Factors That Could Impact Intuitive Surgical’s Valuation – Part 2

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ISRG: Intuitive Surgical logo
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Intuitive Surgical

In the previous article, we discussed how Intuitive Surgical‘s (NASDAQ:ISRG) valuation could be significantly impacted if it is able to prove the efficacy and cost-effectiveness of its da Vinci surgical robotic system relative to laparoscopic surgery. In this article, we discuss how diversification in the use of surgical robots for different surgery types and potential competition from other emerging players could impact Intuitive Surgical’s valuation.

We currently have a price estimate of $479 for Intuitive Surgical, which is slightly below the market price.

See our full analysis for Intuitive Surgical

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Case 2: Diversification In Use Of Surgical Robots

Currently, the da Vinci surgical robot is used for a limited number of surgical procedures, which primarily include urologic and gynecologic surgeries. The da Vinci system is most commonly used to perform hysterectomy and prostatectomy procedures. In 2013, the American College of Obstetricians and Gynecologists stated that robotic surgery was not a preferred choice of treatment for non-cancerous gynecological procedures. However, the da Vinci system has managed to maintain a strong foothold in urologic surgeries where open surgery had been the norm. If the company is able to diversify and expand the uses of its surgical robot to cardiothoracic surgery and head and neck surgery, it could help increase the number of procedures performed. Currently, cardiothoracic surgery (which repairs the mitral valve) and head and neck surgery (which treats oral cancers occurring in the oropharynx and larynx region) categories account for only 4% of the total procedural volumes by the company in the U.S.

The market for cardiothoracic surgeries is larger than for head and neck surgery. Therefore, we assume that cardiothoracic surgeries account for 3% (out of the total 4%) of the total procedural volumes for Intuitive Surgical. In this case, the total number of procedures performed would be around 13,500 in 2014.

A study released last year estimated that roughly 4 million people suffer from mitral regurgitation and around 250,000 new cases are reported each year in the U.S. [1] In such cases, mitral valve repair is generally preferred over valve replacement. However, valve repair is considered more complex, and only around 50% of patients undergo this procedure. Based on the above data, we can estimate that there is an approximately 2 million patient (50% of 4 million) valve repair market globally, and Intuitive Surgical has a share of around 0.67% (13,500 of 2 million). Heart valve repair is most common in people who are older than 65, and therefore the market is expected to grow going forward, particularly in developed markets with aging populations. If we assume that the company can double its share in the cardiothoracic surgery market going forward, it will add an additional 13,500 procedures to its total volumes. Considering that the company performed around 570,000 procedures in 2014, this amounts to an increase of 2.4% in overall procedure volumes.

Moving on to the next category, head and neck cancer affects around 600,000 people worldwide every year, out of which 40,000 new patients are expected to be reported in the U.S. annually. If we assume that this category accounts for 1% (out of 4%) of the total procedural volume of Intuitive Surgical, the total number of procedures performed would be around 4,500 in 2014. This translates to a market share of over 11% (4,500 of 40,000) in the U.S. and 0.75% globally. The company can increase its market share in this category, as two thirds of total head and neck cancer patients are diagnosed in developing markets where Intuitive has little presence currently. This is a large untapped market for the company. Additionally, the prevalence of head and neck cancer, which is most common in patients over the age of 50, may increase in developed countries with aging populations. Therefore, the company could improve its procedure volumes in this category in developed markets as well with advancements in the da Vinci system and its related instruments and accessories. Based on the above two factors, the company could double its market share to over 20% in the head and neck surgery category in the U.S. by the end of our forecast period, helping increase company-wide procedure volumes by over 1%. ((Head and Neck Cancer, Cel-Sci))

This could potentially help increase overall procedure volumes by around 4% from cardiothoracic and head and neck surgeries alone, even though they currently contribute less than 5% of the company’s total procedures performed. This is a significant figure, considering that the company’s procedure volumes cumulatively grew 9% from all categories in 2014.

As procedure volumes grow, the demand for da Vinci units is likely to increase, as many new hospitals and healthcare institutions would be encouraged to buy the systems, while existing customers could be incentivized to trade-in old machines and add more capacity. The sale of related instruments and accessories will also rise with growth in procedure volumes as instruments have a limited useful life, after which they need to be replaced. Rising procedure volumes mean a shorter replacement cycle, which will help improve the the average Instrument and Accessories spend per installed unit.

For an additional 3-4% yearly growth in procedure volumes through the end of our forecast period, we expect the installed base of da Vinci units to cumulatively increase by around 3-4% over our existing forecast estimates, assuming that all systems are working at full capacity (procedures performed per system has historically been around 175). However, even if the systems are not working at full capacity, the installed base and number of units sold is likely to increase as the company launches newer and more equipped da Vinci models and related instruments.

An increase in the sales growth of da Vinci systems generally leads to a rise in the average Instrument and Accessories spend per installed unit as well. For instance, with a 9 percentage point year-over-year drop in the growth rate of procedure volumes (from 25% to 16%) in 2013, da Vinci unit sales declined by about 12% and the average instrument spend per installed unit also dropped marginally by 0.3%. Similarly, with a 7 percentage point y-o-y drop in the growth rate of procedure volumes (from 16% to 7%) in 2014, da Vinci unit sales dropped by 21% and the average instrument spend per installed unit also dropped by almost 6%. This direct relationship is also highlighted by the fact that when procedure volumes grew at an average of 30% per year from 2010 to 2012, da Vinci unit sales grew at an average of 22% per year and the average instrument spend per installed unit also grew by almost 8% compounded annually.

Through our forecast period, we estimate sales of da Vinci units to grow in mid-single digits. Given the relationship between unit sales and instrument spending, we expect the average instrument spend per installed unit to increase as well, albeit at a slower pace. We anticipate that an additional 3-4% yearly growth in procedural volumes (due to diversification in the use of surgical robots) could increase the growth rate in average instrument and accessory spend per unit by around 1 percentage point per year over our existing forecast estimates. The impact of both these drivers (da Vinci systems sales and average instrument and accessory spend per unit) could provide an upside of around 6-7% to the company’s valuation.

Case 3: Potential Competition From Google and Johnson & Johnson

In a recent development, Google (NASDAQ:GOOG) announced that it is collaborating with Johnson & Johnson (NYSE:JNJ) to develop surgical robots. The complete details of the deal have not yet been disclosed. This partnership is anticipated to have a long research and development phase but it could threaten Intuitive Surgical’s dominant market position in this field in the future.

On the other hand, Google and Johnson & Johnson’s entry into this field is likely to stir public interest in robotic surgery that may boost market acceptance of such devices, which could eventually help Intuitive Surgical as well. Therefore, the company is likely to gain from improved market acceptance of its product but may face stiff competition from Google and J&J if and when they actually launch a surgical robot. We will keep an eye on the developments on this front.

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Notes:
  1. Percutaneous mitral heart valve repair, ncbi.gov []