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SurModics Stays in the Hot Spot

Advanced coating and drug delivery developer SurModics (Nasdaq: SRDX  ) reported first-quarter earnings after the bell on Wednesday. Even though management made use of the dreaded "record revenue and earnings" boast, the numbers looked fairly clean. Sales were up 16% over the prior quarter, but up only 4% over the fourth quarter -- continuing the company's somewhat erratic history of sequential growth.

Although SurModics has over 80 income-generating product licenses outstanding, Johnson & Johnson's (NYSE: JNJ  ) Cypher drug-eluting stent represents almost 40% of the company's revenue. While JNJ is locked in a fierce battle with Boston Scientific (NYSE: BSX  ) for market share of drug-eluting stents, the overall market is still growing and JNJ's monopoly position in Japan (at least until 2006) should mean continued royalty growth for SurModics.

SurModics occupies a hazy world between biotechnology, pharmaceuticals, and medical devices. Similar to Motley Fool Hidden Gems recommendation FlamelTechnologies (Nasdaq: FLML  ) , as well as NektarTherapeutics (Nasdaq: NKTR  ) and EmisphereTechnologies (Nasdaq: EMIS  ) , SurModics helps companies find better ways to deliver medications or other types of therapy. Unlike those other companies, though, SurModics is completely focused on the medical device applications for its technologies.

In addition to drug-delivery products like the Cypher stent coating, SurModics develops coatings for devices like catheters, pacemaker leads, and other implanted devices. While some coatings are meant to deliver drugs, other types of coating help add lubricity to devices or reduce the likelihood of producing clots or excess tissue growth.

While the company has historically focused its efforts on developing coatings for large clients like JNJ and Abbott Labs (NYSE: ABT  ) , SurModics has begun to develop some of its own products. Having recently purchased privately held InnoRx, the company now has ownership of a coated coil being developed for eye diseases like macular degeneration and diabetic macular edema.

While SurModics sports an A-list of partners and licensees, it also sports an A-list valuation. Though priced roughly in line with peers like Flamel or Nektar, the stock trades at almost 10 times sales and even the forward P/E is a robust 26.5. Though SurModics has revenue and earnings, it is still more akin to a biotechnology company than it is to a medical device company. While this stock breaks most of the rules regarding valuation, it's neck-deep in a hot space. For aggressive investors who aren't troubled by sky-high valuations, this could be an intriguing way to play the growing integration of drugs and medical devices.

Want to read more about drug delivery? Check out these other Foolish articles:

Fool contributorStephen Simpson, CFA, owns shares of Johnson & Johnson.

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