So far 2013 has not been a great year for Intuitive Surgical (NYSE:ISRG) as the stock is up almost 5% since the beginning of the year. The stock has had a roller coaster ride during the year. While the robotic surgical device maker continued to post robust growth in its earnings (read Intuitive Surgical Shows Robust Growth But Concerns Loom), a number of factors including numerous lawsuits, an increase in complications reported to the FDA followed by the regulator’s survey and a detailed study questioning da Vinci’s cost-safety benefits weighed on the stock price (read our note here for full details). While the company has won first of 26 major lawsuits that were filed against it, concerns have not faded completely as investors await the survey report from the FDA and outcome of other lawsuits. Barring any major negative surprise here, we believe the stock remains undervalued due to huge growth potential of the company.
- Intuitive Surgical Maintains Its Growth Momentum With Strong Growth In Procedure Volumes
- Intuitive Surgical Earnings Preview: Revenue Growth Likely To Taper In Q4 After An Exceptionally Strong Q3
- Intuitive Surgical To Benefit From The Increased Dependence On Surgical Robots In Cardiac And Lung Surgeries
- Robust Growth In Procedures, Beneficial Product Mix Drive Intuitive Surgical’s Strong Q3 Performance
- Intuitive Surgical Q3 Preview: New Accessories May Lift Revenues But Margin Expansion Likely To Be Muted
- Intuitive Surgical Retains Its Growth Momentum In Q2
While Intuitive Surgical is off its yearly low of around $450 and is currently hovering around $500 during the past month, it is still well below than the high made post Q4 2012 earnings and our current price estimate of $600. Below we discuss factors that should drive Intuitive Surgical towards our price estimate.
Huge Potential In International Markets And Expansion Of Procedures To Drive Growth
Currently, we expect continued growth in sales of da Vinci robotic surgery systems on the back of an increasing number of procedures and international expansion. International markets also provide a substantial growth opportunity for the business as penetration of the robotic surgery is very low. The medical device maker has increased its marketing efforts to promote the device in international markets like Japan while seeking reimbursement approvals for other procedures. The medical device maker increased the size of the sales force and opened two training centers in Japan during 2012, which should translate into much higher sales going forward. Further, despite difficult economic conditions and various austerity measures in Europe, Intuitive Surgical has managed to grow system sales in the region. Currently, high upfront cost of systems (between $1 million and $2.3 million per system) could be one the factors limiting sales potential. However, when economic conditions begin to gradually improve, demand should increase manifold in the region. Additionally, as the scope of procedures expands, hospitals could better justify the system costs.
With the Patient Protection and Affordable Care Act (“PPACA”), the government estimates that an additional 30 million Americans will have health insurance (either private, Medicare or Medicaid) over the next five years, which in turn will boost the number of surgeries being performed.  In addition, Intuitive Surgical has been seeking reimbursement approvals for many procedures. Assuming these efforts will soon bear fruit, we expect sales to increase meaningfully.
Further, Intuitive Surgical has been seeking to expand its scope to other surgeries. This is expected to convince more hospitals to add the robotic system as many have been hesitant due to the significant initial investment. A wider range of possible procedures will likely result in greater demand for da Vinci Surgical Systems. Additionally, new procedures may require unique instruments or accessories, which would result in incremental revenue for the company.
Instruments And Accessories Benefits From Growing Number Of Procedures
Instruments and accessories are a set of devices that facilitate the use of da Vinci Surgical Systems. Thus, the demand for instruments and accessories is directly proportional to the da Vinci systems. Further, Intutitive Surgery is seeing a continuous increase in average instrument and accessories spend per procedure due to higher sales of new supplementary products like vessel sealers and single-site kit. A greater number of procedures performed also speeds up the replacement cycle as these instruments and accessories have a limited life and need to be replaced periodically.
While the number of prostatectomies (prostate surgery) procedures performed with the system has declined following the U.S. Preventive Services Task Force’s recommendation against routine PSA screening (fewer PSA tests are resulting in fewer prostate surgeries), Intuitive Surgical has been able to manage over 25% growth in the number of procedures by targeting hysterectomies and other procedures like gynecological and general surgery. The da Vinci system became one of the preferred options for minimally invasive hysterectomies and gynecologic cancer. 
While we believe the procedure growth rate to slow down going forward, we still expect it to maintain double digit growth. International markets, in particular will drive the procedure growth. Despite facing pressure in the U.S., prostatectomy procedures are growing internationally. As the scope of procedures widens and a greater number of procedures are performed per unit, we expect the average instruments and accessory spend per installed unit to increase substantially.
Potential Downside From Cost Effectiveness Concerns
Intuitive Surgical usually targets open surgeries on the premise that the robotic system reduces surgical complications and leads to a faster recovery process and lower hospitalization costs compared with open surgeries. System sales and the number of procedures grew substantially due to these claims, coupled with a strong marketing push. A lack of large-scale randomized trials comparing robotic surgery with other minimally invasive surgeries has also worked in its favor. While limited available data failed to show that robotic surgery was superior to other minimally invasive procedures, this hasn’t deterred patients and hospitals from using the system historically. 
However, a recent detailed study conducted by researchers at Columbia University indicated that the cost-benefit ratio of using the robotic surgical system to perform hysterectomies is not favorable. This was followed by similar observations from the American Congress of Obstetricians and Gynecologists, an influential group that represents over 56,000 U.S. physicians. These events could drive hospitals and open surgery patients toward more cost-effective laparoscopic hysterectomies.
- FACT SHEET: The Affordable Care Act: Secure Health Coverage for the Middle Class, White House, June 28 2012 [↩]
- Company Profile, Intuitive Surgical [↩]
- Questions Arise About Effectiveness of Robotic Surgery, Physicians News, May 03 2013 [↩]