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Transcatheter valves still make up one of the relatively few therapeutic areas in med-tech that is both large and growing at a significant rate. That does not mean that it's all downhill for Edwards Lifesciences (NYSE: EW ) , however, as the company continues to struggle to meet expectations in the U.S. and hold off Medtronic (NYSE: MDT ) in the marketplace. Good market positions in tissue valves and critical care will help some, but the twin challenges of competing with Medtronic and overcoming disappointment with the company's growth are likely to still weigh on the stock.
Fourth quarter results don't really hit where it counts
Edwards' fourth quarter results will go into the books as a technical beat, but it's not likely to be one that's going to thrill a lot of investors. Transcatheter valve revenue was up 22% in constant currency and adjusting for a sales return reserve, but U.S. sales were once again short of expectations. Not only have U.S. Sapien sales been basically flat for three quarters, the company continues to miss lowered expectations. With that, the better-than-expected sales in international transcatheter valves is a welcome offset, but most likely a sign of an underlying market recovery as opposed to share gains (we'll know more when Medtronic reports).
Revenue outside of transcathether heart valves was up about 5%, which was better than expected but not likely enough to get investors really excited about the company. Edwards remains a very strong player in critical care, but this is not a growth market anymore (up 2% this quarter). Like St. Jude Medical (NYSE: STJ ) , Edwards reported an uptick in heart valve procedure growth (outside of transcatheter procedures).
Margin analysis is hampered a bit by the noise created by the sales reserve, but it looks as though Edwards was a little light on gross margin. The company compensated with slower growth in SG&A and R&D spending.
... and here comes Medtronic
U.S. approval of Medtronic's competing transcatheter valve, the CoreValve, was not seriously thought of as an "if" question, but rather a "when". As it turned out, though, that "when" came months earlier than expected when the FDA approved the device in mid-January of this year. Although Medtronic will probably not secure approval for the CoreValve in high-risk patients until later in the year, I don't imagine that will make a tremendous difference.
I've talked before about some of the technical/mechanical differences between Edwards' Sapien and Medtronic's CoreValve, but that's not the only competitive factor to consider. Medtronic has a very large presence across cardiology (pacemakers/ICDs, stents, bypass machines, etc.) and can not only leverage a large salesforce, but also use bundling to enhance its sales efforts. Although clinical data have shown that experience with a valve has a lot to do with clinical outcomes, it is my believe and expectation that even modest price competition (whether overt or through bundling) from Medtronic will result in significant share shift from Edwards to Medtronic.
It's not just Medtronic, either...
If it were just Edwards-versus-Medtronic, things could go a little more smoothly for Edwards. Remember, Edwards has done pretty well in court against Medtronic so far. Courts in this country are usually hesitant to block an infringing device altogether, and Medtronic may well owe meaningful royalties to Edwards. However, there are other threats out there.
I have stated before that I believe St. Jude Medical and Boston Scientific (NYSE: BSX ) may well emerge as more significant threats to Edwards than Edwards bulls believe. Both St. Jude and Boston Scientific are aiming for U.S. approval and patient recruitment for those studies could very well lure away patients that would otherwise get a Sapien valve. Of course, success is not guaranteed for either of these would-be rivals. Data on Boston Scientific's Lotus valve has not been uniformly impressive, and it is likewise unclear that St. Jude's Portico will be able to offer enough points of distinction to truly separate itself from Edwards or Medtronic. That said, the importance of transcatheter valves to both Boston Scientific and St. Jude in terms of future growth leads me to believe they will put as much marketing muscle behind them as possible, and while neither can match Medtronic in terms of bundling, they have more to offer hospitals than Edwards.
Some Edwards bulls are looking to the mitral valve program as a significant source of future growth, but the company is behind schedule in its clinical development. Making matters worse, Canada's Neovasc just announced its first human implant of its mitral transcatheter valve (the Tiara). Likewise, the Sapein XT in the U.S. may expand the addressable market for Edwards for a time, but it's not likely to be a lasting advantage.
The bottom line
Calculating intrinsic value is always a subjective exercise, but I think Edwards is close to fairly valued on that basis (and that still assumes double-digit free cash flow growth over the next decade). With Edwards having struggled to establish itself in the U.S. ahead of Medtronic's launch, I think this year is going to be a challenging one for this company and I believe that the company will really have its work cut out to rebuild Wall Street's faith that it retains above-average growth prospects worthy of premium multiples.
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