Downside Risks To Intuitive Surgical’s $600 Fair Value

Intuitive Surgical’s (NYSE:ISRG) stock has been hammered by the recent inflow of negative reports regarding the safety and cost-benefits of its da Vinci Surgical system. A new comprehensive study by Columbia University suggests that surgery through the system costs significantly higher than the standard minimally invasive procedure, and that too without any major benefits. ^[1] Then the news of the FDA surveying surgeons at major hospitals to list complications witnessed with the surgical system further triggered selling in the stock. ^[2]

Adding to the selling pressure was also an adverse comment from the American Congress of Obstetricians and Gynecologists, stating that robotic surgery for hysterectomies doesn’t improve outcomes and it should not be the first choice of procedure. ^[3] A report from Citron Research, highlighting more than 4,600 adverse event reports of many incidences of deaths and injuries, and a growing number of product liability lawsuits relating to the da Vinci system, has also been weighing on the stock since December 2012. ^[4]

While it is unclear at the moment if the aforementioned issues will adversely impact the ongoing business of the company, the stock has fallen more than 20% in the last couple of days. Considering the recent concerns, we evaluate how these events could bring a downside to our $600 price estimate for Intuitive Surgical, which is a 25% premium to the current market price.

See our complete analysis of Intuitive Surgical here

Limited Cost Benefits, Safety Issues Could Hurt Significantly

Recently a detailed study conducted by the researchers at Columbia University has indicated that the cost-benefit ratio of using da Vinci surgical system to perform hysterectomies is not favorable at all. According to the study, using da Vinci costs a significant $2,189 more per procedure over laproscopic hysterectomies, also the rate of complications and length of stay were similar in both procedures. ^[1] The sales of the da Vinci robotic surgery system increased manifold, mainly because the medical device maker’s sales force has marketed the robotic system by citing benefits of reduced surgical complications, faster recovery process and lower hospitalization costs.

Currently, we expect continued growth in its sales since Intuitive Surgical has been increasing its sales team to promote the device in new international markets like Japan. However, with the new clinical data, Intuitive Surgical may have a hard time promoting the use of its system for hysterectomies.

Further, the American Congress of Obstetricians and Gynecologists echoed the research finding and questioned the lack of clinical data to prove efficacy of robotic hysterectomy over cheaper laproscopic hysterectomy. Comments from a group that represents over 56,000 U.S. physicians has the potential to hurt da Vinci’s use for the procedure. ^[3] Historically, prostatectomies and hysterectomies have been the most common procedures accounting for more than 50% of total procedures done using da Vinci systems.

While the number of prostatectomies (prostate surgery) procedures performed with the system is already declining following U.S. Preventive Services Task Force’s recommendation against routine PSA screening (fewer PSA tests are resulting in fewer prostate surgery), we currently expect it be more than offset by devices’ growing use for hysterectomies and several other procedures. However, the new clinical data may drive hospitals and patients towards cost effective laproscopic hysterectomy. Further, concerns over the cost benefits could spill to other procedures, including gynecological and general surgery, hurting an expected rise in these procedures going forward. A lower number of procedures will hurt average instruments or accessories spending per unit as their demand directly varies with the number of procedures.

Further, the Patient Protection and Affordable Care Act (“PPACA”) will come into full force beginning 2014. As the act aims to reduce healthcare costs, the medical device maker may find it difficult to get reimbursement approvals or may even lose existing ones for procedures performed through the robotic system, particularly if da Vinci systems’ cost-effectiveness claim doesn’t hold up.

Also, while the lawsuits mentioned by Citron Research hold Intuitive Surgical responsible for a few deaths and injuries, it is unclear at the moment if the da Vinci surgical system actually caused these events. The number of complications reported are small compared with the total surgeries performed. The FDA’s move to survey surgeons at major hospitals to list the use, training required and complications witnessed in the surgical system can actually help remove those uncertainties. However, an opposite outcome, as is being largely speculated, could significantly hurt the demand of the system going forward.

Intuitive Surgical’s dependency on the da Vinci system is evident from the fact that if da Vinci system’s yearly unit sales decline to slightly to 500 units by the end of our forecast period from over 620 units in 2012, there will be a 40% downside to our price estimate.

Additional Threat If Margins Come Under Pressure

With rising concerns, Intuitive Surgical may have to significantly reduce the price tag on the surgical system. In that case, its gross margins can decline at a higher rate than we currently expect. By moving the chart below, you can see the impact on our price estimate.

What has significantly contributed to the rapid adoption of the da Vinci system is Intuitive Surgical’s strong marketing push. While we currently expect Intuitive Surgical to keep its marketing spending intact for da Vinci sales, we project a decline in Selling, General & Administrative (SG&A) costs as a percentage of revenues by the end of the Trefis forecast period in 2019, as overall revenues grow much faster. However, the aforementioned concerns could compel Intuitive Surgical to further ramp up sales efforts in order to convince physicians and hospitals, thereby pushing SG&A costs up significantly.

The downside to our price estimate could be significantly higher if we take other factors into account like a decline in average instruments or accessories spending per unit and lower gross margins.

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1. Robotically Assisted vs Laparoscopic Hysterectomy Among Women With Benign Gynecologic Disease, JAMA, Feb 20 2013 [↩] [↩]
2. Intuitive Robot Probe Threatens Trend-Setting Surgeries, Bloomberg, Feb 28 2013 [↩]
3. Robot Surgery Isn’t First Choice for Uterus Removals, Bloomberg, March 16 2013 [↩] [↩]
4. Has the Halo Been Broken on Intuitive Surgical ?, Citron Research, Dec 19 2012 [↩]