3 Reasons to Sell Intuitive Surgical?

Editor's Note: The headline of this article and some of the wording has been edited to more accurately represent the analysis provided. The Fool regrets the error.

Intuitive Surgical (NASDAQ: ISRG  ) announced its third-quarter results after the market closed on Thursday. And they weren't pretty.

Revenue for the robotic surgical systems maker dropped 7% year over year to $499 million. Earnings fell 14% to $157 million, or $3.99 per diluted share. Not surprisingly, shares declined more than 7% in after-hours trading.

Should investors join the herd in selling the stock? Perhaps -- if you subscribe to one of the following three irrefutable reasons for selling derived straight from the mouth of Intuitive Surgical CEO Gary Guthart.

Source: Intuitive Surgical. 

1. You don't think hospitals will move past current financial pressures.
Dr. Guthart attributed the difficult quarter in large part to "changing hospital capital spending priorities" linked to the Affordable Care Act, commonly known as Obamacare. He's right that hospitals are under a lot of financial pressure as a result of the health reform provisions.

The main problem is that Obamacare readmission penalties and Medicare cuts have already gone into effect, while promised benefits to hospitals from the legislation won't kick in until next year at the earliest. One of the most important of those hoped-for benefits is cutting the amount of bad debt that hospitals write off in providing care to uninsured patients. HCA Holdings (NYSE: HCA  ) , the nation's largest hospital chain, wrote off nearly $3.8 billion last year. 

Obamacare isn't the only challenge, though. Reduced Medicare reimbursement levels included in the budget sequestration deal approved by the president and Congress have also hurt, resulting in HCA and others encountering financial challenges so far in 2013.

Those pessimistic about the political landscape won't find much reason to hope that prior reimbursement levels will be restored. And the problem-plagued launch of the Obamacare health insurance exchanges doesn't give much comfort to those awaiting millions of previously uninsured Americans to gain coverage.

2. You think robotic surgery is too costly or unsafe -- and will continue to be so.
Comments from Dr. Guthart hinted at another big issue facing Intuitive Surgical: perceived concerns about the cost-effectiveness and safety of its da Vinci robotic surgical systems. He noted that Intuitive is focusing on "educating our community" about the safety and cost-effectiveness of its products and listed "moderating growth in benign gynecology" as a reason for the sluggish quarter.

One possible culprit behind this moderating growth is a warning issued earlier this year by the American College of Obstetricians and Gynecologists, which told patients that "robotic surgery is not the only or the best minimally invasive approach to hysterectomy" and "nor is it the most cost-efficient."  

Multiple lawsuits have been filed against Intuitive alleging serious safety issues with da Vinci. The company, however, says that clinical studies and statistical data from procedures performed using da Vinci show that the technology is safe.

The bottom line here is that if perceptions grow that da Vinci is too expensive and/or not safe, Intuitive's revenue, earnings, and stock could fall even more.

3. You don't think Intuitive Surgical can keep innovating.
Intuitive Surgical ranked as one of the most successful stocks over the last decade in large part because of its innovation. If the company doesn't continue to innovate, it doesn't deserve a valuation richer than that of many other stocks (which it has today even after the big drop in price this year).

The technology landscape is littered with companies that were once innovative but failed to keep up. It wasn't all that many years ago that even venerable IBM (NYSE: IBM  ) was considered a dinosaur headed for extinction. Big Blue turned things around over time, of course, but it wasn't easy. Fast Company called IBM's resurgence, sparked by new innovation, "one of the most unexpected comebacks in corporate history."

Companies that lose their innovation mojo usually don't get it back. IBM is one of the few exceptions. If you think Intuitive Surgical won't innovate in the days ahead, consider putting your money on a company that you believe will.

Refuting the irrefutable
These are three reasons to sell Intuitive Surgical, but the underlying premise that these reasons are applicable to Intuitive can be refuted, in my view.

Hospitals will eventually be able to spend more on capital purchases, regardless of what happens with sequestration cuts and Obamacare. Actually, HCA's just-announced preview of its third-quarter results showed encouraging signs that the company's finances are improving. I think we'll see a similar trend across many hospital operators.

Intuitive must wage a public relations war to convince health-care providers and the public that its robotic surgical systems are safe. I think that battle is winnable and that the data is in Intuitive's favor.

The company must also persuade payers that da Vinci is worth the cost. It can do so, especially if Intuitive highlights the total cost of care including readmissions and surgical complications.

I also don't see any reason to think that Intuitive Surgical won't continue to innovate. The company is spending close to 9% of revenue on research and development. That's a higher percentage than innovative comeback kid IBM spends on R&D, by the way. There are plenty of procedures that could potentially benefit from robotic surgical technology. And that technology can surely get much better over time (improving safety and cost-effectiveness in the process).

One other thing that Dr. Guthart stated in his comments about the company's lackluster quarter is worth mentioning. He said: "We remain confident in the long-term opportunity to fundamentally improve surgery using our technologies." The important phrase to focus on is "long-term opportunity."

If you're just looking at the short term, it might make sense to avoid Intuitive. But over the long run, doesn't it seem quite likely -- probable, even -- that robotic surgical systems will get increasingly better than manual procedures? Doesn't Intuitive have a huge headstart with da Vinci, a compelling reason to remain the leader, and plenty of cash to forge ahead?

If you can answer those two questions with a "yes," don't sell Intuitive Surgical shares. Consider buying them. Because if you're right, you may stand to do quite well over the long term.

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Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 18, 2013, at 10:32 AM, ElHombre55 wrote:

    great article! I read it right after buying. The reasons I bought are:

    -- innovations to which you refer but do not specify. The advanced imaging stuff is HUGE and has barely begun to earn.

    -- awesome margins even with huge R&D spending.

    -- awesome acronym-based moat - IP, FDA approval.

    -- the ACA may depress buying temporarily. But in the long run, ACA means many more surgeries will be performed in USA. And, these will be more routine procedures, replacing procedures that are years too late and unnecessarily complicated. At this time, robots are suited more to the routine work.

  • Report this Comment On October 18, 2013, at 2:33 PM, FoolinSD wrote:

    regarding safety issues, ISRG seems to have implied that the machines were improperly installed by the hospital. Of course the media doesn't bother to report on this. Sex, murders, & etc are more import than shocking surgical equipment.

    foolinsd

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