Is This Robotic Surgeon Broken Beyond Repair?

Intuitive Surgical (NASDAQ: ISRG  ) has been on a roller coaster ride over the past 12 months. The maker of the da Vinci robotic surgical system, once considered a top growth stock in the health care industry, has tumbled on concerns about its safety, efficacy, and market saturation.

The company's third-quarter earnings, which revealed a big drop in system sales, failed to assuage anxious investors, and the stock tumbled nearly 8% after hours on October 17.

Has Intuitive Surgical's growth story grinded to a halt, or is this just a temporary lull that represents a long-term buying opportunity?

System sales fall in the third quarter
For its third quarter, Intuitive Surgical earned $3.99 per share, or $156 million, down from the $4.46 per share, or $183.3 million, it earned in the prior-year quarter. Although the company's bottom line topped analyst estimates, revenue fell 7.2% to $499 million and missed the Bloomberg consensus estimate of $525.9 million.

Let's take a closer look at Intuitive's three main business segments -- systems (sales of da Vinci systems), instruments and accessories (for the da Vinci), and services (also for the da Vinci). Simply put, the company's entire business model depends on continued growth of its systems segment, on which its other two segments rely on.

Segment

Q3 Revenue

Growth (YOY)

Percentage of Total Revenue

Systems

$159 million

(32%)

32%

Instruments and accessories

$239 million

10%

48%

Services

$101 million

15%

20%

Source: Intuitive Surgical Q3 earnings report.

Unfortunately, Intuitive failed to deliver the growth in systems sales that investors were hoping for. Total da Vinci units sold dropped 54% from the previous year.

The company blamed the poor system sales on the moderation of growth in benign gynecology and hospital budget cuts, but those were the exact same problems that the company cited during the second quarter.

However, Intuitive reported that da Vinci surgical procedures grew by roughly 16% year-over-year, fueled by growth in general surgery, international urology, and domestic gynecology.

In other words, hospitals are still using the da Vinci more than ever, but with a steep price tag of $1.5 million plus hundreds of thousands dollars more in annual service fees, there simply isn't enough demand for new units. The market is getting saturated, and it appears that Intuitive is struggling to win over new customers.

As new system sales dwindle, growth at its other two business segments will eventually slow down as well.

The robot doctors shall rise... or not
Yet by all accounts, robot-assisted surgery is still a rapidly growing field. U.S. hospitals used robotic surgical systems in more than 350,000 operations last year, a 60% increase from 2010. The da Vinci system, which is the most well-known and popular system, allows surgeons to control tiny surgical instruments via a console to perform delicate, minimally invasive operations.

According to a JPMorgan Chase survey this month, half of general surgeons intend to install robotic systems in response to rising patient demand.

However, there are skeptics, including the American Congress of Obstetricians and Gynecologists, who claim that higher-priced robotic surgeries have not been definitively proven to be more effective than traditional surgical procedures. Robot-assisted surgical systems have also been implicated in 70 deaths since 2009. Those concerns led to a FDA probe of Intuitive Surgical in March, which resulted in an official warning letter.

To exacerbate this PR nightmare, Intuitive Surgical is dealing with high-profile injury lawsuits from 33 patients, a warning that a cracked surgical instrument could cause internal burns, and a shareholder class action lawsuit against the company for its handling of these affairs.

Are there better robotic surgery companies to consider?
With so much negativity in the air, investors should steer clear of Intuitive Surgical for now until it can get its affairs in order. However, that doesn't mean that investors should avoid the robotic surgery industry altogether.

A good way to invest in robotic surgery without too much exposure to the entire industry is medical equipment manufacturer Stryker (NYSE: SYK  ) . Stryker, which primarily generates its sales from orthopedic, surgical, and spinal neurotechnology products, recently acquired surgical robot maker MAKO Surgical (UNKNOWN: MAKO.DL  ) for $1.65 billion.

MAKO produces two robotic surgical arms -- the RIO system and the MAKOplasty Total Hip Arthroplasty -- which allow surgeons to treat patient-specific osteoarthritic diseases with minimally invasive procedures. Last quarter, MAKO's revenue climbed 19.2% year-over-year, and sales of systems actually inched up 0.6%, compared to Intuitive's 32% plunge.

Another company to keep an eye on is Accuray (NASDAQ: ARAY  ) , the manufacturer of the Cyberknife, a robotically guided laser that maneuvers around healthy tissues to deliver precise doses of radiation into cancerous tumors. The CyberKnife allows surgeons to use real-time X-ray images, rather than pre-treatment ones, to hunt down the tumor. The treatment is considered a viable alternative to chemotherapy, which kills both infected and healthy cells.

However, Accuray has been having supply issues, which caused a 15.6% year-over-year decline in revenue last quarter. The company, like MAKO Surgical, is currently unprofitable. Both companies are also tiny compared to Intuitive Surgical, which is by far the largest player in the industry.

Yet judging from their price performance over the past 12 months, investors still have more faith in these companies than in the beleaguered Intuitive Surgical.

ISRG Chart

Source: YCharts.

The Foolish takeaway
In my opinion, robotic surgery definitely has a place in the future of health care. However, they also face a risky road ahead filled with skeptics, regulators, and lawyers ready to take down these rapidly growing companies.

As the bellwether of this young industry, Intuitive Surgical definitely needs to get its act together, prove that its systems are safe, and start selling more systems before it can be considered a worthy growth stock again.

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