Intuitive Surgical’s Potential Future Growth Strategy

Intuitive Surgical (NYSE: ISRG) is a pioneer in the field of surgical robotics and has dominated the area since its inception. The installed base of its da Vinci surgical systems has grown from about 1,800 in 2010 to about 3,800 as of June of 2016. But as an increasing number of companies vie for a bite of the pie, Intuitive cannot risk to be indulged in business as usual. We believe that the company can potentially adopt a leasing strategy as it enters the next lap of growth. In this article we have developed scenarios to analyse the potential impact that a growth fueled by leasing would have on the value of the company.

Our price estimate of Intuitive Surgical is $687

The Number of Systems Shipped Under Lease May Grow

Intuitive generates roughly 70% of its revenue from the U.S. We expect the next phase of growth to come from emerging economies. Below is the geography-wise break-up of the systems shipped over the last three years:

Source: Company Filings

As the company tries to expand in the emerging and relatively low income countries, leasing could facilitate market penetration. It would provide an attractive option to hospitals and clinics as the upfront expense would be lower. In the U.S., too, the company may need to provide hospitals and doctors with this kind of alternate payment options to  grow further.

Intuitive Surgical started leasing in 2013. In 2015, the total number of systems shipped on lease was about 13% of the total shipments. The customers have the option to purchase the leased systems during the life of the lease. Below is a summary of the number units shipped on lease over last four years:

                                             *2016 figures are annualized | Source: Company Filings

As of June 2016, there were 66 da Vinci Systems on operating lease. We expect the percentage of equipment shipped under operating lease to grow going forward.

We Expect Intuitive To Keep Posting Healthy Gross Margin

Intuitive has generated a gross margin of around 70% over a long period. While we expect the gross margin on systems to come down as competition intensifies, the strategy of installing systems on lease may be better than simply slashing prices. Furthermore, Intuitive generates over 65% of its revenue from replaceable accessories and systems. In general, the margin on these items tends to be higher than that on the main product. Leasing is likely to result in faster adoption and greater penetration. This should translate into higher overall revenue from sale of accessories and services and, healthy gross margin.

What May Be The Potential Impact On The Value Of The Firm?

While leasing would result in greater penetration and prevent any sharp decline in gross margin, it also means increased investment in fixed assets. The company will have to carry the leased out assets on its balance sheet. It would result in reduced free cash flow and lower ROIC, impacting the value of the firm negatively. We have built three scenarios to analyse the impact on equity:

1. Base Scenario: No change in the number of systems shipped on lease
2. Scenario 1: Only the mix of systems shipped changes to 25% by 2023,  i.e. number of systems shipped on lease increases while the total number systems shipped is same as the base case
3. Scenario 2: Total number of systems shipped increases by additional 5% (over our base case) year-on-year, attributable completely to shipments on lease

The table below gives the key metrics for the three scenario:

Results:

Scenario 1: Decrease in revenue along with higher capital expenditure results in reduced free cash flow and about 10% downside to our base case equity value.

Scenario 2: The negative impact of decreased revenue from systems and increased capital expenditure is compensated from higher sales of accessories and services as result increased number of systems shipped. The two effects balance out each other; resulting in no significant impact on equity value.

Will Intuitive compromise on profitability for growth? What will be the right mix of system sold and leased out? With so many variables at play, the next couple of years promise to be exciting in the field of surgical robotics.  Intuitive Surgical has the market position and technological foundation to lead this growing market.

Please refer to our complete analysis for Intutitive Surgical for detailed analysis.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)

Get Trefis Technology