's flagship product, the Davinci Surgical Suite is a robotic tool that allows surgeons to perform surgery laproscopically - through tiny incisions - rather than having to perform more radical surgeries. Because the robot can compensate for hand tremors and other mistaken commands, it reduces surgeon error saving on malpractice suits. Because it performs surgery less invasively, patients undergo less trauma, suffer from less complications, have shorter hospital stays and faster recoveries. This all translates into lower expenses for insurers and happier patients and hospitals. And at a million dollars, the equipment doesn't seem that unreasonable in the grand scheme of things. Additionally, the surgical instruments that the robot uses are single-use and must therefore be replaced after each procedure providing a constant revenue stream between major system purchases. Already there are hospitals buying second and third units and last year they made their first sale overseas. The system is approved for two or three types of surgeries currently and as it is used more, and as new surgical instruments are created for it, that number will grow and with it, the demand for the machines and supplies.

Leader in robotic surgery; good % of recurring revenues through surgical blades that get worn out (think Gillette razor-blade analogy), potential upside is much more downside due to hypersectomy (did I spell that right?). A potential 2-3 bagger at the least if company executes well. Also, CEO more focussed on building business than please Wall St analysts.

They reported a great quarter and seem to anticipate continued strong growth. So, quite logically, the stock got creamed today. I read the whole CC, did not see anything alarming. They allowed for some caution going forward, but made a strong case for the cost benefit of the system and the fact that the procedures are not elective. There is no substantial change in the company's fundamentals, yet the stock is down from a 52wk high of $360. Sure it was expensive then, but I see it as rather cheap now, considering it practically owns this lucrative space. Their installed base is over a thousand systems now, so disposables and service now account for more of their revenue. This seems like a great time to jump in for the long haul...

This is the future of surgery. Robotic controls perfom the surgery based on a surgeons hand movements, but the computer sensors of the da Vinci machine can filter out any sudden movements made by the doctor (ie sneeze, hiccup, hand tremor etc). The da Vinci also can magnify the image, allowing a surgeon to microscopically cut around nerves and blood vessels. With the minimallly invasive procedure, there is less blood loss, faster recovery, and higher rate of success. Da Vinci has become sought after for a wide variety of operations, and actually allows a doctor in the next room to operate on his patient. I don't know if the procedure has been done by a doctor that's not physically in the same location as the patient, but in theory at least, an operation could be perfomed by a doctor halfway around the world. The stock has been volitile and carries a high PE. I think right now is a good chance to get in if you plan to hold on for a fews years at least.

For a number of reasons, I believe this stock will outperform the S&P. The number of skilled surgeons is dropping, as the population ages and needs more surgery. The less invasive surgeries call for less recovery time, a factor favored by the insurance companies. The surgeries being performed are continuing to expand. I can forsee the possibility of surgery being performed through video feeds and computer direction from a distance.