Can Intuitive Surgical Find New Growth?

Intuitive Surgical (NASDAQ: ISRG  ) , the maker of the $1.5 million da Vinci surgical robot, has had a tough year. After peaking north of $580 last February, the stock has fallen more than 20% due to tighter hospital budgets, fewer prostate surgeries for slower-progressing cancers, safety concerns, and questions about the da Vinci's cost effectiveness for certain procedures. The da Vinci is used by surgeons to perform minimally invasive procedures such as prostatectomies, gynecological procedures, and cardiac valve repair.

The number of robotic surgeries performed worldwide surged from 1,000 in 2000 to 450,000 in 2012, according to The Wall Street Journal. That should be a positive catalyst for Intuitive Surgical, the 800-pound gorilla in robot-assisted surgeries -- so what's weighing down the stock?

Good news and bad news
On April 1, Intuitive Surgical announced that the FDA had approved a new version of its surgical system known as the da Vinci Xi. The Xi has thinner and more mobile robotic arms, which decrease the risk of them interfering with one another. That directly addresses a specific problem with the original da Vinci's arms, which the company warned could stall due to friction last November. An FDA probe last year into Intuitive Surgical also resulted in a warning letter regarding possible injuries and death caused by the da Vinci.

The da Vinci Xi. Source: Intuitive Surgical.

Intuitive Surgical clearly wants to move on from those mistakes of the past. Unfortunately, things might get worse for the company before they get any better. On April 9, Intuitive warned that it expects first-quarter sales of its da Vinci systems to decline 59% year over year to $106 million.

Total revenue, which consists of product sales and maintenance services for the da Vinci, is expected to fall 24% to $465 million. Excluding the impact of a trade-out program for older customers to swap their older systems for the newer models, revenue would still have declined 20% to $491 million.

In fiscal 2013, product sales (da Vinci systems, accessories, replacement parts, and other products) comprised 82% of Intuitive's total revenue, while 18% came from maintenance services. Intuitive's quarterly declines in system sales -- which its other businesses are dependent on -- paint a grim picture of the company's future:

Quarter

Systems Revenue

Year-Over-Year Growth

1Q 2013

$256 million

24%

2Q 2013

$216 million

(6%)

3Q 2013

$159 million

(32%)

4Q 2013

$205 million

(23%)

1Q 2014 (Expected)

$106 million

(59%)

Source: Intuitive Surgical quarterly reports.

There are two ways to look at these sliding numbers -- the bears believe that 2014 won't be any better than 2013, but the bulls believe that the storm has passed, especially with a newer system on the way to boost its systems revenue.

The good news is that Intuitive Surgical is getting cheaper from a fundamental perspective. The stock currently trades at 27 times trailing earnings -- a steep drop from its P/E of 60 back in 2010.

ISRG Chart

Source: YCharts.

Looking overseas for growth
A possible solution to Intuitive Surgical's problems is to look overseas for growth. In 2013, 72% of the company's revenue came from domestic markets -- down from 79% in 2012. This indicates that Intuitive Surgical could balance out its domestic slump with higher demand from growing markets such as China. Intuitive Surgical first entered the Chinese market in 2007 to tap into a growing, aging middle class that prefers minimally invasive procedures.

Smaller players in robot-assisted surgery have also noticed the growth potential of the Chinese market. Accuray, which manufactures the $4 million cancer-cutting CyberKnife laser system and the layered radiation TomoTherapy machine, showcased its technology at ChinaMed 2014 in Beijing last month, and some Chinese hospitals have begun adopting its systems.

Stryker (NYSE: SYK  ) , which makes orthopedic implants and medical devices, expanded its footprint in China by acquiring Hong Kong-based Trauson, one of its major Chinese competitors in the spinal trauma business, last March. It then acquired MAKO Surgical, a maker of the RIO Robotic Arm Interactive Orthopedic System, for $1.65 billion last September. MAKO had already installed the RIO in Chinese hospitals to assist with joint surgeries. With a growing footprint in implants and robot-assisted surgery in China, Stryker is another company which could benefit from the rise of the Chinese middle class.

The Foolish takeaway
In closing, if you want to invest in Intuitive Surgical, you need to believe three things -- that the Xi won't suffer from the same problems as the da Vinci, systems growth will pick up domestically, and that it can eventually flourish in new markets such as China.

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