Medical equipment suppliers

[tucker]

Dear RainFrog partners,

At RainFrog's March meeting, partners will be asked to consider whether RainFrog should invest in one or more health care equipment manufacturers. I have included a brief research summary of each of the six candidates below. The research summaries are shorter than usual. In each case I have provided a link to the company’s web site that describes the company’s business, and introduced a few key issues or concerns that investors should consider. More detailed research from Standard and Poors will be sent to partners in a separate email on Monday.

As always, partners are invited to discuss these potential investments here on the forum. I will also be happy to answer partners’ questions by email.


SonoSite (NASDAQ: SONO)
Recent Price: $32.35 Revenue: $194.6mil
Market Cap: $540mil
EPS: $0.50
Shares Outstanding: 16.7mil
P/E: 65.22
Avg. Volume: 267,732
Dividend: --
Book value: $11.12
Yield: --

SonoSite manufactures hand-held ultrasound devices for a range of applications including monitoring pregnancies, assessing injuries, or detecting cancer. Because the company’s products are portable, they allow they use of ultrasound technology in settings where it would not otherwise be possible (http://www.sonosite.com/investorinformation/). In 2007, nearly half of SonoSite’s products were delivered to markets outside the United States.

SonoSite is an aggressive growth investment. Hand-held equipment is the fastest-growing segment of the ultrasound market, and SonoSite expects to introduce six new products this year. Analysts are projecting earnings growth of up to 60% annually over the next five years, which would make a fair current price for the stock somewhere around $65. On the other hand, the high P/E means SonoSite has to grow at a nearly 40% rate just to justify its current price.

On February 14th, SonoSite announced fourth quarter 2007 earnings lower than analyst expectations, and fear that growth might be slowing sent the stock tumbling to close more than 15% off the weeks high on Monday. On the positive side, the earnings miss didn’t indicate lower revenue growth: The company’s revenues were in line with analysts projections, but costs rose 19% year-over-year.

Several important expenses contributed to SonoSite’s lower-than-expected margins.

•Research and development expenditures were 28% higher in 2007 than 2006. The hand-held ultrasound market is rapidly developing and increasingly competitive, and SonoSite will likely need to maintain or increase R&D to remain a leader.

•SonoSite also experienced an effective tax rate of 37% in 2007 versus 8% in 2006. Now that tax loss carry-forwards have been exhausted, SonoSite can expect the higher rate going forward.

•In the past, SonoSite has marketed to physicians offices via a distributor, while they have handled direct to hospital sales themselves. However, at the end of 2007 the company decided to bring its office channel in-house. This will certainly mean higher expenses during the transition period, although the company hopes to achieve higher sales and margins over the long term.

•SonoSite experienced legal costs of over $4 million in 2007. The company is preparing to defend patent rights against GE. If SonoSite eventually wins its case the company may recover some part of costs, but in the near term litigation costs are expected to rise. Because of the highly competitive nature of the field, expenses for patent defense may be a continuing cost for the company.


Advanced Medical Optics, Inc. (NYSE: EYE)
Recent Price: $22.95 Revenue: $1.03bil
Market Cap: $1.39bil
EPS: -$3.16
Shares Outstanding: 60.5mil
P/E: --
Avg. Volume: 1,009,540
Dividend: --
Book value: $9.99
Yield: --

Advanced Medical Optics manufactures products for laser vision surgery, cataract and lens replacement surgery, and contact lens and eye care (http://www.amo-inc.com/about-amo/overview).

Like SonoSite, Advanced Medical Optics is a growth company, with analysts projecting 19% growth annually over the next five years. However, at 17.4x projected 2008 earnings, the company may represent something of a value play as well.

EYE is trading down from a high of $44 in May of 2007. The biggest factor in this decline appears to be a pair of product recalls. In November of 2006 the company incurred $15 million in costs related to a recall of contact lens solution in China. In May 2007 the company voluntarily recalled its Complete Moiture Plus contact lens solution after US FDA tests indicated that use of the solution may contribute to types of eye infection. The direct cost of the recall may have been in excess of $40 million. The company appears to have acted quickly to protect the health of its customers, but investors are concerned that the reputation of the company’s products may have been damaged. Analysts are also concerned about an apparent slowdown in the US laser vision correction market, and possible delay in obtaining FDA approval for the company’s new Tecnis intraocular lens.

On February 14th, Advanced Medical Optics announced cost-control plans for fiscal 2008. The plans include the consolidation of certain corporate offices and well as a staff reduction of approximately 4%. After initial costs of $25-30 million, the company expects the restructuring to reduce operating costs by $4 million to $7 million in 2008 and $10 to $12 million annually thereafter. On general principal RainFrog has usually been reluctant to buy on news of lay-offs, but the market reacted positively, boosting share by more than 7% on the day after the announcement.

Although Advanced Medical Optics 2007 bottom line was disappointing, pro forma revenue growth for the year was over 7%. If the company can turn revenue growth into the analyst-projected 19% earnings growth, a fair current price for the stock could be as high as $31.

China Medical Technologies (NASDAQ: CMED)
Recent Price: $51.61 Revenue: $96.23mil
Market Cap: $1.41bil
EPS: $1.57
Shares Outstanding: 27.4mil
P/E: 32.87
Avg. Volume: 581,146
Dividend: $0.38
Book value: $6.75
Yield: 0.70%

Mindray Medical International (NYSE: MR)
Recent Price: $34.15 Revenue: $283.3mil
Market Cap: $3.64bil
EPS: $0.67
Shares Outstanding: 106.6mil
P/E: 51.05
Avg. Volume: 801,860
Dividend: $0.15
Book value: $3.35
Yield: 0.40%

China Medical Technologies is primarily involved in the detection and treatment of cancers (http://www.chinameditech.com/eng/about/profile.htm). Other products include diagnostics kits for the early detection of diseases including diabetes, hepatitis, disorders related to reproduction and growth, SARS, Down syndrome, liver fibrosis, and thyroid disorder. As of 2006, substantially all of China Medical Technolgies sales were in China, but the company is developing channels to market its products in Japan, South Korea, and Europe.

Mindray Medical International develops and manufactures devices for patient monitoring, diagnostics, and ultrasound imaging (http://www.mindray.com/main/aboutus/company%20profile/index.jsp). Approximately half of Mindray’s sales are in China, where it is the recognized market leader in patient monitoring equipment. International sales in over 140 countries account for the remaining revenue.

China Medical and Mindray are very different companies, even to the point that they can’t really be considered competitors. I have grouped them together based on a single, but very important, shared trait: They are both Chinese. Both companies are trading at an inflated P/E that some investors have called “the China bubble.â€

[juliefitz44]

Does KCI profit from war? Is this an issue that might concern us?

[tucker]

Hi Julie,

KCI almost certainly profits from war. The company’s products are used for treating traumatic injuries, and war certainly causes plenty of those. KCI invested a great deal in having its products approved for use by the US military, and their VAC products are now in use in both Iraq and Afghanistan.

Profiting from war is something we should be concerned about, but in and of itself it may not be a deal killer. After all, KCI’s products are designed to save lives, not to take them. I think you and I agree that the US military oughtn’t be in Iraq or Afghanistan, but I think we also agree that the men and women who are there deserve the best medical treatment our country can offer them.

I think the pertinent question here is not whether KCI profits from war, but rather whether they promote it. That is a little harder to answer, but one way to approach the question is to ask where the company makes political donations. In an ideal world we might expect companies to stay out of the political arena altogether, but from a practical perspective it might be enough if a company’s political contributions don’t conflict strongly with our principles as investors.

A list of politicians to whom KCI has contributed can be found at http://www.opensecrets.org. The list is a mixed bag of Republicans and Democrats, people who support military solutions to foreign policy issues and those who don’t. I am not going to try to interpret this list, but I provide here for your convenience. In evaluating the list, it is probably worth noting that KCI is headquartered in San Antonio. For this reason, the list is heavy with Texans, and this may result in a Republican or conservative bias.

Jason Altmire (D-PA)
Max Baucus (D-MT)
Evan Bayh (D-IN)
Jeff Bingaman (D-NM)
Henry Bonilla (R-TX)
Kevin Brady (R-TX)
John Breaux (D-LA)
Michael Burgess (R-TX)
Richard Burr (R-NC)
James Clyburn (D-SC)
John Corny (R-TX)
Henry Cuellar (D-TX)
Tom Delay (R-TX)
Christopher Dodd (D-CT)
Chuck Grassley (R-IA)
Orin Hatch (R-UT)
Sam Johnson (R-TX)
Jon Kyl (R-AZ)
Blanche Lincoln (D-AR)
Jim McCrery (R-LA)
Ben Nelson (D-NE)
Pat Roberts (R-KS)
Rick Santorum (R-PA)
Lamar Smith (R-TX)
Debbie Stobenow (D-MI)
Bill Thomas (R-CA)
J.C. Watts (R-OK)

Totals: Democrats $23,000, Republicans $38,500.

Tucker

[candelis imagegrid]

great information