Intuitive Surgical Follows Buffett's Advice

An analyst on yesterday's earnings call with Intuitive Surgical (Nasdaq: ISRG  ) management asked why the company hadn't repurchased any shares in the first quarter; it didn't buy back any shares in the previous quarter, either, despite having $568 million in board-authorized buybacks.

The response from management was interesting. Gary Guthart, Intuitive Surgical's CEO and president, quoted Warren Buffett's recent letter to Berkshire Hathaway's shareholders, saying repurchases are best when these two conditions are met:

  • The company has ample funds to take care of the operational and liquidity needs of its business.
  • Its stock is selling at a material discount to the company's intrinsic business value, conservatively calculated.

Guthart concluded, "I think [Buffett] says it right. I think we are happy to emulate his behavior here."

Following Buffett is quite Foolish --with a big F -- in my opinion, but investors should be wondering which of the conditions Guthart thinks isn't being met, if not both.

Clearly, Intuitive Surgical has no problems with cash to cover operations; the company added nearly $200 million to the bank account in the last quarter, bringing cash and investments to $2.4 billion. That's a lot, but if Intuitive Surgical was going to buy something the size of MAKO Surgical (Nasdaq: MAKO  ) with a market cap of $1.8 billion, that doesn't leave much wiggle room. Maybe it's a liquidity issue, although I'd argue that a large acquisition wouldn't be the best move for Intuitive Surgical at this point. It's proved that it can drive value-developing products, so if it decided to diversify, a company like spine-surgery expert NuVasive (Nasdaq: NUVA  ) would be a better option and clearly affordable even if some of the cash were spent on repurchasing shares. And if it wanted another robotic specialist, Hansen Medical (Nasdaq: HNSN  ) with its Sensei system for catheter placement has a market cap under $200 million.

The more likely issue is that management doesn't think its shares are cheap at the moment. After the first-quarter earnings of $3.50, Intuitive Surgical trades at a P/E of 45. Repurchasing shares would reduce the P/E because earnings per share would go up -- but not by a whole lot. Each dollar spent on a buyback would essentially yield 2.2%, only slightly better than Intuitive Surgical can get holding it in the bank.

Does that mean you shouldn't buy Intuitive Surgical at this price? I don't think so. The company is still growing rapidly. Procedures were up 29% year over year, and Intuitive Surgical is just getting started with new products including single-site incisions for removing gallbladders and Firefly Fluorescence for kidney surgeries. Intuitive Surgical probably isn't "selling at a material discount to the company's intrinsic business value, conservatively calculated," but just because it isn't Buffett-dirt-cheap doesn't mean it isn't still a good buy.

Two of David Gardner's six signs of a Rule Breaker are that it has had strong past price appreciation and that it's been called overvalued. Intuitive Surgical hits both. You can read about the other four and one company he thinks has big potential in the Fool's free report, "Discover the Next Rule-Breaking Multibagger."

Fool contributor Brian Orelli holds no position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of Intuitive Surgical, Berkshire Hathaway, and MAKO Surgical. Motley Fool newsletter services have recommended buying shares of Intuitive Surgical, MAKO Surgical, and Berkshire Hathaway. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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  • Report this Comment On April 19, 2012, at 5:41 PM, TheDumbMoney wrote:

    Here is the actual text of an email I sent their investor relations department on November 7, 2011:

    "I am a very minor investor in your company, but a big believer in it, and I have made (at least what seems to me) a nice chunk of money on your stock. It therefore was a big disappointment to hear that you are planning a $500 million share buyback at this time. Not all buy-backs are created equal. With the stock price at all-time nominal highs, and pricing in significant growth (at an optimistic appraisal), now seems like an absolutely terrible time to initiate a stock buyback.

    If I recall, ISRG also bought a big building in early 2008, at a terrible time. Is this a pattern of waste? I am beginning to think that the folks running this company are great managers, great innovators, but maybe not such good capital allocators. Why not spend that $500 million on buying out (or along with some debt, buying out) one of the even faster-growing smaller robotic surgury companies? Why not hold it in reserve? It looks to me like this is a buyback initiated at a time of maximum optimism, and that has no reason for its existence, other than perhaps to reduce dilution from stock options grants to executives.... This looks to me like ISRG pulling a Netflix; doing a massive buyback when it should be reinvesting in growth, or, holding the cash in reserve until a compelling growth-investment opportunity presents itself. I'm sure many more sophisticated investors than I am are watching this closely, too. I would like to have ISRG as a long-term holding, but at a certain point I'm going to have to reevaluate that if it seems like management has a proclivity for wasting free cash flow."

    Here is the actual text of my subsequent email to them on November 22, 2011:

    "Behold, per the below, now Netflix is trying to RAISE capital:

    Is ISRG going to be in this position in a year or two? I understand the business model is different, but the board should set a book value or P/E limit, where it values the company, above which no shares may be bought. It would be a travesty if the strength of your business, and it's cash flow, is wasted on stock buy-backs, unless you are 100% sure you have no better use for that money."

    That's right, I am a total busybody, and a total tool. I claim credit! :-)

  • Report this Comment On April 29, 2012, at 12:15 AM, gatortaxpro120 wrote:

    I totally agree with the previous comment. Stock buybacks are a waste of money unless the stock, for whatever reason, is trading at a material discount to its value. This does not seem to be the case for ISRG at the present time. If you insist on returning value to shareholders, do it through dividends.

  • Report this Comment On April 29, 2012, at 3:37 AM, NYCDOG wrote:

    I have some troubles with this thread. It appears to me that Guthart is not considering a share buy-back at this time yet everyone here is acting like he is! The concept itself can't be evaluated without political/macro-economic factors being considered. Just as sub-prime rates were designed to buy votes by extending interest rates to under-financed future deadbeats funnelled by their banking facilitators- rates that a AA-rated company couldn't negotiate. So too current interest rates are being kept artificially low for all (don't count on the blow-back being less painful) Many a firm borrows funding to buy their own high growth stock and repays at these low, low rates. That 2.2% is nothing to sneeze at!

    I do not champion constant buybacks, just pointing out that the obvious per-share earnings plusses can have "wind at the back" of the re-purchaser. It's often a good thing but a savvy buyout may well be a better idea, as most here seem to feel,

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