Sharpen Your Medtech Investing Edge with Genomics, Imaging
and Diversified Supplies: Junaid Husain
Source: George S. Mack of
The Life Sciences Report
Medical supplies and diagnostics may not sound exciting, but
recurring revenue is key to restful nights and steady growth.
Dougherty & Company Vice President and Senior Medical
Technology Analyst Junaid Husain has a rule-based approach for
selecting winners. In this exclusive interview with
The Life Sciences Report,
he offers his best ideas and the logic behind them.
The Life Sciences Report:
Junaid, I'm hearing a lot of general negativity on medical
technology stocks. Analysts are complaining about slow approval
times and additional data being required by the U.S. Food and
Drug Administration (FDA). Many believe these factors have slowed
innovation. With all of this somber talk, why would anyone invest
in medtech now?
You hit on a few points that I hear over and over again when I
talk to investors. The regulatory environment is tough.
Reimbursement is tough. In 2013 we're going to be hit with a
medical device tax. With all of the headwinds the industry is
facing, where are those hidden jewels? Where is that diamond in
the rough? At the end of the day, there are opportunities in
medical technology investing. You just have to go out and find
How do you go about finding them?
I like companies that have a couple of different edges to them. I
follow four rules when I consider medical technology
Rule number one is that I look for an innovation story.
Pipeline strength goes hand-in-hand with innovation. Does the
company have technologies that are cutting edge? Does it have
enabling technologies that help physicians in areas of medicine
where there is a lot of unmet medical need? If you have a company
with a strong pipeline that can address deficient areas of
medicine, then I see this as a compelling investment
Rule number two is that it should help hospitals save money.
Can it provide technologies that can bend the cost curve? If a
technology can save a hospital money, that's a win for both the
company and for the hospital.
Rule number three is consideration of the company itself. Is
there a gross margin story? If you can expand your gross margins,
you will get upside in your numbers. Companies that can expand
gross margins year-over-year are going to be winners because that
has a material impact.
Of course, expanding gross margins goes back to rule number one:
Exactly. Can you innovate to create technologies with which you
can maintain market dominance and competitive pricing while
concomitantly reducing your cost of goods to expand margins?
Finally, rule number four is whether the company has strong
hospital relationships. I can't emphasize this enough. Companies
with the best hospital relationships, as well as those with group
purchasing organizations (GPO) relationships, are the companies
best positioned to win because it is all about product access.
GPOs and hospitals are the gatekeepers for adoption. If a
hospital or GPO doesn't want to take on your products, then you
are in trouble.
Companies that can follow these four rules are the stories
that are going to win.
Along the line of strong hospital relationships, physician
adoption is a big challenge. Are some companies better at getting
doctors to adopt new technologies after they finish their
residencies and fellowships?
You raise a very interesting point: Physicians and hospitals, as
institutions and purveyors of standard-of-care medicine, are
animals of habit. As animals of habit, they do not like to
change. They want to stick closely to the drug-eluting stent
they've been trained to use or to the hip or knee they've used in
thousands of other procedures before. Medical technology
companies are very much in tune to this.
Consider for example, Intuitive Surgical Inc. (ISRG:NASDAQ).
They are the industry leader in surgical robots. When they
introduced the da Vinci System years ago, it got traction with
urologists who were performing prostatectomy procedures. The
interesting thing about the urology demographic was that we saw a
lot of younger generation docs gravitate to the robot first.
Tech-savvy docs who grew up with Playstations, the Internet,
iPods, cell phones and the like would come out of medical school
and begin residency training programs and/or fellowship programs
in minimally invasive surgery hungry to learn the latest and
greatest technologies. And Intuitive was only too happy to oblige
these young kids. Through clever hospital marketing you got
patients clamoring for these new technologies. Soon enough, the
older surgeons started to feel a little ancient as they saw their
patients gravitate to younger docs with cool gizmos. In an effort
to keep up, the old-guard surgeons began to incorporate these new
technologies into their practices. Bottom line: In 10 short
years, Intuitive Surgical has transformed minimally invasive
surgery with da Vinci-a technology that began as an esoteric
device championed by the younger docs and is quickly becoming
One of your major focuses is genomic and molecular biomarkers.
Traditional diagnostics have had short shelf lives because of
constant innovation and new competitors. Will these genomic-based
technologies remain fresh longer than traditional
That's an interesting question. I think the best way to answer it
is that the velocity of innovation in general, whether it is in
diagnostics or pharmaceuticals or medical supplies, has
increased. Bringing that down to molecular diagnostics, I think
the shelf life of any molecular diagnostic is getting shorter.
Molecular diagnostic companies constantly need to refine and
tinker with technologies to make them better. To that point, I
follow Sequenom Inc. (SQNM:NASDAQ). It launched its diagnostic
test MaterniT21 to detect Down syndrome (an extra chromosome 21,
called trisomy 21 or T21) in mid-October 2011. It is a minimally
invasive test in which you take a blood draw on the mom in the
early first trimester and from the draw you can identify fetal
nucleic acids that have crossed the placenta into the maternal
blood circulation. Within two short months, the company had
already made changes to the test: Not only can it identify
trisomy 21, it can now identify trisomy 18 (Edwards syndrome) and
trisomy 13 (Patau syndrome). I think that we're going to see
further tweaks to this molecular diagnostic test. The key
takeaway here is that companies have to constantly innovate to
stay relevant to the healthcare audience and to stay ahead of the
You have Sequenom rated Buy with a $7 price target for an implied
upside of about 75%. The stock is down about 14% over the past
month. Is this a buying opportunity?
Yes, I think it's a buying opportunity, especially at these
Start with the catalysts. What is going to move Sequenom?
We're waiting to hear from the payers. Are the payers going to
start lining up and put the test in their networks? As we go
through the next one to two quarters, we're going to see payers
include the T21 test in their formularies. That will be catalyst
Catalyst number two is the adoption curve in general. When
Sequenom reported on its most recent quarter a couple of weeks
ago, it gave a preliminary read on MaterniT21 adoption at least
for the first two months, and that was two to three months ahead
of my expectations. Sequenom has targeted total testing volume of
about 20,000 in 2012. I think that vastly under-represents what
it can truly do. The total market for the T21 test in the country
is five million (
) pregnancies. A portion of those are not going to do the test
for religious reasons, but that still leaves a sizable number of
patients who will be interested in getting their T21 status
You follow some medical suppliers, such as Baxter International
Inc. (BAX:NYSE), ICU Medical Inc. (ICUI:NASDAQ) and others. I
realize you have a Hold rating on Baxter, but what general case
do you make for investors owning suppliers?
I like diversified medical supplies companies in
general-companies like Baxter, ICU Medical, Johnson & Johnson
(JNJ:NYSE), Abbott Laboratories (ABT:NYSE) and Teleflex
Incorporated (TFX:NYSE). These are good, solid, well-run
companies, and they have businesses that some might consider to
be fairly boring, unsexy and commoditized. But sometimes boring
is better because these are dependable businesses.
The issue here is consumables and recurring revenue, correct?
Correct. It is about consumables, recurring revenue and
businesses that are recession-resistant because hospitals need
the products in good times and bad.
Your target is $53 on ICU Medical.
I like ICU Medical. I've known these guys for the last eight
years. It is a nice recession-resistant business that has been
doing fairly well. It generates a ton of cash, about
$15-20M/quarter in operating cash flows, because it has
businesses with products that hospitals can't do without, such as
connectors, tubing, critical care and oncology products. ICU
Medical is levered to large distributors, one of which is Hospira
Inc. (HSP:NYSE), which accounts for somewhere between 35-40% of
ICU Medical's total sales. So anytime Hospira sells an infusion
pump, it also sells a contract for ICU Medical's products. It
goes back to the whole recurring revenue stream. It's a nice
business to have.
Why are you neutral on Baxter?
Baxter's business has two sides-a bioscience side and a medical
products side. A lot of investors and my colleagues on the sell
side love this stock because of the bioscience business, which
has some of the best margins in the company overall and which
investors see as a growth driver. My Hold rating is a contrarian
call. In Q312 Baxter has to shut down and move a large
manufacturing facility and assets in Los Angeles to another
facility. The move is for its bioscience/intravenous
immunoglobulin (IVIG) business. When you tinker with plasma
production, it's just not easy to turn manufacturing off and then
turn it back on again. Plasma manufacturing at Baxter is
fully-integrated-Baxter owns the entire production cycle from
soup to nuts, including the plasma collection, fractionation and
distribution. From the point where you collect the raw human
plasma to the point where you distribute it to customers in the
form of finished product requires a six- to nine-month lead time.
Plasma manufacturing is a high fixed-cost enterprise. As such,
anytime you tinker around with production, you have to be
concerned about what kind of ramifications it could possibly have
for gross margins, expenses and the bottom line.
So the shutdown is your neutral case.
Yes, this is why I'm neutral on Baxter. This shutdown is a major
headwind, which makes me cautious on the stock.
Let me move to a company you follow that is in the news right now
because of its proximity to a U.S. Supreme Court case. Are you
still positive on Myriad Genetics Inc. (MYGN:NASDAQ)? Is your
target still $28?
Yes and yes.
I noted that 80% of Myriad sales were coming from its
BRACAnalysis test for BRCA1 and BRCA2 gene mutations that
determine risk for breast cancer. That's a lot of revenue coming
from one basket, no matter what. On March 23, the Supreme Court
handed down a unanimous decision holding for Mayo in
Mayo v. Prometheus.
There's a similar case pending against Myriad in
ACLU v. Myriad.
What's your take on this?
Mayo v. Prometheus
is interesting because it is obviously a Section 101 case. Under
Section 101 of the Patent Act, a patent cannot preempt the laws
of nature, physical phenomenon or abstracted ideas that are free
to all and reserved exclusively to none. The ACLU case is also a
Section 101 challenge, so it has the potential to fall under the
High Court's purview. Nevertheless, days after the
decision was rendered, the Supreme Court remanded the
case back to the federal circuit-the lower court-which will
rehear the case in light of the Supreme Court's decision on
Obviously, there are a lot of moving parts on the legal front for
So, what's at risk? Essentially, I see seven patents and 15
claims that could potentially be invalidated. Do these seven
patents and 15 claims represent the entire intellectual property
estate for Myriad? No, of course they don't. Myriad has something
like 25 patents and more than 500 claims associated with its
intellectual property relative to BRAC. The loss of seven patents
would not invalidate the BRACAnalysis business, nor would the
business fall apart the day after a negative Supreme Court
ruling. Myriad has a robust intellectual property estate, with
blocking patents that prevent other companies from coming into
the space. More importantly, those little companies itching to
get into the BRAC analysis business are going to have difficulty
breaking in because Myriad has the ability to identify mutations
associated with the BRCA1 and BRCA2 genes-this is something that
the little me-too companies simply do not have.
Let's assume Myriad retains its seven patents and all the claims
in those patents. Where is growth going to come from?
Growth is going to come from a number of different areas.
Obviously, you have the BRACAnalysis business, and I recognize
that it's 80% of total sales, but over the last four quarters it
has been growing in the double-digit range. When I hear people
say Myriad has to diversify away from BRACAnalysis, I completely
agree. It has other diagnostic tests in the pipeline. Within the
last year or so, it introduced the Prolaris test, which is a
prostate cancer staging test. It enables oncologists to ascertain
which prostate cancers need more assertive treatment versus the
slower-growing types. Prostate cancer is a large market here in
the U.S., and I think Myriad is offering a compelling diagnostic
test to the oncology community.
You have Bio-Rad Laboratories Inc. (BIO:NYSE) Buy-rated with a
$115 target, but this one has a $3 billion (
) mid cap with some potential for growth.
I think there is some possibility for growth in a story like
this. I like the company despite the uncertainties of the global
economy, because two-thirds of its business is clinical
diagnostics. The other piece is life sciences tools. These are
two businesses where the revenues are stable and recurring, and
it has customer/product/geographic diversification. No single
customer is greater than 2% of total sales for its products.
Ultimately, I like this story because the risk has really been
Hologic Inc. (HOLX:NASDAQ) and Varian Medical Systems Inc.
(VAR:NYSE) are two mid cap companies that have major franchises.
You have them both rated Buy. On March 1 you raised your target
price on Hologic to $26. Tell me that story first.
Hologic started out in the business as a capital equipment
manufacturer. It manufactured bone densitometry machines for
years. In early 2001-2002, it introduced two-dimensional (2D)
digital breast mammography. And 2D mammography was all the rage
back in 2001-2002, as other modalities within the radiology
department were going digital. Hologic introduced its digital
mammography system after General Electric Co. (GE:NYSE).
Nevertheless, in two to three short years, GE lost its
first-mover advantage and this little company from Bedford, MA,
was able to bring GE to its knees in digital mammography.
Fast-forward to what the business looks like today, and it's
much more complicated. In 2007 Hologic acquired Cytyc
Corporation, a women's health company with a lot of diagnostics
and surgical tools. Now, post-acquisition of Cytyc, it's a
different growth story with a different growth trajectory. So I
view Hologic as more of a diversified medical supplies company.
In February 2011 Hologic received key regulatory approval of its
digital breast product, Dimensions Tomosynthesis. This is 3D
breast imaging. Hologic is the first to introduce breast
tomosynthesis to the market. We've seen a nice, steady rollout
over the past year. And I think 2012 could be the inflection
point we see on the rollout of tomosynthesis, especially as we
see more meaningful clinical data and tomosynthesis reimbursement
moves closer to reality.
You have a $76 price target on Varian Medical Systems (VAR:NYSE).
This is a major radiation oncology franchise. What's your
investment theory here?
Varian is the 800-pound gorilla in radiation therapy. It has been
doing it the longest; it has been in the market for 30-40 years.
It has the capacity, the capital and the critical mass to make it
in this space. Radiation oncology is one of the last great profit
centers for hospitals, and they're always on the hunt for the
latest and greatest new technology. Varian is always ready to
provide them with that new technology. There's a prevailing
thought in this environment that everything under the sun is
being cut at U.S. hospitals, and rich reimbursement rates are
next on the chopping block. Varian is very cognizant of the
prevailing mood-the company has planned for it and has baked
lower reimbursement rates into expectations, to the tune of down
2-4%/year. But at the end of the day hospitals still need new
technologies, and a 2-4% reimbursement cut probably does not
change the payback calculus for a hospital. Nevertheless, while
the U.S. market for radiation oncology systems might seem a bit
soft, Varian is feeling confident in its international strategy.
The company is hopeful that it can win a big chunk of
international business from all three of the major ex-U.S.
geographies-Europe, Latin America and Asia.
When could proton therapy be a factor at Varian?
Proton therapy is turning into a real product now. It's not so
much of a science project anymore. Back in 2007, the skeptics
amongst us thought that few if any hospitals or academic
institutions would have $80-100M in their budgets to fund this
pricey piece of equipment. But we've seen Varian book three
orders for its proton therapy system in the last two quarters
alone, with another three orders that could close pending
confirmation of financing. So this is starting to become a real
business for the company. While the proton business is currently
dilutive to earnings, management is hopeful that it can get to
breakeven by 2013, if not sooner. And I think there is some
leverage for Varian, as its proton therapy business becomes more
Thank you very much, Junaid.
Thank you too.
Junaid Husain is a Vice President and Senior Research Analyst
at Dougherty & Company, covering the medical technology
sector including capital equipment, medical supplies,
diagnostics, and life sciences tools. He has been following the
health care sector for 15 years as an analyst, consultant,
business development professional, and academic. Prior to joining
the firm, Husain worked as a medical technology analyst with
Ticonderoga Securities (formerly Soleil Securities). Previously
he worked for Leerink Swann & Co., Constella Health
Strategies and Decision Resources. Husain has been recognized
| StarMine as the #2 (2010) and #3 (2011) earnings estimator
in the Health Care Equipment & Supplies Industry. While at
Leerink Swann & Co., he was on the analyst team awarded
Institutional Investor's "Best of the Boutiques" in medical
technology. Husain received his bachelor's degree in science from
the University of Saskatchewan, a master's degree in science from
McGill University, and a master's in business administration from
Queen's University. In 2010, he received his third master's
degree in liberal arts from Harvard University, where he was
commencement speaker for his graduating class.
1) George S. Mack of
The Life Sciences Report
conducted this interview. He personally and/or his family own
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3) Junaid Husain: I personally and/or my family own shares of the
following companies mentioned in this interview: None. I
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