Will 2016 Be Intuitive Surgical's Best Year Yet?

The company has some serious incoming opportunities. But competition looms on the horizon.

Michael Douglass
Michael Douglass
Dec 22, 2015 at 11:18AM
Health Care

No one can predict the future. But there are three good reasons to think 2016 could be embattled surgical-robot provider Intuitive Surgical's(NASDAQ:ISRG) best year yet.

There's also one that could blow up all of the company's good work. But I prefer to start by thinking positively.

International growth
Intuitive reported a strong third quarter of 2015. And the press releases were littered with great numbers -- 117 da Vinci systems shipped, compared with 111 in Q3 of 2014, 37% year-over-year growth in adjusted net income, the list goes on. But one number in particular stood out: 28%.

That's how much international procedure volume using da Vinci systems grew (U.S. procedure volume grew by 12%). And while Europe is a solid contributor, the big opportunity is Asia. And Intuitive is pushing hard to grow its opportunities there.

Intuitive Surgical is in active conversations with Japanese medical societies and regulators about getting approval for government reimbursement across a number of different procedures. The most immediate opportunity is approval for partial nephrectomy, as the other conversations in Japan -- according to Intuitive Surgical CEO Gary Guthart -- are "ongoing but... not yet at that level of rigor for the '16 review, and as a result, I don't think it's likely that they'll be included in the '16 book." (This and other quotes come from S&P Capital IQ.)

New products
Intuitive Surgical is rapidly developing its da Vinci SP (single-point) system. And management has assured analysts several times that everything is going on schedule, but no one has been willing to share what that schedule is -- whether 2016 or later. As you can imagine, a good launch could do great things for Intuitive Surgical's top line, but timing is the big question here. SP should help Intuitive grow its opportunity in single point-of-entry operations such as some head and neck surgeries. Regardless of timing, it's a nice long-term opportunity for Intuitive Surgical to continue growing and diversifying its market.

Strengthening margins
Intuitive Surgical has found that new products tend to achieve lower margins during the initial launch, with better margins as time goes on. That's in part because Intuitive Surgical can't negotiate volume discounts with its suppliers until, well, it gets some actual volume on parts.

Another big matter is that the company actively works to re-engineer its products for better cost savings. According to CFO Marshall Mohr, the re-engineering benefit has been muted thus far, but the company will see "more of the benefit... in 2016 and even more in 2017." Just how much that benefit will be remains to be seen, but that could be a nice tailwind for the company as it gears up for the SP launch.

One big fly in the ointment
Healthcare behemoth Johnson & Johnson (NYSE:JNJ), best known for Tylenol and Band-Aids, also has a massive presence in medical devices. Johnson & Johnson and Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG) execs recently shared more details about a previously announced joint venture to develop -- you guessed it -- robotic surgical tools. Now, it's not as if Verb, the name of the joint venture, is going to immediately release a robot that's better than Intuitive Surgical's da Vinci Xi. Intuitive Surgical definitely has a big first-mover advantage here.

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But now that they've proved out the business model, J&J is seeking to improve on it with a smaller surgical robot -- and some analysts, notably RBC's Henry Brandon, believe that the robot will also be significantly cheaper than the Xi. After all, J&J and Alphabet have the financial firepower to undercut on price and seize market share -- and between you and me, I find it tough to bet against the big guys in this oncoming battle. J&J and Alphabet have been coy about timelines, but J&J built a prototype of the robot last year.

It's tough to know whether this will affect Intuitive Surgical's 2016, but at some point the company is going to have to respond to significant robotic competition. Thus far they've had the market to themselves, and whether the company is able to adapt quickly is, in my mind, the most important question investors should be asking over the long term.