PHIL TOWN

JOHN DUNCAN ON INTUITIVE SURGICAL - MOS BUT NO PBT

John Duncan posted this ISRG analysis on my facebook messages page and I thought it was rational so here it is:

 

The Robotic Surgery money machine

Phil, I would appreciate it if you could review my analysis of Intuitive Surgical (ISRG).  I purchased this business (okay, not the whole thing, but quite a few shares of it) when it was definitely on sale and made a good profit.  I recently sold it.  Since then it has run up even more in value.  Now I wonder if I made a mistake.

What is Intuitive Surgical?

ISRG is a manufacturer of a proprietary robotic surgical system - the "Da Vinci System."  ISRG dominates this emerging industry in the medical field - surgical procedures done by robots acting as extensions of the surgeons hands  - giving the surgeon the kind of hand eye control and precision humans could only dream about having.  It, in essence turns the surgeon into a biotic man or woman!  The systems offers hospitals enormous savings and it offers patients less intrusive procedures with much faster recovery times.

MEANING

Although I have never had to undergo serious surgery, it was easy for me to find meaning in this company.  If I was to ever need surgery, the first thing I would do is research to find out if the procedure was qualified to be done with the Da Vinci system and if it was, I would then seek out a hospital and surgeon who had this capability.  It is easy to find overwhelming evidence of the benefits of using this equipment - much faster recovery times, less pain, lower risk of complications, and because of that - major cost savings for hospitals who employ Da Vinci.  The Da Vinci systems offer surgical capabilities in urology, gynecology, cardio, transoral, and a few others .  They continue R&D spending on new instruments to expand the capability into other specialties. ISRG's conference calls always end with a real testimonial from a patient.  ISRG is what is right with American health care - innovation that makes life better for people, and will save the system money in the long run.

MOAT

ISRG appears to have 3 moats - intellectual property, toll, and switching.  I have done enough research to know that ISRG has a huge lead on competitive robotic systems.  You want to compete?  Good luck trying to develop something this sophisticated along with the FDA approvals necessary to commercialize a product like this.  I believe there is a huge barrier to entry because of patent protection, but also, just how hard it would be to create an alternative system and get it approved?  Intuitive continues to invest in R&D - they were just awarded FDA approval of the new instrument - the EndoWrist.  ISRG's business model resembles the Gillette razor model - sell the expensive equipment into as many hospitals for a relatively reasonable price (a system might cost $1million), but the high margin part of the business is the selling of surgical tools, instruments, service, and training for the systems.  Once a hospital has made the huge capital investment, it will be very difficult to drop the system or "switch" to another supplier.   Each new machine represents years of training and service.   Each time a surgery is done using Da Vinci, new sanitized instruments are needed.  It's a snowball effect.

 

Red Flags - I have 3 big concerns with ISRG at this time.  First, because their machine would be considered a major capital investment, for many hospitals, this probably involves financing.  The crisis in Europe could trigger borrowing problems slowing growth in Europe.  Europe is a big part of ISRG's growth strategy.  If the credit crisis would spread, ISRG could be hit hard because of the nature and expense of its product.  The other problem is around uncertainty.  I don't have a good grasp of what the new health care law (Obamacare) might mean to high end products such as this one.  From what I can tell, it appears the legislation really tries to hammer  medical suppliers such as ISRG.  I see this as really unfortunate.  And 3rd, a major part of ISRG's method of retaining top engineers and talent is the use of stock options.  The dilution of shares has been offset by share buy-backs.  I need to understand if this cost is truly being accounted for in financial statements, so far, it appears to be okay.

MANAGEMENT

Intuitive Surgical is led by Gary Guthart, Ph.D.  He's been with the company since 1996.  He became CEO in 2010.  He was part of the core team that developed robotic surgery at the Stanford Research Institute - so he has the technical background from the infancy of the industry.  His salary is $504K with stock options his total compensation is over $5 million.  From what I can tell, the top management team and board of directors are very qualified individuals who have a passion for the product they are selling.  I enjoy listening to the quarterly conference calls.  It is all about how the use of their products in procedures benefit patients.  I have found nothing negative in my research.

MARGIN OF SAFETY

ISRG has outstanding growth rates and return on capital that you would expect from a company in high growth mode.

ROIC:  5.8% (10 yr); 15.2% (5 yr); 18.1% (1 yr);  Note:  ISRG lost money during its start up years which lowers the 10 year average, however, the trend is good and they have consistently returned over 10% for the past 7 years.

BVPS:     31.9% (10 yr); 34.7% (5 yr)

EPS:         30.8% (10 yr); 49.6% (5 yr)

Sales:                      44.3% (10 yr); 30.5% (5 yr)

Cash Flow:  38.7% (10 yr); 30.1% (5 yr)

I attempted to normalize the data for EPS and cash flow due to negative numbers 10 years ago during what I would consider a start up phase.  Analysts estimates range from 19% - 21% growth rate.  Their  historical PE has been ~ 34

 

VALUATION

ISRG currently trades at $471 giving it a PE of 40. Based on what I hear in quarterly conference calls I felt comfortable pegging it's future growth rate at 22.5%, and I think it deserved a PE ratio of 36.  The last 4 quarters of earnings were $11.58.  This gives the business a sticker price of $784 so the MOS would be $392.  The current payback time is 11.4 years - not good.  I purchased ISRG around $275 and sold it at $425 simply because the payback time had gone up to 11 years.  The stock has obviously continued to rise.  Maybe I should have waited, but man I wish it would pull back to earth so I could buy it again!

 

Thanks John.

 

Now go play.

 

THE SECRET DOCUMENT THAT TRANSFORMED CHINA

My daughter, Danielle, found the following incredible story on the NPR iPhone App:
http://www.npr.org/blogs/money/2012/01/20/145360447/the-secret-document-that-transformed-china?sc=17&f=1001

The Secret Document That Transformed China
by David Kestenbaum and Jacob Goldstein

- January 20, 2012

In 1978, the farmers in a small Chinese village called Xiaogang gathered in a mud hut to sign a secret contract. They thought it might get them executed. Instead, it wound up transforming China's economy in ways that are still reverberating today.

The contract was so risky — and such a big deal — because it was created at the height of communism in China. Everyone worked on the village's collective farm; there was no personal property.

"Back then, even one straw belonged to the group," says Yen Jingchang, who was a farmer in Xiaogang in 1978. "No one owned anything."

At one meeting with communist party officials, a farmer asked: "What about the teeth in my head? Do I own those?" Answer: No. Your teeth belong to the collective.

 

In theory, the government would take what the collective grew, and would also distribute food to each family. There was no incentive to work hard — to go out to the fields early, to put in extra effort, Yen Jingchang says.

"Work hard, don't work hard — everyone gets the same," he says. "So people don't want to work." In Xiaogang there was never enough food, and the farmers often had to go to other villages to beg. Their children were going hungry. They were desperate.

So, in the winter of 1978, after another terrible harvest, they came up with an idea: Rather than farm as a collective, each family would get to farm its own plot of land. If a family grew a lot of food, that family could keep some of the harvest.

This is an old idea, of course. But in communist China of 1978, it was so dangerous that the farmers had to gather in secret to discuss it.

One evening, they snuck in one by one to a farmer's home. Like all of the houses in the village, it had dirt floors, mud walls and a straw roof. No plumbing, no electricity.

"Most people said 'Yes, we want do it,' " says Yen Hongchang, another farmer who was there. "But there were others who said 'I dont think this will work — this is like high voltage wire.' Back then, farmers had never seen electricity, but they'd heard about it. They knew if you touched it, you would die."

Despite the risks, they decided they had to try this experiment — and to write it down as a formal contract, so everyone would be bound to it. By the light of an oil lamp, Yen Hongchang wrote out the contract. The farmers agreed to divide up the land among the families. Each family agreed to turn over some of what they grew to the government, and to the collective. And, crucially, the farmers agreed that families that grew enough food would get to keep some for themselves.

The contract also recognized the risks the farmers were taking. If any of the farmers were sent to prison or executed, it said, the others in the group would care for their children until age 18.

The farmers tried to keep the contract secret — Yen Hongchang hid it inside a piece of bamboo in the roof of his house — but when they returned to the fields, everything was different.

Before the contract, the farmers would drag themselves out into the field only when the village whistle blew, marking the start of the work day. After the contract, the families went out before dawn. "We all secretly competed," says Yen Jingchang. "Everyone wanted to produce more than the next person."

It was the same land, the same tools and the same people. Yet just by changing the economic rules — by saying, you get to keep some of what you grow — everything changed. At the end of the season, they had an enormous harvest: more, Yen Hongchang says, than in the previous five years combined.

That huge harvest gave them away. Local officials figured out that the farmers had divided up the land, and word of what had happened in Xiaogang made its way up the Communist Party chain of command.

At one point, Yen Hongchang was hauled in to the local Communist Party office. The officials swore at him, treated him like he was on death row.

But fortunately for Mr. Yen and the other farmers, at this moment in history, there were powerful people in the Communist Party who wanted to change China's economy. Deng Xiaoping, the Chinese leader who would go on to create China's modern economy, was just coming to power.

So instead of executing the Xiaogang farmers, the Chinese leaders ultimately decided to hold them up as a model. Within a few years, farms all over China adopted the principles in that secret document. People could own what they grew. The government launched other economic reforms, and China's economy started to grow like crazy. Since 1978, something like 500 million people have risen out of poverty in China. Today, the Chinese government is clearly proud of what happened in Xiaogang. That contract is now in a museum. And the village has become this origin story that kids in China learn about in school. But the rest of the story for the original Xiaogang farmers is more ambiguous.

Our first day in Xiaogang, we asked to talk to Yen Hongchang, the farmer who actually wrote the contract. The local Communist Party officials told us he was out of town. It turns out that wasn't true: We went back to Xiaogang the next day and tracked Yen Hongchang down. He told us he had been in town the day before.

Yen Hongchang told us he started a couple businesses over the years, but the local communist party took them away once they became profitable. He also said that the new new factories springing up around Xiaogang these days are largely empty, and haven't created many jobs. Local officials say none of this is true. They say everything in Xiaogang is going great. [Copyright 2012 National Public Radio]

 

GARRETT SLAMS BUY AND HOLD, DAVE RAMSEY AND ALL OUTLANDISH PROJECTIONS

This is an interesting post that I thought should go up on its own.  From Garrett.  As always, fascinating and right on:

Rulers:

Recently I was on Dave Ramsey's web site to use his investment/mortgage calculators.  While there, I got distracted like usual (oh look..a chicken!)...and starting reading what some fans had posted.  I noticed some things that permeate investor’s thoughts.  And they just aren't true.  They're more lies that have been fed to us by the Financial Services Industry.

Here's the dialog among 4 individuals responding to something Dave had apparently said on his radio show.  I copied and pasted it.  See if you can find the myth or at least some distortion of the truth...it's tricky because we've been brainwashed so much.

 

--------

 

Jordanwilliamleahy:

You said on the radio that 50,000 at 12 percent for forty years would be 6 million. Why would you tell a listener they could receive 12 percent for forty years straight? Last time that happened it was called Bernie M and a ponzi scheme. You sure are smart. 12 percent!?! 

 

thisisfutile:

Stock Market has averaged 12% since inception...that's including the Great Depression. Why is this confusing?

 

pennywise:

12% AVERAGE. Some years you are up 28% some years you lose money, but the average over 10 years or more is what he's talking about. Go look up the Royce Heritage fund and look at its 15 year average rate of return. How about the Yacktman Fund over 10 years? Or the Delafield Fund?

 

Daniel_7916: 

Thats the average rate of return in the stock market. 12% Has been for 100 years. AVERAGE is the key word here. Some years it's lower, some years it's higher. Look in to it. Its real.

 

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Ok...What's the deal and why am I bringing this up?

 

The Financial Services Industry will tell you that since 1929 the stock market has averaged 12%.  This is accompanied by a nice fat sum of money at the end of 30 years as long as you give your money to them.  

 

It goes like this.  We start with nothing, throw a bunch of money into a 401K every month and keep doing that until we can't work anymore.  WoW!  We're GOING TO BE Rich!  

 

Let's say those projections show us with $2,996,000 in 30 years with a 12% annual ROI.  After all, we've already been shown that the market has averaged 12% since 1929.  Seems reasonable right?

 

Nope.  Not even close to reality.

 

Let's say that in the 10th year, we're doing great and when our little monthly statement shows we've got $310,600 towards our retirement next egg.  But...in the 11th year, we actually get a 12% loss. 

 

That means at the end of the year, we only have $273,300.  What does that do to our 30 year projection?

 

Well, instead of having $2,996,000 we now only have $2,354,000.  That's $642,000 less!  Did your Financial Planner show you that chart?

 

And let's get realistic.  In 30 years is your employer's mutual fund going to give you a 12% ROI?  Of course not.  It's a lie.

 

In fact, it would take a 42.5% ROR the next year (then back to 12% for the remaining years) to make up for that ONE -12% loss.  

 

Do you think that's going to happen?  No way.  

 

I wish I had some original thoughts.  The above is from a book published 4 years ago by G. Gunderson, "Killing Sacred Cows - Overcoming the Financial Myths that are Destroying your Prosperity"

 

So, Please Dave Ramsey, if you're going to start telling people to Save for the Long Haul, Invest for the long term, eat Top-Ramen noodles and live in Scarcity, make sure you give them the above example and while you're at it, show them how much a 16 Trillion defict is going to effect their savings when inflation and taxes take their toll and what the new reserve currency will do to the US Dollar and their lifestyle. 

 

Suze Orman, Dave Ramsey, David Bach...all good folks I'm sure. But they're still just selling a financial plan to poverty.  I just wish they taught people how to create wealth the way they did it...by being an entrepreneur, creating licensing agreeements, investing in real estate and collecting royalties.

 

I don't believe any of them made it as a stock market investor. I could be wrong and please educate me if I am.

 

Oh...and just how large (or small) would that nest egg look if you invested in the S&P 500 from 1974 to 2003?  In twenty years, you'd have about $500,000, you'd have peaked at about 1.5 mil in 1999 and finished in 2003 with about 1.25 mil.  Hmmm...not quite the dream we were sold 30 years ago!     

 

To Your Wealth!

Garrett