SPAC Watch: Will This Be the Next Intuitive Surgical?

Motley Fool contributor Brian Feroldi brings another innovative healthcare company to the show: Vicarious Surgical. The robotic-surgery company will come public via a merger with special purpose acquisition company (SPAC) D8 Holdings (DEH), and in this episode of Industry Focus: Wildcard, we talk through the robotic surgery market; how the company's planned technology stacks up to the business that created the space, Intuitive Surgical (ISRG -0.50%), and what investors need to keep in mind with investing in pre-revenue businesses.

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This video was recorded on May 5, 2021.

Dylan Lewis: It's Wednesday, May 5, and we are talking about a new challenger to Intuitive Surgical. I'm your host, Dylan Lewis. I'm joined by fool.com's vivified veteran, victim of vast vanishing value, Brian Feroldi. Brian, how are you doing?

Brian Feroldi: Dylan, happy Cinco de Mayo to you.

Lewis: Happy Cinco de Mayo to you, too, and for any Arrested Development fans out there, happy Cinco de Cuatro, wound up hitting that one yesterday, they always come back to back. Brian, how are you doing?

Feroldi: I'm doing great. My family is going to be celebrating with some wonderful Mexican food tonight, even though we already had it once this week. We're that committed to Cinco de Mayo.

Lewis: That's awesome. I haven't gotten there mentally yet. I don't know what's for dinner [laughs]. We haven't planned that far in advance. But I'm due to do some cooking, we'll see what winds up happening. But this is the beauty of being at home, Brian. You could spend a little bit more time thinking about the stuff you wind up having things together. Not the case for me right now, but that's all right. Been too busy preparing for today's show. We're going to be talking about a SPAC coming out, D8 Holdings. This is probably one of the more interesting companies that you've brought to the show, Brian. I think we've talked a lot about SPACs over the last year or so. They've really heated up in the market. This company that we're going to be talking about today seems to have the hallmarks of what you'd expect a SPAC to be.

Feroldi: Yeah. I think it does, and it has been like weeks since we've talked about another SPAC, what's with the dearth of ideas that we've had, so it is good to see another one coming on. SPACs have seemed to have fallen out of favor over the last couple of weeks, but to your point, when I came across this one and I started to dig in, I was like, this is an interesting one for sure.

Lewis: Yeah. For folks that are familiar with the Foolish universe and the Foolish community of stocks, this is going to be playing in a market that you may already be familiar with. They are going to be seemingly competing relatively directly with Intuitive Surgical. A lot of very happy shareholders of Intuitive Surgical probably just had their ears perk up because it's been a heck of a stock to own.

Feroldi: I've owned it for almost a decade now, and it is maybe one of my favorite businesses of all times. I love the technology that they have, I love how they're making surgery safer, a less blood loss, less time in the hospital. It's a win on so many fronts, plus a recurring-revenue business model, lots to like. What's interesting is that the company we're about to profile today is called Vicarious Surgical, the ticker for the SPAC that you can buy today is DEH. We don't know what the ticker symbol is going to be once the merger closes. But if you look back on history, there have been lots of upstart challengers that have been trying to take down Intuitive Surgical, or at least challenge its dominance. So far, all of them have struck out. Getting a surgical system through the FDA, approved and commercialized, is an incredibly difficult challenge, to say nothing of the fact that they are going up against Intuitive Surgical, which has more than 6,100 systems installed nationwide. The switching cost of these machines are immense. So it's been a very tough space to do. It's possible that what we've seen so far makes it that Vicarious Surgical actually has a chance of doing it.

Lewis: Yeah. We talk a lot about switching costs when we do our Friday Tech show together. I think recently, with some of our healthcare episodes, we've talked a little bit about how, you've what are the standard software switching costs that come with training, but particularly, when you get into the health and med tech space, you have very expensive machinery that is expected to have a pretty long useful life for most care providers. That creates an even larger burden for companies, especially disruptors, to overcome when they are trying to enter a market.

Feroldi: When you think about how difficult it is to sell one of these da Vinci systems, and again, there's more than 6,000 of them in place around the world. Physically getting the device installed in the operating room, to say nothing of all the training that has to go on with the doctor, the support staff, for the patient education, for billing. Ripping those systems out and starting from scratch would be unbelievably expensive in terms of time as well as raw dollar costs. It's a huge challenge that a company like Vicarious is facing.

Lewis: Yeah, but also one worth going after. We've seen the success of Intuitive Surgical. I think generally, we are seeing in the healthcare industry more investment in tech, more investment in smart solutions, and are questioning maybe how we've been doing things in the past, looking for ways to improve patient outcomes and also make things a little bit easier on care providers. Let's start with the patient side of this because I think it's helpful for us to give an overview of where surgery is today.

Feroldi: If you rewind the clock a few decades, most surgeries that were done were done open, wherein a big hole would be made in the patient and then the surgeon would go in there with tools and make physical changes. What's fascinating about that is that most of the complications that arose from surgery were actually not from the internal workings of the patients, but from the hole that was made in the patients to get in there surgically. Because of that, a few decades ago, minimally invasive surgery was starting to commercialize. The idea there was to make very, very small incisions into the patients to really get the trocar sized out, as small as possible. 

Over time, that developed into robotic surgery and the incisions got even smaller, and there was even less blood loss, and there was even less physical damage to the patient for the surgery. However, if you look at the numbers, even today, despite how far robotic surgery has come, only about 3% of surgeries are done using robots. There's a number of reasons why. The first one is just cost. An Intuitive Da Vinci System ranges in price anywhere from $1 million to $2 million up front. Then there's also service contracts that you have to sign. There's disposable costs for each of the products. That makes it a really good business for Intuitive, but that's just too high of a price for many patients and hospital providers to pay. The second limitation is just the learning curve of getting started on the system. It is an enormous task to sit down, and physically train yourself for how to use these devices correctly. Again, you're operating on a patient. Mistakes are incredibly costly, and can have huge ramifications down the road. When you combine those together, it's understandable why even though robotic surgery has come really far, the penetration rate globally is still so low.

Lewis: Yeah. It totally makes sense, and it also makes sense why there is interest in investing in this space because if you look at it from the patient side, we're going to borrow a couple of stats here that we see from the slide deck, from Vicarious Surgical, the complication rates from incisions. In that open surgery model, you're talking about 15% to 20%. You get down to minimally invasive surgery, it's about 1.2% and the single-port robots, somewhere in between the two. And so if you are able to reduce the complications, you are going to lead to better outcomes for our patients. That's really the paramount thing with all of this in the healthcare space.

Feroldi: Sure. Any of the proposed cost savings of robots go right out the window if there's a complication rate, and the patient has to stay in the hospital. So anything that can be done to minimize the damage to the patient's body while surgeries are happening, has huge potential to be a big cost savings down the road. That is the opportunity that Vicarious is going after.

Lewis: I think some of our astute listeners may have been paying attention as we were laying up the current state of robotics and started saying, OK, this is the disruptor that we're talking about here. What are some of the pain points that Vicarious is going to be addressing? You teed it up well, Brian. The cost side of things is huge, and the training element of things are huge. What else are they going after in terms of making it easier for providers to hop into the robotics space? Maybe choose them over Intuitive.

Feroldi: Again, this company is going to have some massive obstacles to overcome, so they really better wow with their product then. When you look at the headlines that they're promoting, they are doing just that. The biggest plus to this product is actually from the surgeon's side, and they are really promoting this thing called nine degrees of freedom per arm. If you look at an Intuitive, the robot, it's basically a straight line that goes into the patient with the little grasper on the end. They have lots of different accessories that go on that, that allow surgeons to perform different types of surgery. However, they're going into the patient at a straight line, and that limits the surgeon's range of motion when they're doing surgery inside the patient. They actually have to go through a pretty extensive planning up front before they can get the surgery to go on, because they have relatively limited range of motion. That is something that Vicarious is looking to solve, again with this nine degrees of freedom per arm. Their device has two arms that go inside the patient and if you look at them, these two arms are basically exact mimics of human arms. There's a shoulder. There's an elbow, and then there's a wrist, and at the end of two wrists, there are the graspers. Both of these devices go into the patient, and then it is like the surgeon has miniaturized hands that are operating inside the patient. That's benefit 1, and that is a big one. 

No. 2 is the incision that this device does in the patient. Intuitive single-port system is about a 2.5 centimeter cut that goes in. By comparison, this is a 1.5 centimeter cut that goes in to get this increased range of motion. That's about almost half the size of Intuitive's single-port system. Finally, is the cost of ownership here. Vicarious believes that at scale, its device will be anywhere between 5x to 10x lower cost than Intuitive's to use. When you combine all those together, that's a pretty strong selling proposition.

Lewis: Yeah, it is, and I think anyone who's ever had surgery can appreciate getting cut open less. I think [laughs] that's an easy thing for you to wrap your head around as a patient. This is one of those businesses that I think it's helpful to look at the slide deck for what they're proposing because in trying to describe it over audio, we fail it a little bit. But one of the things that I do think is very compelling, and really driving home the dexterity that the machinery offers, Brian, they have this slide basically where the machinery is right next to the surgeon operating it, and you can see it's basically set up in the same joint way that human arms are. It's very intuitive. It's very easy to wrap your head around. That seems like a big part of the narrative that they are trying to push with their equipment.

Feroldi: Yeah. Another benefit that they're touting is just the physical size and dimensions of this system. Intuitive's devices have three parts to them. There's a surgeon console, there's a viewing angle, and then there's the device itself. This by contrast is just two. The surgeon console, and the screen are combined into one. That is a small enough device, and it's actually on wheels so it can be rolled in and out of patient operating rooms fairly easily. The patient cart, the device that actually holds the robotic hands that go into the patient, that's also physically smaller than Intuitive systems. That could be a big plus for this company. If say, you can buy one of these and then you can roll it in and out of different operating rooms far easier than an Intuitive device could, again, yet another benefit that might convince some hospitals to switch.

Lewis: Yes. I think it can be helpful at times to recast certain businesses as other types of business. We tend to think of hospitals or doctor's offices as care providers, and that's what they are. It's the primary reason people go there. But if you're looking at more like a managerial accounting or financial accounting way of looking at that business, they have these smaller spaces that are being occupied. If there's someone in there, it can't be occupied by anybody else, and if there's things in that room that occupies space, it affects the amount of room that they have to put patients or other equipment, things like that. There's a defined amount of real estate that they're working with. To some extent, it's going to be zero sum. The more flexible the space is, the smaller of the equipment is, the more things that you can use that equipment for, the more compelling the offering is always going to be to a healthcare provider.

Feroldi: Especially, it depends on the healthcare facility too, right? Hospitals, yes. If you're at a massive hospital that has tons of square footage, that's one thing. If you're at a small community hospital or an outpatient facility, getting an Intuitive system in there, the physical footprint might be a barrier. If this can address that, then this company might have the ability to go after accounts that have said no to Intuitive all along the way. 

Another interesting thing here that again, jumped out to me when I was doing the research thing here is what the FDA has said. This device is not yet approved. It is still in the development phase, and the FDA approval actually won't be submitted for a few years. The company is targeting 2023. However, the FDA has looked at this device already, and they have given it the breakthrough technology designation. This is the only surgical robot to receive a breakthrough designation from the FDA ever. That is a huge feather in this company's cap and it could allow Vicarious to even charge for this device on an investigational purpose before they have FDA clearance. Plus, once the company is going through the FDA approval process, it means that senior leadership is going to be involved with the application of this product right from the get-go. Those could be major pluses that give this product a really good chance of getting through the FDA.

Lewis: Yeah, I'm glad you brought that up, Brian and gave us that sense of where it is because that's [laughs] something that can get lost when we're talking about futuristic tech, particularly in the healthcare space. This has been under development for quite some time. This is not necessarily something that is going to be working with patients tomorrow. We have to set our expectations accordingly with this, and that's a huge part of why I think this is a classic SPAC style business. It's something where there's a really compelling story, there's a really interesting market for it, but it's basically a pre-revenue business.

Feroldi: It will be for a long time. That's a really important point. The timeline that the company has laid out for us so far is that they're going to be doing some FDA pre-registration activity later this year, but they don't plan on moving forward with their first actual FDA approval until the start of 2023, with an ideal approval of the end of 2023 or early 2024. Now, because it's a SPAC, the company can go on record and give some financial projections. Spoiler. They're optimistic, shall we say? The company says that it plans to have its 100th unit on the market and operating before the end of 2025. By 2027, it plans to basically have 1,000 of these in operations. If true, that would be some remarkable growth in a short period of time, but make no mistake: Even after this SPAC goes through, investors have some long waiting to find out if this thing is going to make the FDA clearance.

Lewis: Yeah. And for folks that are trying to categorize this company, we have talked about businesses that are in similar stages where it really comes down to, "Hey, the approval is going to happen before we can really get too excited about this, " that's the case here. I think you've got to bucket this one in the same place as Nano X or Nanox.

Feroldi: Yeah. For sure. There is still a huge risk that is ahead of this company to say nothing about the commercialization effort so that is an excellent point here. This company is pre-FDA approval, which makes it about as risky as it gets.

Lewis: I think people are going to pay attention because we've seen this model work before, and we've seen it work tremendously well. Depending on where you are as an Intuitive shareholder, Brian, I don't know your basis, but it's a 100 bagger for some people. It's not quite a 100 bagger, but it's a multibagger for a lot of investors too because it has been such a tremendous growth story and it's come into the market in a way that really, it created the category in the way that we know robotic surgery. It's about $100 billion business right now. We are seeing this SPAC come through at what looks like a little over $1 billion valuation. There is [laughs] plenty of room to run if things wind up going the way that we expect they could. But there's a lot of TAM [total addressable market] that they will have to be stealing away from Intuitive or creating other use cases for it in order for that to come together.

Feroldi: Yeah. It could be either-or. That's an important point here. The company isn't necessarily banking on just physicians switching from Intuitive to this for the benefits, plus the market for surgical products is enormous. The company estimates that its addressable market opportunity will exceed $136 billion. And again, of that number, only a few percent are currently covered by robotic surgical systems. Now, the other thing this company has going for it is that it's going to be following Intuitive's footprints when it comes to the business model. It's going to be raking revenue in three ways. First, from the capital sale of the product itself. The second is from some disposable products for each surgery, and the third is from service agreements that are going to come from the sale of each. The company does estimate that within a few years of launch, it's going to have gross margins in the high 70s or even in the low 80s. That's not pie in the sky because those are the numbers that we've seen from Intuitive Surgical. Again, if the company can make this work, the opportunity is very large.

Lewis: I guess the flip side of them having to unseat someone who has already established the space is, we have the benefit of being able to stack everything that they're throwing at us against Intuitive, both currently and also at earlier stages when it was much more of a growth story type business.

Feroldi: That is the benefit of going second, [laughs] is somebody can blaze the trail for you and then you can come along and say, "We have that plus better, but we can follow in the company's footsteps and get it done." Robotic surgical today is a much easier sell than it was 20 years ago when Intuitive was inventing the field.

Lewis: Yeah. Even now it still feels kind of space-age, right Brian? [laughs] It's a little bit different than I think what a lot of people tend to picture when they hear surgery.

Feroldi: It certainly is. But again, there is plenty of clinical evidence that Intuitive has been producing for years that show the benefits of robotic surgery. Now, one thing that I do want to say here is that when it comes to making something like this work, who the management team is and who the backers are really matters. When it comes to that, Vicarious has some impressive people on board. First, the company is still led by its co-founders. Its co-founders are Adam Sachs and Sammy Khalifa. Both of these friends met at MIT as engineers and have experience working at Apple. They left seven years ago to found Vicarious Surgical, and have attracted a really impressive group of other backers behind them. This includes Khosla Ventures, this includes Bill Gates, and this includes Innovation Endeavors, which is Eric Schmidt, the former CEO of Google's fund. Those are some heavy hitters that are backing this company up.

Lewis: Those are very heavy hitters, Brian. And I think we talk about it a lot with the sub $5 billion market cap space. But management matters a lot more when you're small because it comes down to basically, management's vision for what a company can become and the motivation to make that vision happen. You tend to get that more when you have a founding team that is still in the mix. There's a little bit more passion and vision behind people that have been there since day zero of the business.

Feroldi: For sure. The other person that's worth highlighting here is the executive chairman named David Styka. He was the CFO at Auris Surgical, which is a company that was bought out by Johnson & Johnson. Auris was co-founded by Dr. Frederic Moll, who founded a company called Intuitive Surgical, so there are some deep roots here and deep ties to the surgical robot from the beginning.

Lewis: Yeah, and you always like to see it. That's what I tend to focus on when I am looking at a company that operates in a space that I just don't have great command over is, do we have some social proof that they're on to something? Can we look back at a track record that suggests there is something here? We see pretty good money in the case Eric Schmidt's funding or Bill Gates' money, going into business it's a little bit easier to get on board with something. It sounds maybe futuristic and out of your core competency.

Feroldi: Post SPAC going through, the company is going to be pretty well-financed as well as it would need to be because it's still going to be dripping red ink for quite some time. The company does say that it will have over $400 million in cash and no debts after the SPAC goes through. We don't have financial statements to go off of. We don't know what the cash burn has been historically looking backwards. We don't know what the projections are moving forwards, you can almost be assured that this company will be raising capital in the future. But that is at least a pile of cash that can be used to likely fund this company until it gets to commercialization.

Lewis: Yeah. And that's what you need for this type of business is, you need the cash on hand so that you can support all the development efforts. It's really hard, particularly for this market, to get anything that is commercialization-ready without a huge pile of cash. It's just one of the major limitations of the health and medtech space.

Feroldi: Yes. The number of barriers that have to be overcome right from the get-go for any medtech company are enormous. There's developing the product, there's getting around the patents that have already existed. There's going through the arduous regulatory approval product, and even then you still have to convince healthcare providers and payers and patients to get on board. It is a monumental challenge to do so. While this company has knocked down a few of them or at least it's off to a good start, it still has some huge mountains to climb in the year up ahead. But what we've seen thus far, it has a chance.

Lewis: Yeah, it does. There is a compelling growth story here. You said it before because it's a SPAC we have to look at some of these forward-looking financial projections, and even if they don't hit what they're thrown out there, if they hit a fraction of it it's a pretty compelling investment thesis. We're seeing a massive ramp in revenue. We're seeing a massive ramp in installed base and market penetration throwing out there. All depends on FDA clearance. [laughs] All depends on them being able to get the machines into facilities. But there's a proven track record in this space. It seems like more and more of the industry is moving in this direction. I think there's probably room for two players in robotic surgery. I don't know if it's a winner-take-all market. Very few are, Brian.

Feroldi: I think it's a winner-take-most, and Intuitive certainly has taken most. Intuitive Surgical's moat that it has built up over 20 years when it comes to the clinical data that's produced, when it's come to the 6,000 devices that are physically installed, when it comes to the training that's been going on for physicians, the moat that that company has developed for itself is very very wide. Even if Vicarious can do everything that it says that it can do, and executes flawlessly, even within six years, this company's supposed installed base is going to be one-sixth of Intuitive's current installed base. What's Intuitive's installed base going to be with six more years of growth behind it? Probably double of what it is today. There's also saying, what new products Intuitive is going to launch in response to this. They're going to get better over time as well. However, to your point, the market for surgical robots, the potential is just massive. It's a $100-billion-plus market, and the numbers are going to just grow as the population continues to age so yes, it's not going to be a winner-take everything even if Intuitive does take most.

Lewis: I'm curious, Brian, having run through the high-level of what this company does, what a future growth story for this business looks like and some of the obvious risks with this company, where does it sit for you in terms of investable ideas?

Feroldi: Well, let's dig through what we talked about that I really like. I really like that it's founder-led. I really like that this company has the backing of Bill Gates, Khosla Ventures, and Eric Schmidt. I really like that the FDA has already given this thing a breakthrough therapy designation. I understand how this product could be differentiated in the market, and I see the appeal if you were a surgeon. And I like that the addressable market opportunity here is just massive. What I don't like is that we're still two-plus years away, best-case scenario, from FDA approval. I don't like the execution risk that comes with commercialization because developing a product and selling a product are two completely different skills and you can't automatically assume that a team that's good at one is going to be good at another. And also if you look back in history, there've been several other robotic surgical companies that have just been disasters for shareholders. They also promised, had promising technology. If you bought it anytime, wow, are you down big. I think that this is going to be a great company to watch over the next couple of years. I'm not going to be diving in today because I would want to see this company get FDA approval before I would probably commit capital to it. But am I going to be watching it? Yes, I am.

Lewis: I think for a lot of folks, we talk about a business and we know at core, we're getting really four updates a year that tell us the direction of the company and whether or not the thesis is intact or the signs that the thesis is intact. Those are our earnings reports. We get the update for management, there might be news throughout the quarter that is interesting and lends some credence to whatever we may believe in terms of where our business is going. The earnings reports aren't going to be particularly helpful [laughs] for this company, because there's not going to be a whole lot to report there. We'll get management commentary and I think that'll be helpful, but what are you watching for the folks that are going to be tracking this company, let's say over the next couple of years, what are the big milestones that make you pay attention and give you a better sense that this business is on track?

Feroldi: For me, it's going to be all the commentary about any clinical data that this company can produce, as well as any additional hints that we can get that the company is going to have a more successful FDA approval. But just like we've seen with Nanox since it came public, what we said from the beginning is this is very, very risky and the only thing that matters here is going to be FDA approval of this commercialization system. They have made progress, but if you look at the company stock, it's been all over the map. It's been as low as $20 and as high as like $90 because there is nothing else to judge the company on than short-term excitement about the potential. I could easily see this company doing something similar where the stock price is just going to go crazy based on whether it's going up in momentum and those kinds of things. So that's why I'm going to focus on the signals which are going to be FDA approval and revenue, and we still have a lot of waiting to do on those two things.

Lewis: So it sounds to me, Brian, like this is a watch list stock for you, but it's a watch list stock in the sense that you're really watching the company and there's a lot of things that still needs to go right for this to be an investable idea that you're going to put money behind.

Feroldi: Yeah. For sure. I'd also love it if Intuitive swooped in and bought this thing prior to the SPAC going through. I mean, this technology does seem to be disruptive, and if they have developed this, I would love it if Intuitive made this a part of their arsenal. That's not something that they have done historically with some of the other players, possibly because maybe they looked at that technology and didn't think that it was a threat. But this, to me, seems to be the most credible threat, at least from a pure-play perspective that we've seen, so it will be interesting to see what Intuitive says about this.

Lewis: It's interesting, because I just pulled up Intuitive's balance sheet. If Intuitive thought it was an interesting acquisition candidate, the money is certainly there. They have like $4.5 billion in cash in short term investments on the balance sheet. That's like three times the implied value of this company once it comes public via its SPAC. The money is there if they think it's a good idea.

Feroldi: Yes. [laughs] Intuitive would have no problem buying this thing out if they thought that the opportunity was there. I don't even think regulators would give too much of an issue to this because again, it's not like the technology is on the market, and this is the clear No. 2, especially when companies like Medtronic, Johnson & Johnson, Google [Alphabet], etc., are getting into the robotic surgical space. So if it happened, I wouldn't oppose it.

Lewis: Yeah. Well, you'd wind up owning shares, I guess, [laughs] right?

Feroldi: That's right.

Lewis: [laughs] Indirectly. Brian, always love having you on to talk through some of the futuristic healthcare industries and businesses out there. It's always great to talk about these things. I know our listeners tend to miss our healthcare episodes, Wildcard Wednesday, so nice to give it to them.

Feroldi: Doing my best, listeners, to make sure Wednesday is always Wildcard Wednesday.

Lewis: [laughs] Listeners, that's going to do it for this episode of Industry Focus. If you have any questions you want to reach out and say, "Hey," shoot us an email at [email protected] or tweet us @MFIndustryFocus. If you are looking for more of our stuff, subscribe on iTunes, Spotify, or wherever you get your podcasts. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for all those work behind the glass today, and thank you for listening. Until next time, Fool on!