Better Budgets, Better Times For Robots

By Stephen D. Simpson, CFA | July 12, 2011 AAA

The healthcare capital equipment market is slowly getting better, as hospitals are starting to pick up spending in the wake of the budget lockdowns forced by the credit crisis and recession. Not only is that good news for major imaging system companies like General Electric (NYSE:GE) and radiology companies like Varian (NYSE:VAR), but also for the burgeoning field of surgical robotics.

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Intuitive - Biggest and Best, But Not Home-Free

The go-to name in surgical robotics has pretty much always been Intuitive Surgical (Nasdaq:ISRG), and the company has been exceptionally successful in placing its da Vinci robots in surgery centers around the world. Revenue has rocketed from $227 million in 2005 to over $1.4 billion last year, and the company has established a very profitable recurrent business model.

The challenge for Intuitive is what comes next. Intuitive has done a great job of advertising the benefits that da Vinci can bring to procedures like prostatectomies and hysterectomies, and the company has a strong position in urology and gynecology. The trouble is, Intuitive's shareholder base is ravenous when it comes to demanding growth, and Intuitive needs to start proving that its long-held promise in markets like colorectal, thoracic and cardiology can actually bear fruit. Success will mean hundreds of millions of dollars more in recurrent revenue, but investors will not wait forever.

Hansen Medical and Stereotaxis Look for Profits

Hansen Medical (Nasdaq:HNSN) and Stereotaxis (Nasdaq:STXS) are more focused, and so far less successful, robotic surgery companies relative to Intuitive Surgical. Hansen's Sensei system is focused on catheter guidance and ablation, offering doctors better control and less radiation exposure for the patient. The trouble with Hansen is momentum - after selling 58 systems in 2008 and 2009 (combined), the company sold 16 in 2010. Maybe a recent deal with Philips (NYSE:PHG) will help (and ease some financing concerns), but the company needs to deliver on its promise in vascular and electrophysiology to maintain its recent momentum.

Stereotaxis' systems (the Niobe, Epoch and Odyssey) are not identical to Hansen's offerings, but there are undeniable similarities. Stereotaxis is more focused on cardiac mapping, ablation, and stent and lead placement, and likewise offers the attraction of more efficient surgery. With the Niobe and Odyssey systems together costing about $1.5 million, these are not slam-dunk decisions for hospitals, and the company still has to prove that there is enough benefit to justify the costs. Investors should also realize that both stocks frequently trade on rumors that companies like Medtronic (NYSE:MDT), St. Jude (NYSE:STJ), Boston Scientific (NYSE:BSX) or Johnson & Johnson (NYSE:JNJ) will make a play for one of the companies.

MAKO Making Progress

Also trading near a 52-week high, there are big growth expectations for MAKO Surgical (Nasdaq:MAKO). MAKO has specialized in robotic approaches to orthopedic surgery, and its RIO system can be used in knee or hip procedures. MAKO has yet to prove it can replicate its success in knees and hips, but that is a major part of the near-term thesis, with longer-term possibilities in extremities and perhaps spine.

MAKO arguably has a bit more to worry about with competition. Intuitive Surgical's da Vinci could conceivably be adapted for orthopedic procedures (at least more easily than for the procedures provided by Hansen and Stereotaxis robots), and companies like Curexo Technology and Orthopaedic Synergy are trying to get a piece of the market as well. That's also not to exclude existing orthopedics companies like Biomet, Stryker (NYSE:SYK), and Smith & Nephew (NYSE:SNN) that are working on new procedures, some of which are image-guided.

Can IMRIS Shake Up the Market?

Canada's IMRIS (Nasdaq:IMRS) has a shot to play spoiler, but with a market cap of about $300 million, expectations are not huge yet. IMRIS has an emerging business with its image-guided therapy systems - basically allowing the capabilities of the MRI (and other imaging technologies) to be brought into an operating suite. That is promising (and the company has a relationship with Varian), but expensive at $10 million.

More interesting for this article, though, is the prospects of NeuroArm - a robotic surgery system that is arguably the most comparable to the da Vinci system of all the previously mentioned rivals. NeuroArm has shown some encouraging results in early trials and could be a player in microsurgery. Going a step further, it seems reasonable to wonder whether a system precise enough to be used in microsurgery and neurosurgery could have broad applicability in a much wider range of procedures.

The Bottom Line

There is no risk-free or value option in this sector. Intuitive has more than proven its ability to profit, but can it maintain the growth that its valuation demands? Can Hansen and Stereotaxis convince hospitals to buy enough machines to reach positive free cash flow? Can MAKO hold off would-be rivals in orthopedics? And last and not least, can IMRIS find its way into tight budgets with a very expensive imaging suite and succeed in getting FDA approval (and market acceptance) of another true surgical robot?

IMRIS is an exciting, if risky, play, and Hansen and MAKO both have some pretty robust opportunities in front of them. Investors should make sure they are comfortable with the risks and the above-average due diligence requirements, but these could be exciting plays on one of the relatively few explosive growth opportunities in medical devices. (For related reading, also see Healthcare Funds: Give Your Portfolio A Booster Shot.)

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