Shares of innovative healthcare company Outset Medical (OM 7.83%) are trading for about 25% less than their 52-week high, even after a recent rally. In this Fool Live video clip, recorded on Aug. 23, Fool.com contributor Jason Hall discusses why Outset Medical could be worth a look for patient long-term investors now.
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Jason Hall: So, Outset Medical is a really interesting business and like a lot of other Fools, Brian Feroldi put it on my radar. My mind just went completely blank, had a Monday moment there. It's a dialysis machine business essentially providing dialysis services, which might sound really boring, and like OK, but it's very disruptive. The company manufacturers a dialysis machine that is substantially smaller, substantially simpler to operate, and has substantially lower operating costs than the entrenched players in the dialysis business of which there are some really big ones. It's FDA cleared and the growth metrics have been quite good, doubling revenue, adding lots of patients that are using it.
This is a device that's really interesting, not just because people can actually use it at home for chronic treatment, which is a massive improvement in quality of care, but there are some substantial benefits for healthcare providers, particularly hospitals to be able to utilize Outset Medical's system to provide dialysis. A lot of hospitals tend to outsource this to dialysis specialists, upside of that they don't have to have skilled people that know how to do it. They'll let the experts deal with that specific thing. The downside is they generally don't get much of a cut from it.
With Outset Medical's device, it's much simpler to use. The company does a really good job providing training. Healthcare providers, hospitals, medical centers can bring this in-house using existing nursing without having to add substantial training, substantial infrastructure for these more complex, larger machines, and that can add substantial funds to their bottom line. Now, dialysis in particular takes a very outsize cut of healthcare. I think it's somewhere around 7% of the spend for 1% of the patients. It's incredibly expensive and creates additional burden on the healthcare system. This is one of the reasons Outset Medical is targeting this. It's because it can help drive down that cost of care, improve outcomes for patients, and the growth is there. The growth rates are really good, but starting from a very low base. These guys are basically just now ramping up and selling their machines.
How does Outset make money? In theory, it makes money selling the machines. That hasn't happened yet. But the metrics are getting much better, the year-over-year quarter was negative 57% gross margins in equipment. I think it was down to about negative 7% this past quarter as they get operating leverage as they scale up in that manufacturing. Their total gross margins increased from negative 40% a year ago and I think this last quarter. The first quarter of the year was about 4% and it's about seven or 8% in this last quarter. You're seeing as operating scale goes up as the patient load increases, the margins are getting better. Starting to drive the leverage of adding that scale and that's positive.
Now, here's the thing that you have to watch right now. I'm going to talk our both sides of my mouth here a little bit. I was talking about SoFi increasing their operating costs. That's something I'm watching and concerned about that I want to see them leverage their tech more and remain lean and that they're not really at a point where that's happening. Frankly, it's the same story with Outset Medical, their operating costs are skyrocketing. They're growing at a very high rate, but out of necessity. The company is getting into more markets. It's working with more payers, it's working with more providers and it has to have physical people in those areas to train healthcare workers, to train patients, to make sure people can use the equipment, to make sure that it can service its installed based on machines, which brings us to the way the company makes money.
Again, eventually, it should make money selling machines. It also makes money and its best margins right now are on the cartridges that go into the machine for each dialysis treatment and there's also it makes money servicing and repairing the machines. Those are the three buckets that it operates in. What's our favorite medical device company that makes the da Vinci surgical machines? Intuitive Surgical. I'm not calling it an Intuitive Surgical because at the end of the day, Intuitive Surgical has a gigantic addressable market in terms of all of the different procedures that its machines can be used for. But with the $2 billion market cap, Outset Medical is really interesting on a very expensive part of the healthcare load. It's also one that's growing, spending on dialysis is growing about 7% or 8% a year in the U.S. The need is very strong. I think it's a really interesting business, very compelling and it's really compelling at these prices.