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Tuesday, December 23, 1997

Cardiothoracic Systems, Inc.
(Nasdaq: CTSI)
Phone: 408-342-1700
Price (12/22/97): $4 13/16


Cardiothoracic Systems competes in the exciting world of minimally invasive cardiac surgery. The key word here is "competes." The competition from Heartport (Nasdaq: HPRT), an early participant in the industry, and from more substantial players like Medtronic (NYSE: MDT) and U.S Surgical (NYSE: USS) have been part of the reason Cardiothoracic Systems shareholders have lost heart.

In addition, profits have been more elusive than anticipated and losses have actually widened even though the company is now selling products.

Mix those factors together with a stock that had been pushed to unsustainable heights on the hope of a new technological breakthrough and you have Trouble.


Cardiothoracic Systems makes devices used for minimally invasive cardiac surgery. Using a very small "keyhole," surgeons can do bypass surgery using the cardiothoracic devices. This procedure competes with standard bypass surgery and with angioplasty as a means to restore blood flow to the heart.

Cardiothoracic Systems' products can be used on a beating heart, in contrast to Heartport's system, which requires cardiopulmonary bypass. Until recently Cardiothoracic's procedure could only be done on a single vessel, a distinct disadvantage. However, the company recently released its ACCESS MV device that allows multiple vessels to be bypassed on a beating heart.


Income Statement
12-month sales: $6.7 million
12-month income: ($20.3 million)
12-month EPS: ($1.53)
Profit Margin: N/A
Market Cap: $65.1 million

Balance Sheet
Cash: $4.8 million
Current Assets: $41 million
Current Liabilities: $4.4 million
Long-term Debt: None

Price-to-earnings: N/A
Price-to-sales: 9.7


Both Heartport and Cardiothoracic Systems are significantly off of their highs. An April Wall Street Journal article warned of the hype surrounding these shares, and the announcement by Medtronic in May that it was entering the business should have given investors pause. Cardiothoracic Systems was the most vulnerable of these companies given that its initial product offering was only useful for single vessel surgery.

The simple truth about Cardiothoracic Systems is that, when priced at $25 a share earlier this year, it was ripe for a fall. By any valuation measure it was excessively priced and hope had won out over reality. This trouble could have been avoided by waiting for evidence of sales and waiting to see how the marketplace would receive the competing products.


With the recent release of a more versatile product, Cardiothoracic Systems looks like a better competitor. Sales have ramped up from a mere $140,000 in 1996 to over $6 million so far this year, not a bad start. The company still sells at a high multiple to sales, but with current sales growth this ratio should fall rapidly.

In Ken Fisher's book Super Stocks he explains a ratio that is useful in evaluating companies at this early point of sales, the Price-to-R&D ratio. A ratio under 15 is considered a reasonable value. Cardiothoracic's stock is currently selling at 7 times R&D, a pretty good value. On top of that, an investor is paying under twice the company's cash and marketable securities, which amount to around $3 per share.

Given the new product, more sensible pricing, and the undoubtedly huge potential for the company's product, an investor might consider these shares for the most speculative part of their portfolio. But, be wary, stocks like this can give an investor cardiac arrest.

-Mark Weaver, MD

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