Intuitive Surgical: Renaissance healthcare play

ISRG generates revenue from both its flagship products through the sales and sales-type lease arrangements. For the former, revenue is recognised upfront while for the latter, particularly in operating lease transactions or usage-based arrangements, revenue is recognised over time. The company also earns recurring revenue from the sale of instruments, accessories and services along with the operating leases through its da Vinci and Ion endoluminal systems. The company derives almost 70% of its revenue from the US and the rest of its turnover comes from overseas, mainly Europe and Asia.

Our case for ISRG is that it is a healthcare play with a profitable business model and strong moat — a medium- to long-term healthcare play with some risk stemming from its slightly expensive valuations. The company’s business model is centred around minimally invasive care (MIC) and we think MIC is crucial for patient care, especially in surgery and other acute medical interventions.

Firstly, it is important to note that the alternative to MIC is traditional open surgery, which has many limitations such as longer hospitalisation and recovery times, higher hospitalisation costs, and additional pain and suffering. ISRG’s systems, being robot-assisted, are more dependable as it utilises technology. For example, surgeons are able to use a range of robot-assisted surgical instruments analogous to the motions of a human wrist, while filtering out the tremors which is inherent in a surgeon’s hand. This is why ISRG’s products are much safer to use and more life-enhancing.

ISRG’s systems are one of a kind in its field too and solve many practical problems faced by the healthcare system while enhancing the quality-of-service healthcare institutions provide. Firstly, the company’s products and services improve outcomes of surgeries, operations, and acute medical interventions through state-of-the-art technology. Lower variability leads to more predictable outcomes and surgeries are more likely to be successful with robot-assisted systems.

Secondly, patient experience is enhanced by minimising the trauma caused to patients physically as surgeries can be more precise. For example, surgeries can be performed through small ports rather than the alternative which require larger incisions. Mentally, it should be a better experience too, as patients feel safer knowing the percentage of error is much smaller with a robot-assisted system. ISRG’s systems can also be optimised for the care environment, which makes them more dependable and have stickier demand. Further, the total cost to treat per patient can be lowered through ISRG’s systems, compared to existing alternatives, which ultimately provides a return on investment for hospitals and healthcare institutions, and value for payers and patients.

The value growth of ISRG depends on the worldwide trend of surgery growth, particularly for general surgery, gynaecology and urology of which the da Vinci systems are most sought after. For this year, projected growth is in the low single-digit CAGR range due to Covid-19.

The impact of the pandemic was mostly adverse for ISRG as many healthcare systems and institutions around the world diverted resources to respond to the pandemic. Though this affected the number of procedures from ISRG’s systems last year when the pandemic peaked, the volume of surgical procedures recovered towards the end of the year and early this year. The takeaway from this is that as the effects of the pandemic lessens, along with planned vaccination, ISRG will recover strongly. We think given its competitive edge in its healthcare niche, the adoption rate of ISRG’s da Vinci and Ion endoluminal system will increase exponentially, as it has been historically.

In 4QFY2020 ended Dec 31, 2020, ISRG saw a y-o-y increase for its worldwide da Vinci procedures despite the pandemic, while the installed base of its da Vinci surgical systems grew 7% over the same period. Though minimal, revenue and earnings grew for the same period as well. Operating margins are at a strong 31.3% for the period, reflecting the company’s strong competitive advantage — given the very low number of players in the robot-assisted surgery niche, and high barriers of entry through a lengthy and arduous process that would require FDA approval.

Further, this moat or competitive advantage is supported by the nature of the systems and services ISRG provides. Both the da Vinci and Ion endoluminal systems have limited lives and will wear out as they are utilised in surgery. This would then require them to be repaired or replaced. ISRG mostly provides service contracts for these systems with an annual fee — and as new models of the da Vinci and Ion endoluminal systems roll out, the older models become more obsolete. It is likely that ISRG’s clients would switch over to newer models because of lower repair and maintenance costs, better technology, and most importantly, they have the option to lease the systems rather than fully purchase it, which significantly reduces the financial burden of its clients.

The company’s financials are reliable and have shown consistent, stable growth. Over the past 15 years, ISRG has seen positive net income, operating cash flow and free cash flow. Chart 1 illustrates the historical financial performance of the company. Valuations-wise, the company appears to be slightly expensive as its yields are comparable to the risk-free-rate and the company trades at a premium to its peers for its P/E and P/B. And with a current ratio of 5.8 times and no debt, the company should not have any complications with its liquidity and solvency.

Analysts have given a target price of US$764.53 ($1,019.74), which is around its current trading price of US$762.25. Our inhouse valuation of the company indicates that this company holds a double digit average yearly return over the next three to five years. Intuitively, investors should not buy expensive stocks, but this is an exceptional case where investors should be clinical and realise the value of the business has good potential to grow exponentially over the medium- to long-term — and with good reason too, given the consistency of the company.