Small-Cap Ideas with Double-Digit Growth Potential:
Frederick "Rick" Wise
Source: George S. Mack of
The Life Sciences Report
You can own large medtech and diversified medical supply
companies for low volatility and incremental upside in a trending
economy (yawn. . .), but small- and mid-cap companies offer the
real double-digit growth possibilities. In this exclusive
The Life Sciences Report
, Analyst and Managing Director Frederick "Rick" Wise of Leerink
Swann shares small-cap ideas that could wake up investors'
The Life Sciences Report:
Back in early March you attended the 2012 Society of American
Gastrointestinal and Endoscopic Surgeons (SAGES) meeting in San
Diego. Were there topics or companies that the physicians were
especially interested in?
Whether in a consumer setting or a medical meeting, doctors are
drawn to what's new, just like consumers would be. Physicians
want to see innovative technologies and understand them. There is
a competitive element to it, and two of the biggest companies in
the general surgery space were there:
Covidien Ltd. (COV:NYSE )
Johnson & Johnson (JNJ:NYSE)
Ethicon Endo-Surgery. Both were displaying a number of new
surgical products. I would say that one of the most exciting
innovations right now in the medical technology space is in
robotics, and for that reason there was a great deal of interest
at SAGES in
Intuitive Surgical Inc. (ISRG:NASDAQ)
, which is in the earliest stages of taking its da Vinci robot
into the field of general surgery. That's a hot topic for
You follow the large-cap diversified supply and device companies.
Every recession brings a shakeout that creates efficiencies in
business. Have you seen this occur?
That is a crucial point when thinking about this industry today.
Virtually every large company I follow has, in some way, shape or
form, announced formal restructurings, increases in efficiencies
and headcount reduction. Many have combined business units and
are looking for efficiencies in terms of manufacturing,
distribution or sourcing among other factors.
When the economy and employment recover and when patients return
for the elective procedures they've been putting off, will these
large companies be better positioned than they were in the
Yes, I think the large-cap mature companies are moving past many
of the obvious negatives and challenges, and are extremely well
positioned to show some positive sales and operating leverage as
the global economy gradually recovers. Most of these larger
companies have market-leading positions in their major markets.
All of them are reshaping their portfolios and focusing on more
innovative, differentiated products and markets with potentially
better pricing, better demand and better margins. We don't have
to get back to 15% top-line growth to see leveraged bottom-line
growth. Maybe we can get to a point in the recovery where
incremental top-line growth of even 12% could produce very
positive, very leveraged impacts on the bottom line.
With a few exceptions you're basically in the large-cap medical
device and diversified supply space. What case do you make for
I've never been very fond of generalizing, but I think you have
to start from the point that this group has underperformed the
broader markets and often the rest of healthcare now for several
years. Multiples are low; dividend yields have risen; free cash
flow yields are actually at historically high levels. This is all
understandable in the context of a maturing industry. I'm
inclined to think that in a stable to improving economy, with
procedures rebounding, tremendous cash flows, the improved
operating leverage I mentioned, and with virtually all large-cap
companies increasing dividend payouts, that these could be very
attractive total return stories without a lot of risk over the
next few years.
Clearly, recurring revenue is part of the story for the mega-caps
like Johnson & Johnson (J&J),
Abbott Laboratories (ABT:NYSE)
and even smaller large caps like
Baxter International Inc. (BAX:NYSE)
and Covidien. But these companies are so widely diversified in
their product portfolios that growth is difficult. Also, huge
market caps like $90 billion (
) are hard to double. What kind of edge can investors get?
I don't know that there is an edge so to speak, but again, I
don't think you have a lot of downside with the large-caps mega
companies like J&J, with revenues approaching $70B, and
Abbott, approaching $40B. My theme has been to focus on the
relatively smaller large-cap companies. In particular, I'm
St. Jude Medical Inc. (STJ:NYSE)
Stryker Corporation (SYK:NYSE)
(now followed by another Leerink colleague), both of which have a
relatively smaller revenue bases that should be growable,
especially given their increasingly attractive
portfolios-especially if the business has been run well and if
their pipelines are growing and expanding. That happens to be the
case with both of these companies.
Speaking now to the mid-cap and small-cap companies in your
coverage, is consolidation part of your theme?
As I said, one of my themes is the low-risk, total-return
concept. A second theme is buying the larger-cap companies with
the best pipelines, but with a relatively small revenue basis and
that are able to grow faster than the group average-like St. Jude
Medical and Stryker. My last major theme is in the direction you
May we speak about some of your recommendations for investors?
Let's talk about specific companies.
I'm going to start with two companies I just initiated coverage
on that I'm very excited about. These are at the opposite end of
the spectrum from J&J, Abbott,
Medtronic Inc. (MDT:NYSE)
Boston Scientific Corp. (BSX:NYSE)
and St. Jude.
First, I would like to mention
AtriCure Inc. (ATRC:NASDAQ)
, the market leader in the surgical treatment of atrial
), with roughly half of the surgical AF market.
We're talking about atrial ablation, correct?
Right, but ablation in a surgical setting. Atrial fibrillation,
as you know, is a complex and very serious disease. The idea is
that you burn lines in the heart tissue to stop the cascade of
heart cell contractions, which is a harmful process that almost
is like dominos falling, but in a chaotic fashion. With these
burn lines, or lines of block, you prevent the electrical
arrhythmias from running all over the heart, and if you are
successful, you force them back into more regular patterns.
Electrophysiologists do atrial ablation procedures as a
catheter-based procedure from inside the heart. But, cardiac
surgeons have a major opportunity to treat AF from outside the
heart. And if you're doing coronary artery bypass graft (CABG) or
valve replacement or repair procedures, with the chest open,
you've got open access to treat the AF.
What's the size of this market?
In the U.S. alone, again just looking at the AF procedures done
surgically, atrial ablation done with open-heart procedures could
easily be a $250 million (
) market. In round numbers, there are about 350,000 (350K) CABGs
done annually in the United States alone, and obviously a lot
more internationally. Probably a quarter of them-or about 85K-are
performed on patients who have AF, which is not surprising since
older people, ages 60-80, tend to have multiple co-morbidities,
multiple clinical issues. Of the 85K potential cases of AF, fewer
than 20% of them are actually treated during a surgical
procedure, despite the fact that it's very well documented in
clinical studies that approximately 80-90% of these patients are
cured if their AF is treated during surgery. Patients can even
stop taking anticoagulants, which are expensive and produce
complicating side effects that make it difficult for physicians
to manage other co-morbidities. This is a great procedure.
Rick, in December Atricure received FDA approval for an expanded
AF indication for its Isolator Synergy Surgical Ablation system.
You have written that this should drive growth, but the stock
didn't react particularly favorably, or for that matter
I'm glad you asked about that because it's important to reflect
on the challenges AtriCure faces, as well as the opportunities.
Historically, for a couple of reasons, the company was not able
to optimally train and educate doctors about its atrial
fibrillation treatment. Cardiac surgeons got excited about this
approach to AF in the days before AtriCure became public in
August 2005. Then the company faced a very challenging period
from 2008 to 2010, when the Department of Justice (DOJ) and the
U.S. Food and Drug Administration (FDA) stepped up enforcement on
off-label promotion of medical products and drugs for all
healthcare companies. Unfortunately, AtriCure was one of the
first companies to feel the ramifications of this stepped-up
enforcement. They weren't doing anything terrible, and their
products were approved, but approved for general approaches to
cardiac ablating procedures, rather than for specific targeted
procedures, and not specifically for atrial fibrillation use. And
so again the FDA decided to raise the bar, not just for AtriCure,
but for everybody. We've also seen this same raising of the
regulatory bar in the spine/orthopedic arm of the industry, for
example. For Atricure, this process understandably changed the
company's approach to training and education. The very good news
for the company is that this DOJ investigation was fully resolved
in 2010. Having been the first in, if you will, AtriCure is also
now, in a sense, the first out. Now Atricure is the only company
with an AF device specifically approved and labeled for educating
and training doctors in atrial ablation, etc.
Having said all that, frankly, I can understand why investors
are in a "show me" mode relative to the stock. Especially since
I'm in that mode, too. But I believe the company is well
positioned to show me-and show the rest of the investment
community-that they have a real opportunity to drive surgical AF
procedure penetration. It's like baking a cake in a way. If you
have got all the ingredients-flour, sugar, butter, etc.-you can
turn those ingredients into something very special. Although it
will take a few quarters to see it show up in revenues, I think
there's an above average chance that we'll see all the
ingredients coming together to bake up something very tasty at
Training is a major issue. It's important to get new modalities
into teaching institutions because established clinicians do not
want to take up new procedures. The cardiovascular surgeon wants
to graft the new vessels onto the myocardium and get out.
Well said and so true. As in the evolution of all procedures and
all technologies, the docs are thinking about what they know from
three, five or eight years ago, about earlier generations of
these AF products and earlier experiences with less-evolved
products and techniques. In the case of surgical atrial ablation,
my due diligence suggests that under the best circumstances it
can take only an additional five minutes of operating room time
to do this procedure successfully. AtriCure's challenge is to
bring that message more clearly, succinctly and directly to
surgeons, and to help them understand what's possible despite
their existing mindsets. This is trench warfare for
Atricure-doctor by doctor, hospital by hospital. You can't just
put an ad on the screen at the Super Bowl to make this process
happen. It's a doc-by-doc training and education process.
What was the other company you just initiated coverage on?
The other small-cap company is
Unilife Corporation (UNIS:NASDAQ)
. It's more of a hospital supply-type name, but a very special
one. Unilife manufactures prefilled syringes for large
pharmaceutical and biotech companies that want to take both new
pipeline products, as well as products coming off patent, and
package them attractively in a user-friendly, safer way-and in
the process meaningfully differentiate their delivery system from
others. There's also the important and essential issue of
preventing accidental needle sticks for health care workers and
patients alike. The company has something like 12 issued patents
on their safety and delivery technologies, with a core patent
covering the key feature in all of Unilife's safety syringes,
revolving around the method of needle retraction within an
Rick, because these are off-patent drugs and because only a
device as been added, can these syringes be approved through the
The simple answer is yes, but your premise isn't 100% correct.
Some are going to be drugs coming off patent, absolutely. But
some are going to be drugs in development that can go through all
the clinical trials with the Unilife device. Some devices will be
approved as a 510(k), some will be approved as part of a
Unilife is a small-cap company, and manufacturing prefilled
syringes sounds like a capital-intensive business. I'm curious to
know about the drug trials you just referenced. Are the pharma
partners going to be paying Unilife for these syringes during the
trials? Is the company capitalized well enough to withstand these
Excellent question, because the company has barely any revenue
right now. Unilife does have development/customization programs,
and it does get paid, but the business is capital-intensive to
the extent that it had to build a facility. You have to spend
money on equipment to manufacture prototype devices, and the
company has done this. Will it need additional capital going
forward? The simple answer is probably yes. The complex answer is
that maybe it will depend on how the deals are structured and how
the cash flows are structured.
What else are you talking to investors about currently, Rick?
On the smaller side we continue to like
Volcano Corp. (VOLC:NASDAQ)
. Volcano sees itself today as a very high-level, precision
guided therapy company. Volcano already is the global market
leader in intravascular ultrasound (IVUS), as well as being one
of two key players in the rapidly growing fractional flow reserve
) measurement market. IVUS imaging is used inside the coronary
artery before, during and after procedures to better understand
both the anatomy and the nature of the blockages inside the
artery during percutaneous coronary intervention (PCI) (stent)
Volcano has had an excellent track record since it became
public in 2006. The company has steadily gained market share on a
global basis and at the same time has invested heavily in the
future. Right now the company has a global installed base of some
6,800 IVUS instruments alone in catheter labs around the world.
And at this point, particularly with its latest generation
platform, it has the opportunity to expand into other areas of
As I mentioned, right now both Volcano and St. Jude Medical
are benefiting from the very rapid growth and acceptance of
fractional flow reserve (
) technology, another important diagnostic tool for the catheter
lab. It allows for very effective, very simple assessment of
coronary artery blockages. Bottom line, right up front doctors
get more accurate diagnoses and measurements to determine which
patients should get a stent, and whether patients should be
stented at all.
Is Volcano an acquisition candidate?
I definitely believe Volcano is an acquisition candidate. As a
reminder, the other major player in the global IVUS market is
Is Medtronic in this market?
Medtronic does not offer either IVUS or FFR. Looking at the stent
market, Abbott, Boston Scientific, and Medtronic are the three
major players in the global stent market. But, of the three, only
Boston has IVUS, not FFR, and again, Volcano has both an IVUS and
an FFR offering, as well as a full pipeline of new additions to
its precision guided therapy portfolio. So, you'd think that
could be an interesting portfolio addition at some point.
Do you also follow Boston Scientific?
I think it's fair to say it is one of the most controversial
large-cap stocks I follow. Boston Scientific has had a very
difficult decade. The headwinds that the entire industry has been
facing have been doubly or triply challenging for Boston
Scientific for a host of reasons. The company very famously paid
top dollar for Guidant in April 2006, just as the implantable
cardioverter defibrillator (ICD) market slowed precipitously and
just as the FDA was raising standards. Expenses were too high and
revenues were slowing in a world that was changing dramatically,
and the company suddenly found itself overleveraged. It has taken
the company time to adapt to the changing environment and its
changed circumstances-a process that is far along but still
You've got Boston Scientific rated Outperform. Why?
Today, with an entirely new management team in place and with
significant restructuring, the last of the major rating agencies
has just returned the company's debt to investment grade from a
junk rating. The company is generating over $1B/year free cash
flow, and the business has now stabilized. It has made
significant and important external investments in new and
emerging markets, and in products. It very recently made an
acquisition that brought with it some differentiated and
potentially very exciting ICD technology. I think Boston has
positioned itself for much better revenue and earnings-per-share
growth over the next three to five years. Its stock has
understandably been largely avoided, but over the next one to two
years people are going to say, "Wow, that's better than I
thought," as opposed to the opposite.
You alluded to the recent (March) deal to acquire Cameron Health,
which has developed a "leadless" ICD system. How important is a
This is a fascinating idea. Cameron has been working to develop
this technology over the last decade, and Boston has been an
investor from the beginning and has had an option to buy the
company for a long time. There were very specific milestones, and
Cameron must have met those milestones, based on the decision
Boston has made to buy it.
For general background, you need to first appreciate that one
of the major challenges in using ICDs is that the leads create
many complications. Every major company has had performance
challenges with their leads. Having thin wires inside a beating
heart for years can take a toll on the products. With traditional
ICDs, once the leads are in place they grow into the heart
tissue, and it's hard to take them out without a very invasive
procedure. If you could develop a product that, for a significant
number of patients, could eliminate the need for a lead, the
implantation procedure would be made simpler, faster, easier and
less complicated. Cameron has done that. Boston has acquired
them, and I think Boston could be well ahead of the pack in this
At minimum, then, you are thinking Boston Scientific's cardiac
rhythm management division could be revived?
A fully approved Cameron device would be transformative to
Boston's cardiac rhythm management business. The ability to talk
about a unique, and potentially game-changing, technology with
hospitals and physicians would enhance Boston's ability to
sustain and even gain both market share and physicians' mind
share. All this could be quite positive for the company's
Customer Relationship Management division outlook.
Rick, many thanks to you. I've enjoyed this.
Thank you. My pleasure.
Prior to joining Leerink Swann in 2008,
Frederick "Rick" Wise
was a senior managing director and medical supplies and devices
analyst with Bear Stearns for 22 years. For the past 13 years,
he has been a member of the Institutional Investor All-America
Research Team, most recently with a runner-up ranking in the
2009 poll. He was also ranked #4 in the 2006, 2007, and 2008
Greenwich Associates U.S. Equity Analysts poll. Prior to
joining Bear Stearns, Wise served as an analyst at Kidder,
Peabody & Co. and at Forbes, Inc. Wise received a master's
degree and a bachelor's degree from the Manhattan School of
Music. He is also a Chartered Financial Analyst.
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1) George S. Mack of
The Life Sciences Report
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3) Frederick Wise: I personally and/or my family own shares of
the following companies mentioned in this interview: Abbott
Laboratories (ABT:NYSE). I personally and/or my family am paid by
the following companies mentioned in this interview: None. I was
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