Deep Value Found in Small Medtech: Jason Mills
Source: George S. Mack,
The Life Sciences Report
Medical device companies need to demonstrate four qualities to
be good investment ideas, according to Senior Medical Devices
Analyst and Managing Director Jason Mills of Canaccord Genuity.
In this exclusive interview with
The Life Sciences Report
Mills shares his precise criteria and pinpoints specific growth
names that are trading at value levels.
The Life Sciences Report:
Do you have a theme currently?
With medical devices, investors must be cognizant of regulatory
and reimbursement themes. Overall that environment has been
somewhat arduous over the last couple of years, perhaps even more
arduous than in the past. Investors are not surprised by this. In
addition, some larger medical device markets are seeing more
intense competition and resultant price pressures. They are also
seeing declining procedural growth, coming down from historic
highs. That's the case in some of the areas I follow in
cardiology medtech, such as interventional cardiology,
drug-eluting stents, electrophysiology with the implantable
cardioverter defibrillators (ICDs) and even in atrial
I think medical devices tend to be a stock picker's
environment, in which not all stocks are attractive at any given
time. There are some obvious reasons for the trough valuations
that we're seeing, but these also create opportunities.
Negative headwinds are obvious and baked in, but beyond that do
you see some of these stocks trading at deep value?
Yes. The valuations for the medical device sector are at levels
we haven't seen for years. Back in the early part of the last
decade-2001 and 2002, when the tech stock boom was coming off its
highs-we saw valuations in small- and large-cap companies down at
trough levels, but we're trading well below those levels
Given these negative factors, what do you look for in a medical
We believe that the most attractive medical device companies
possess a few specific characteristics.
First, we favor growth. Growth is at a premium in medical
devices today, given that there are fewer markets where critical
mass has been achieved in terms of size and continued good growth
prospects. Continued growth must be based on a large
underpenetrated patient population in which the clinical data
suggests the therapeutic modalities have improved patient care.
In our view, few medtech companies have prospects for 15%+
revenue growth over the next couple of years. We use that as a
screen in our coverage to identify strong growth companies.
Second, we look for an emerging leadership position. We favor
companies that are not just players in hot or potentially hot
markets, but that are also set to be market leaders for several
years. This status is based on differentiated technologies used
to treat conditions that are ubiquitous and for which reliable
data shows that they are doing a good job for patients.
Third, we look for a pipeline. In order to maintain a
leadership position over a long period of time, a company has to
continue to innovate. Having new, innovative products in the
pipeline is important to maintaining a competitive advantage in
some of the nascent markets over time.
Fourth, as far as being attractive for investors, we look for
companies that would fit strategically and synergistically within
a larger medical device company. The larger medical device
companies are generally growth-starved but cash-rich. They have
the wherewithal and propensity to do more acquisitions to augment
the growth profile of their large medtech franchises.
So, growth via penetration is number one; number two is emerging
leadership through innovation; number three is the existence of a
deep pipeline; and number four is desirability as an acquisition
When doing channel checks, you speak to physicians actually using
the new technologies. They are by definition more adventurous,
and I wonder how you discern if their experiences might translate
to the bread-and-butter interventional cardiologist,
cardiovascular surgeon or electrophysiologist?
TheEdwards Lifesciences Corp. (EW:NYSE) transcatheter heart valve
recently went through a very large clinical trial called PARTNER.
The company released some data from one arm of that study, and we
saw outcomes for physicians who were involved early on and could
be considered experts. Then we saw data from physicians who were
relatively new to the technology. What we saw was that newer
physicians did just as well in delivering care as the more
experienced ones. That's one way to get a sense for whether or
not a medical device and therapy are transferrable to physicians
out in the field once it becomes commercial.
The other way to discern whether a medical device will
ultimately become ubiquitous is by talking to the thought leaders
and asking them about the pitfalls and snags they encountered
early on in delivering therapy.
It always strikes me that these interventional cardiovascular
procedures are so technique sensitive that the adoption curve is
going to be related to ease of use. Where are you currently
seeing vigorous uptake of technology?
In medtech, the most excitement exists in areas where delivery of
care is becoming less invasive. If patients can spend less time
in the hospital and get an outcome that's as good as or better
than that of a patient receiving a more invasive treatment,
that's ideal. It also works from a health economics standpoint
because hospital stays are typically the most expensive component
of an intervention, whether for a surgical or a less-invasive
percutaneous medical device intervention.
From an investor's standpoint, what we typically look for is a
new device that is at least as good as the competitive,
older-generation technology. Does it address a larger patient
population? Can you deliver a superior result to the patient?
Those are some of the issues you look at, but minimally invasive
technologies have been, in general, an area that folks look to
Jason, can we talk about some examples of successful innovation
and vigorous uptake?
Yes. The first would be transcatheter heart valves. If a
patient's aortic valve is not functioning properly, you have a
very symptomatic condition that is not only life-threatening but
also affects quality of life. Typically the condition has been
treated with a very invasive, open surgical procedure-and it
still is treated that way very effectively. However, Edwards
Lifesciences and others are developing a percutaneous valve that
can be delivered much less invasively and has proven in clinical
trials to be superior in treating some patients, especially those
who are too old, too sick or too weak to be surgical
Another example is mechanical circulatory support for very
sick, end-stage heart failure patients. These left ventricular
assist devices (LVADs) have really been miniaturized.Thoratec
Corporation (THOR:NASDAQ) andHeartWare Int. (HTWR:NASDAQ) have
done a good job of reducing the size of LVADs and making them
significantly more durable. We are talking about a very invasive
surgical procedure here, but it has been made much easier and has
resulted in fewer hospital stays and improved outcomes for those
Peripheral artery disease (PAD) is another area in which we're
seeing growth. Treatment involves the use of percutaneous devices
to clear out arteries encumbered by plaque and calcium-containing
thrombi, and all the other nasty stuff that can build up in leg
arteries. Innovative devices are being developed, including new
atherectomy catheters, or new drug-coated balloons, that really
tackle the issue of PAD and, more specifically, the bad outcome
of amputations, of which there are still a couple hundred
thousand done annually in this country alone.
Can we speak about some of your specific ideas for investors?
I like Edwards Lifesciences, the leader in the transcatheter
heart valve segment; HeartWare, which is one of the emerging
companies in the LVAD heart-failure segment; andSpectranectics
Corp. (SPNC:NASDAQ) , which is an emerging company delivering
technology for excimer laser energy to treat PAD.STAAR Surgical
) is in the ophthalmology field and is at an inflection point
right now with a technology called the implantable Collamer lens
(ICL). Some like to refer to it as the implantable contact lens,
which gives you the context. It is an emerging competitor to
laser-assisted in situ keratectomy (LASIK) eye procedures, which
have complications. ICL is an interesting technology that has
been around for a while but is now being positioned as a really
solid, first-line alternative to patients who want a permanent
fix for refractive error.
We've discussed Edwards, but tell me the growth story.
The growth story for Edwards is driven by its leadership position
in the transcatheter aortic valve replacement market. We think
that market will grow to $1.5-2B worldwide, with Edwards leading
over the next half-decade. We're modeling its earnings growth
over the next couple of years to reflect its penetration of this
market. We're looking for its transcatheter valve franchise to
grow 40-50% over the next two years and really drive that
earnings growth. We think that could be a catalyst for the
I keep hearing that the transcatheter heart valve market is
really "hot." Has there been any overhype in the amount of the
growth that could occur in this realm?
I don't know that I would call it overhype. I think it's been
well debated. There are solid arguments on both sides. I don't
think anyone argues that the transcatheter valve market treats
patients who don't otherwise have options. For those patients, it
can never be overhyped.
The second company you mentioned is HeartWare International. What
is the growth story there?
It starts with our bullish stance on technologies that can be
advantageous to an ever-increasing percentage of end-stage heart
failure patients. Thoratec, which I cover as well, has done a
fantastic job of developing the market. HeartWare is following in
Thoratec's footsteps. We expect U.S. Food and Drug Administration
(FDA) approval for HeartWare's HVAD left ventricular assist
device to come later this year, likely in September. That would
put it into competition with Thoratec in the U.S. market. We see
market growth for these devices being faster than in most medtech
markets over the next several years because the patient
population is so severely underpenetrated. We estimate that there
are about 40,000 (40K) applicable patients for LVADs in this
country, with less than 10% penetration to date. We think the
penetration level can rise to as much as 30-40% before we should
start to worry about growth decelerating markedly. We have a long
way to go. Both Thoratec and HeartWare should compete
successfully in this market, but HeartWare is going to grow from
very little share right now.
What percentage of LVAD candidates are awaiting heart
Theoretically all of them, but donor hearts are not available.
Heart transplants would be ideal, but there are somewhere between
2-3K hearts, at the very most, available at any given time. The
likelihood of getting a donor heart is very low. The LVAD
companies are working on improving the therapy to make it less
invasive and more effective.
HeartWare recently announced an agreement to acquire WorldHeart
Corp. (WHRT:NASDAQ) for $8 million. The company's shares had been
beaten down hard. What does HeartWare get out of this? Is it
basically just intellectual property?
This deal triples HeartWare's intellectual property portfolio. It
is getting technology in the magnetic levitation (mag lev) field,
which is one way to move blood. It previously did not have
specific technology on the mag lev side prior to the acquisition.
It's another arrow in the quiver of its armamentaria. Whether or
not anything comes of it, who knows? But at the valuation it
acquired WorldHeart, it seems to be worth the money spent.
What is your growth theory on Spectranetics?
The PAD market remains underpenetrated. The end market for
procedures to treat PAD is still growing nicely-we think over
10%-which makes it one of the better growth markets in medtech.
Spectranetics has a litany of devices based on its excimer laser
and catheter technology to provide therapy. It has what could be
a "killer app" for treating peripheral in-stent restenosis, which
is the bane of interventional cardiology. There aren't too many
good options for this problem. The excimer laser catheter from
Spectranetics could prove to be a nice option for clinicians
treating that condition. We think that kind of application drives
the vascular intervention business over the long term.
On the lead management side, Spectranetics has a frontline
technology to extract expired leads. Many thousands of ICDs and
pacemakers have been implanted over time. Some good quality
clinical data proves that taking the leads out, especially when
they're infected, improves a patient's survival rates markedly.
Spectranetics has seen positive tailwinds in that business. We
think both of those areas are primed for accelerating growth over
This question applies to both Spectranetics andVolcano Corp.
(VOLC:NASDAQ) . Are either of these companies developing
diagnostic or therapeutic tools for vulnerable plaques?
Volcano has been very active in the area of detecting vulnerable
plaques. Spectranetics, to my knowledge, has not been involved in
the diagnosis of vulnerable plaques.
Do you have a story on Volcano, which is in the invasive
intravascular imaging and precision guidance market?
We have a Hold rating on the stock. We've been on the sidelines
given the general sluggishness in the underlying growth of
percutaneous coronary interventions (PCI). The company has done a
phenomenal job of outgrowing the underlying trend in the PCI
market, which has been weighed down by reports of overutilization
of stents. But Volcano has risen above the fray. There has been
underpenetration in the use of intravascular imaging, and the
company has done a phenomenal job of developing that market. It
has an emerging leadership position in fractional flow reserve (
), which is another intravascular imaging diagnostic that has
proven in clinical trials to be very advantageous. This market is
growing, and we anticipate the company growing in the low- to
mid-teens for the next couple of years. I think it's one of the
best-managed medtech companies in my universe. But we see it as
being near full valuation right now, so we're looking for a
better entry point for our investors.
Any other company that you would like to comment on?
Another big medical device growth area is atrial fibrillation. I
followAtriCure Inc. (ATRC:NASDAQ) , which just received FDA
approval for a surgical medical device to treat the problem. I
think AtriCure has some fantastic prospects over the longer term.
It is trying to put its training and education initiatives in
place to develop the market, which is challenging for any
company, let alone a small company. But I think it will get
there. I think it is very well managed with tremendous prospects
for growth given that the market presents a big frontier for
medical devices and remains underpenetrated.
Does AtriCure get a bad rap because of the U.S. Department of
Justice issues that it faced?
No. I think that is largely behind the company. The stock
experienced a big impact from that, but the management team was
open with the Justice Department and answered all its questions.
ArtiCure paid a small fine and is now moving forward as a better,
stronger, quality-controlled company.
Many thanks to you. I've enjoyed this.
I appreciate it.
Jason R. Mills joined Canaccord Genuity after leaving First
Albany Capital, where he was managing director and senior
analyst covering the medical devices sector, with a specific
focus on the areas of cardiovascular health, ophthalmology and
sleep disorders. Mills previously served as a vice president
and senior research analyst with Thomas Weisel Partners, where
he covered companies in the ophthalmology and sports
medicine/arthroscopy sectors. Mills holds a master's degree in
sports administration from Ohio University and a bachelor's
degree in economics from Yale University.
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1) George S. Mack of
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