It really wasn't that long ago when rampant enthusiasm for minimally invasive heart valves sent the shares of Edwards Lifesciences rocketing from around $22 to almost $110 per share in about four and a half years. While the stock was in the $90s, I dutifully played my role of Cassandra -- pointing out that analysts and investors were getting carried away with their expectations for the adoption of transcatheter heart valves and underestimating the risks of competition from companies like Medtronic (NYSE:MDT).
As it turns out, a lot of those fears were well-founded. Sales in the U.S. have disappointed for four straight quarters now, and the shares have been cut down by near 40%. Although I do believe that transcatheter heart valves will go down as a significant move forward in the treatment of valve defects, I also believe that Edwards has likely put too many eggs in this basket and under-invested in other parts of the business. With less initial enthusiasm for transcatheter aortic valve replacement, or TAVR, in the U.S. than expected and more competitive risk from Medtronic, St. Jude Medical (NYSE:STJ), and Boston Scientific (NYSE:BSX) than the bulls wanted to acknowledge, Edwards is still looking at a rough couple of years for growth and expectations.
The technology is sound, but the market needs time to develop
Edwards made a good decision years ago when it decided to prioritize and refocus on higher-growth, higher-margin products to offset sluggishness in its historical core markets of surgical heart valves and critical care products. Likewise, directing resources to TAVR was a good decision.
There's little question that TAVR is a big leap forward for those patients who have such elevated risk factors that they are not candidates for surgical heart valve replacement. Unfortunately, that's a market of about 150,000 patients per year. While high-risk and medium-risk patients can double that addressable market, it's going to take quite a bit more time and data to drive adoption there.
Edwards has already shown that its Sapien valve can deliver significant benefits in inoperable aortic stenosis patients, and solid data in high-risk patients resulted in an expanded FDA approval about a year after the initial approval in the U.S. What has been harder to prove, though, is the economic benefits to the procedure. While TAVR with the Sapien family of valves does result in shorter hospital stays, they're not as short as initially advertised, and that compromises the argument. In addition, the outcomes of TAVR appear to be highly experience-dependent, which means that many hospitals have taken a "go slow" approach with their initial cases.
But competition is coming
While sell-side analysts have published wide-eyed estimates of a total TAVR market opportunity of more than $10 billion, I expect something more on the order of $3 billion to $5 billion over the next three to five years. A $5 billion market would mean about 37% overall penetration, with much higher rates (80% or higher) in inoperables and high-risk patients (50%-plus), while a $10 billion market would require better than 80% adoption -- not an impossibility, but not something that is particularly likely in the near future.
Unfortunately, it's increasingly obvious that Edwards is going to have to share that market. Medtronic's CoreValve has already proven to be a formidable competitor to Edwards in Europe, and while neither company's valve has established a real edge in outcomes, some believe the CoreValve is easier to deliver and deploy and there is little question that Medtronic has a formidable sales force to back up its efforts. Although Edwards has secured an injunction against Medtronic marketing the CoreValve in Germany due to patent infringement, it's unclear if Edwards will succeed in other markets, including the U.S.
It's not just Medtronic that threatens Edwards, though. Both St. Jude Medical and Boston Scientific have advanced TAVR programs, with both companies looking to gain U.S. approval in the coming years. While neither of these companies have shown meaningfully better outcomes in clinical trials so far, "ease of use" considerations like the ability to reposition or remove the valve could be a differentiating factor in the market. I believe that St. Jude's long history in the heart valve market will give it some credibility when it attempts to market the Portico valve in the U.S., but I think it will take a while for either company to gain share given the potential reticence of established Edwards or Medtronic clients to switch over to a new valve and possibly have to face a new (albeit certainly not completely different) learning curve.
The bottom line
My base-case scenario sees Edwards capturing and holding about 35% of a market I believe will be worth $4 billion in five years. Should the company's legal strategy succeed in keeping Medtronic out of the game in major markets, 50% to 60% share could be possible, but I do believe the market will want at least one viable major rival. With all of that, I'm looking for long-term revenue growth on the order of about 7%, with nearly double that pace of free cash flow growth as Edwards leverages better operating margins.
Unfortunately, that's all worth about $70 per share today, and Edwards is likely to be facing solid clinical data from Medtronic at TCT this year (and ACC next year), not to mention successive updates and progress to marketing approval from St. Jude and Boston Scientific. While legal victories could certainly boost sentiment and there are additional opportunities for Edwards to build its business (including transcatheter mitral valves and/or deploying cash toward M&A), I still don't think Edwards is quite cheap enough yet to make it a top-tier idea for new money.