Is This Highly-Anticipated Gene Therapy in Trouble?

Novartis' (NVS 0.72%) Zolgensma could revolutionize how patients with spinal muscular atrophy are treated. A one-time gene therapy, Zolgensma provides patients with a functional copy of a missing gene, restoring the production of a protein critical to survival. Despite its effectiveness, its expected approval in May could be in jeopardy, following news of a patient death that could have been the result of Zolgensma. Is this game-changing therapy destined for the dustbin?

In this episode of The Motley Fool's Industry Focus: Healthcare, analyst Shannon Jones and contributor Todd Campbell explain why this drug could still win approval. Also, Jones and Campbell weigh in on Intuitive Surgical's (ISRG -0.50%) first-quarter earnings miss. Listen in to hear why they think the robotic-surgery company could be a bargain worth buying.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on April 24, 2019.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every single day. Today is Wednesday, April the 24th. I'm your host, Shannon Jones, joined by Foolish guru, healthcare specialist, good guy all around, Todd Campbell. Todd, how are you?

Todd Campbell: I'm good, Shannon! Hey, Shannon, you know what I really love?

Jones: What is that? Me?

Campbell: [laughs] Yes, absolutely! I love the show! I love when great companies go on sale. I love it!

Jones: You're speaking my language here! I love the fact that you brought that up because that is really the first topic of today's show. We're going to be diving into a great company, a Fool favorite, that has gone on sale. We're going to be talking about what exactly is going on. And then in the second half of the show, we've been keeping you up to date on all the latest with gene therapy. We've got some news coming out of Novartis and AveXis. We'll be getting you all up to speed with that. Todd, let's dive right in to this bargain opportunity. Shares of Intuitive Surgical, ticker ISRG, the company behind the da Vinci robotic system, saw shares plummet about 7% in after-hours trading last Thursday. Todd, what was behind the drop?

Campbell: Earnings season always gives you one or two really great opportunities to buy good stocks on sale. [laughs] Investors have this tendency to overreact to these short-term blips on the radar. In the case of Intuitive Surgical, as you mentioned, the maker of the da Vinci surgical-assist robots, they reported earnings that were about $0.09 shy of what Wall Street's fortune-tellers were looking for. As a result, everybody got really nervous, and they said, "Oh, my God! I have to get out of this stock!" And they sent it down lower. I think that's creating a really interesting opportunity for investors, because the numbers are a lot better than what the stock price indicated.

Jones: So true. Intuitive Surgical is such a dominant player in the market. They've got a massive installed base -- 5,000 devices worldwide. They've done 6 million surgeries. Last year, 1 million of those happened. This is a company that is dominant, and I love the way that you phrased it, Todd, because this is really a blip on the radar. When you're talking about numbers actually being better than they appear, revenue was $974 million. That's up almost 15% year over year. Adjusted EPS [earnings per share] was $2.61, up from $2.44. A big part of the miss was on earnings, as you mentioned. But really, Todd, they're spending money where they should be spending money right now. This doesn't concern me.

Campbell: Right. Think about this: Robotic surgery offers some really unique advantages over traditional freehand surgery. What happens is, the surgeon is operating the robot from another location. It has 3D cameras that help the surgeon see exactly as if the surgeon was actually operating over the top of the patient. It adjusts the surgeon's movements to smooth them out a little bit. So you end up with reduced complications and faster recovery times. I think that's a huge value-add for hospitals. The last thing you want is to have to perform another surgery, or have someone be readmitted because of a complication.

As you mentioned, they are the dominant player. There really isn't anybody else out there that's even worth discussing at this point in this industry. They've got over 5,100 installed devices. Their devices are being used more frequently in other indications. It used to be that these systems were being used primarily in gynecology and urology. Now they're being used in general surgery, like hernia repair, as well. And the company continues to innovate. Like you said, yes, their expenses are increasing, and that creates a little bit of a short-term drag on their earnings. But they're increasing because they're investing in greater functionality of their systems, opening up the door to more widespread use. This company makes a lot of its money not from the systems it sells, but from the instruments and the consumables that are used each time a procedure is done.

Jones: Yeah, instrument and accessory revenue increased by about 20% to $552 million. That was about 56% of revenue. As you mentioned, the more and more that these devices are used, you see a jump in procedure growth. That went up 18% year over year. Overall, I do think this is very much short-term pain for them.

We were talking a little bit about how they're investing. They've been investing not only in technology, but also in expansion outside of the U.S., which is an awesome opportunity for them -- massive opportunity for them -- and particularly in fields like imaging and also informatics, and scaling the infrastructure to support this international expansion they're going after. They're investing in the technology to drive future growth. They're pushing the needle even in areas like with augmented reality. They have a new system called IRIS which basically allows surgeons before and during surgery to use this 3D image of the patient's anatomy, which is really innovative, very cool. They're continuing to invest in new technology, to continue to grow that massive installed base.

You mentioned a little bit, there really are no other players out there. That's not to say that they are not coming. Speaking of which, Medtronic is developing a machine to go into direct competition with Intuitive Surgical's da Vinci system. Remember, they bought Mazor Robotics last year, I believe it was a $1.6 billion deal for their spinal surgery systems. We've also got J&J [Johnson & Johnson], which announced it was partnering with Alphabet to form Verb Surgical, and they did acquire a private robotic company called Auris Health. But those to me seemed like so far away, and honestly, with Intuitive Surgical's massive installed base, the switching costs are just so high. Even if competitors come to the scene, many of these large hospital systems that have already paid for these devices, trained their physicians -- I think they've trained more than 40,000 doctors on their devices -- they're not going to be so quick to go ahead and switch to some of these competitors, especially if they can't compete on price, and with technological innovation as well.

Campbell: Yeah. One of the other things, Shannon, I want to make sure everybody understands -- in looking at this earnings report and trying to figure out why it sold off, and why I say I think the results are actually better than the stock price suggests -- is, you have to realize, to your point about the installed base and having this dominant position where it's hard for competitors to knock them out, they've penetrated all of the big hospital systems, they have the deep pockets. Now, they're looking at it and saying: How can we still get more of our systems installed at some of these other hospitals, these smaller hospitals? And what they're doing is, they're increasing the number of systems that they're leasing. I think that's important because a lot of people maybe have looked at the fact that system revenue only grew 6%, and said, "Wait a minute, what's going on here?" But a lot of that was because of the fact that they're leasing more of these. And as they're leasing them, they're spreading out the revenue across the lease term. You're not getting that one big up-front uptick in revenue from selling the actual system; instead, you're amortizing it over the whole period of time. I think they said that of the 5,100 they have installed, a little bit less than 500 are operating leases. And they reported about $20 million in revenue from those operating leases, which was double a year ago. I think investors need to realize that this is, yes, a short-term hit on the system revenue side, but it actually creates more recurring revenue. That's great because it provides clarity. Clarity is something investors love, right, Shannon?

Jones: Absolutely. Diving a little bit more into the leases, you did see an uptick in these leases that happened quarter over quarter. There are these near-term headwinds associated with that. But as these devices are leased out to these hospital systems, you get more and more physicians trained on the systems, they continue to grow procedures over time. A short-term hit for what I think will just be a much bigger longer-term opportunity for a lot of these smaller systems.

The other factor is trade-ins as well. Customers are trading in these da Vinci systems for newer ones. The company does actually give credit toward the purchase of these newer systems, so you do see a slight decline in average selling price. But again, customers who are trading up are more likely to perform more procedures, which should drive revenue over the long term.

Campbell: Right. Future growth, where would it come from? I think that you can increase the number of procedures per installed machine. They reported that they grew by mid-single digits in procedures per machine. And then of course, as more procedures are eligible for using these machines, hospital systems will add more machines. There is, obviously, a capacity component to that. Maybe we'll have two machines, three machines. So even though they're getting pretty penetrated as far as systems, there's a really good opportunity for consistent double-digit procedure growth. And I think that's really what's going to drive this company's results in the future.

Plenty of cash. It's got $5 billion in cash, doesn't have any debt. I think this is a really good opportunity. It's not a value stock, but you're buying it cheaper than you could have a few weeks ago, for reasons that I don't think those who are selling it fully understand.

Jones: Yeah, I completely agree. Definitely not a cheap stock by any means, if you look at it from a price-to-earnings basis. It stands at around 44, about twice as expensive as the broader market average right now. On a PEG [price/earnings to growth] ratio perspective when you factor in growth rates, Intuitive is right at about 3.7. Not a cheap stock. But, if you're looking for a long-term winner who will continue to dominate this market, I totally agree, Todd, now is a perfect time to buy.

We've been covering the gene-therapy space, keeping all of our listeners up to date on all the latest developments. The latest news coming from Novartis, ticker NVS, and AveXis with their gene therapy has not been so exciting, though. Todd, the news that came out of Novartis probably could not have come at a worse time for the company, who was attempting to land a landmark FDA [Food and Drug Administration] approval.

Campbell: Right. Novartis spent $8.7 billion to acquire the rights to Zolgensma, a one-time gene therapy that's under FDA review for approval in a condition called spinal muscular atrophy, an ultrarare disease. SMA is a condition in which a genetic mutation makes the body unable to produce a particular protein that's necessary to maintaining healthy nerves and muscles. Because of that, most of these patients end up dying before their second birthday. Obviously, that means that there's a significant need for new approaches. Now, there is a drug that's already on the market for this indication, but it requires multiple injections per year for life, and it doesn't work for everybody. So expectations or hopes were very high that Zolgensma, if approved, would provide a one-time functional cure for this patient population.

Unfortunately, news came out this week saying that one patient passed away in a trial that's ongoing in Europe. The investigators, the people who are looking at this stuff, think that it could be the result of the treatment, Zolgensma. Whether or not that actually derails approval, though, Shannon, is unknown. Remember, this is a very, very devastating condition with a very poor survival rate.

Jones: Yeah. With news like this, of course, there's always a plethora of bad news in the world of biopharma; [we] especially don't like to see it when there are children involved. But like you mentioned, Todd, SMA is a progressive disease. You mentioned that many of these infants don't even make it to their second birthday, and are oftentimes, within that last year, on ventilators trying to hold on. The need here is huge. Biogen (BIIB 0.23%), of course, does have Spinraza on the market for SMA. Zolgensma is hoping to be the first gene therapy for this particular type of SMA -- specifically type 1, at least initially -- if they are able to get approval, which could come in May, so next month, even early June. They're really on the cusp of hopefully getting approval for a very, very serious disease.

But if I'm Biogen right now, I'm thinking, Spinraza is my bread and butter. It's really what's been driving the business. The most formidable competitor right now has some question marks on safety. I'm thinking OK, we might be OK. Even if it gets approved, there may be enough safety concerns that physicians are unwilling to prescribe it as much as Spinraza.

Campbell: It'll be very interesting to see, if it's approved, how doctors view the availability of Zolgensma. You have to take a couple of things into consideration when weighing the pros and cons associated with this potential gene therapy. When asked about or when addressing the fact that there was this patient death, Novartis came out and said, "This is a devastating disease. Only about 8% of children survive 20 months. In the trial data that we submitted for the FDA approval, 15 out of 15 patients that were given Zolgensma made it to 20 months." I mean, that's just remarkable. They also said, "Listen, this child was identified as having five different viral infections, including RSV," which is a severe respiratory infection. So this child was potentially even more compromised, maybe, than some of the other ones who would be receiving it.

We need to see how the investigators actually view this. We need to see what the FDA says about it. Then we need to see, if approved, how doctors view those pros and cons, the safety versus the efficacy, considering how devastating the disease is.

Jones: Exactly. For Novartis, they're also hoping to get approval in Japan and the European Union later this year, as well. So it'll be interesting to watch. I do think another factor you'll have to keep in mind, and this even goes beyond Novartis and Biogen but the gene-therapy space as a whole, is pricing. Spinraza is a drug from Biogen, it's got a price tag of $850,000. Naturally, Biogen has gotten a lot of flak for how it's priced this drug. You've had the ICER, the Institute for Clinical and Economic Review, issuing a report suggesting that the price be cut by about 83% based on the value and effectiveness of the drug. And then, if you remember, back in August, the U.K.'s agency NICE [National Institute for Health and Care Excellence], which basically decides on cost-effectiveness and which drugs will ultimately be included in the national public health system, they pushed back, recommended against treatment with Spinraza despite the substantial benefit that was seen with it. I know with ICER in particular, even though it's early, the drug's not approved, they also put out some information suggesting that this drug could be overpriced based on its value. That'll be another key area to watch.

I know Novartis right now is saying that they believe the treatment is cost-effective in the $4 million to $5 million range, which is astronomical if you think about that. Some analysts are saying more than likely they'll probably back down. Could be $2 million. We'll have to wait and see there. All in all, pricing will continue to be a major issue for a lot of these gene therapies, whether they get approved or not.

Campbell: I think the Institute for Clinical and Economic [Review] said that to meet the quality-adjusted life-years metric that they use for pricing, Zolgensma would have to hit the market with a price tag of no higher than $900,000. I don't know where the price is going to fall. Obviously, Novartis is saying, "We're saving you $4 million to $5 million over a lifetime," versus ICER saying, "$900,000 is pretty much where it would max out." It'll be interesting to see where pricing falls. Even though there are only a few thousand patients with this condition, that kind of price point suggests a multibillion-dollar drug. If you think about Spinraza, Spinraza sales last year were $1.7 billion, up 95% year over year. This is obviously a very important therapy for multiple reasons. Obviously for the impact that it could have on patients, but also for the impact it could have on investors, not only of Novartis but of Biogen, because of the show we did a few weeks back, talking about Biogen's stumble in Alzheimer's disease. This is definitely going to be one to watch.

Jones: Yeah, definitely one to watch. And yes, Biogen's Spinraza, $750,000. It was Spark's Luxturna that was $850,000, the other gene therapy that was approved for the market. You can see that range that they're playing in. As you mentioned, there'll be a lot to watch, especially as we get closer to approval with Novartis and AveXis. We'll be sure to keep all of our listeners up to date on all the latest approvals and pricing news that come out of this space.

That'll do it for this week's Industry Focus: Healthcare show! Thanks so much for tuning in! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Todd Campbell, I'm Shannon Jones. Thanks for listening and Fool on!