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Why Cooperman and Price Are Betting on Boston Scientific’s Turnaround
Posted by: Matthew Indyke and Brian Zen (IP Logged)
Date: December 31, 2012 05:23PM
Boston Scientific(BSX) is a worldwide developer, manufacturer, and marketer of less-invasive medical devices used in a broad range of interventional medical specialties. The company has always prided itself on its continuing development of medical innovations aimed at raising standards, reducing costs, increasing efficiency, and providing faster recovery times for patients. Leon Cooperman and Michael Price have positions in Boston Scientific (BSX), one of the stock market’s most heart-breaking companies in the last few years. The company’s strengths are evident in its strong growth platform of products, a favorable price reflected in its low P/B ratio, a positive direction taken by new management, and aging populations around the world.
Improving Operating Margins and an Innovative Product Portfolio
Boston Scientific remains one of the top players when it comes to intellectual property in the medical technology arena, which bodes well for its ability to innovate. The company possesses an innovative product portfolio and strong growth platforms, opening up opportunities to improve its operating margin which currently sits at 13%. Boston Scientific, at the same time, is refocusing its business portfolio through acquisitions of related healthcare companies in direct support of new strategic priorities. The company, most recently, signed a definitive agreement to acquire BridgePoint Medical, a privately held company that has developed a proprietary, catheter-based system to treat coronary chronic total occlusions (CTOs). The acquisition of BridgePoint Medical is expected to build upon the company’s rich product portfolio in cardiology and represents an important part of its growth strategy in the industry of medical device manufacturers.
New Management Shifting Focus on Rightsizing Cost Structure
Boston Scientific carries a forward P/E of 13.44, the hidden value coming from a revamped management team led by new CEO Michael Mahoney, who has considerable experience in management roles within the healthcare industry. New management, under Mahoney, has shifted its focus on rightsizing cost structure in an aim to revive the company’s mission of delivering affordable, value-based care to patients. Boston Scientific recently underwent the first step in developing a more cost-efficient arrangement when it merged the cardiovascular group and cardiac rhythmic management (CRM) group into one product group. This transaction was designed to transform Boston Scientific into one stronger and more competitive organization intended to deliver better care to hospitals, better solutions to physicians, and better outcomes to patients. The company now has new CRM products, including next-generation defibrillators and new pacemakers that is helping it recapture lost market share it suffered as the company’s revenue went downhill. The CRM unit has provided the company with much-needed diversification since the merger, as Boston Scientific’s CRM products have accounted for 27% of company sales. Interventional cardiology (ICD) products have made up 29% of sales, resulting in Boston Scientific’s cardiology products making up 56% of sales altogether. Boston Scientific continues to be one of the leading manufacturers of medical devices in the $33 billion worldwide cardiology devices market and it would make itself more valuable were it able to introduce new products at lower costs.
Demographic Trends Favorable for Repeat Business
Boston Scientific has positive longer-term fundamentals, including increasing global demand for quality health care, aging populations and rising R&D outlays, leading to a steady flow of new diagnostic and therapeutic products in cardiology, orthopedics, and other areas. On the heels of healthcare reform and an aging population, utilization of the company’s most valuable resources will increase and help improve Boston Scientific’s operating efficiency. Most of a healthcare organization’s patients are older people who are more likely to suffer from health complications that demand quality and timely care. As it turns out, the average age of the population continues to grow worldwide, especially in the United States. The US has been growing older in the last decade and is expected to grow older in the next half a century, as the portion of the population that is currently at least 65 years old is at 13 percent, and expected to reach about 20 percent by 2050. The rapid increase in the average age of the population in the US is a result of the aging baby-boom generation that is entering retirement. The demographic developments of an aging population support Boston Scientific's goals of improving the quality of patient care through the use of less-invasive medical devices. And Boston Scientific’s products compete primarily on their ability to safely and effectively perform diagnostic and therapeutic procedures in a less-invasive manner. If Boston Scientific is able to produce high-quality products, the company should receive favorable reviews or analyst upgrades.
Increasing Expenses and Plunging Sales Could Spell Trouble
The company's weaknesses, however, are easily noticed in multiple areas, such as its deteriorating net income, disappointing return on equity, and generally disappointing historical performance in the stock itself. Although their cash flow remains strong, Boston Scientific’s operating expenses have continued to increase, leading to a steep decline in revenues and the share price for Boston Scientific. In its most recent quarter, sales plunged, with its interventional cardiology segment seeing a 20% decline and cardiac rhythm management revenue dropping 8%. Those two divisions make up more than half of Boston Scientific's sales and guidance for the current quarter hasn't been encouraging either. Preoccupied with the immediate need to fix dysfunctional operations, Boston Scientific has taken its eye off of its core strengths in innovation. Its stock, which has been in the doldrums for years, sank below $5 per share in July and has traded below $8 per share since early 2010. “Cardio integration has helped drive leverage, but it may have also contributed to recent share loss and growth deceleration, particularly because competitors have not been as aggressive in integrating sales channels,” Morgan Stanley analyst David Lewis said in a research note.
Boston Scientific once enjoyed a wide moat as one of three major cardiac device makers that consistently led the way but it now appears that the company is falling behind its closest competitors, including Meditronic (MDT). Unlike Boston Scientific, Meditronic has gotten ahead in the race to develop and introduce the emerging technologies that are likely to fuel growth in cardiac devices over the next decade. And Meditronic, unlike Boston Scientific, is not reeling in a negative ROE or profit margin due to continued write-downs. Boston Scientific’s ROE continues to stay negative at -44% and its profit margin has been stuck in the red at -55%. To make matters worse, consumers, right now, are continuing to defer care because of rising out-of-pocket costs, forcing Boston Scientific to find ways to counter another culprit of the company’s decline in revenue.
One Ill-Advised Acquisition Equals a Pile-Up in Debt
Old management showed a complete disregard for existing shareholders' interests as the firm pursued the pricey acquisition of defibrillator and pacemaker Guidant and Boston Scientific is still recovering from the ill-advised transaction. In the years following the purchase of Guidant, Boston Scientific ran into a rough patch. The process of integrating Guidant and addressing its quality problems revealed considerable dysfunction in BSX's own processes and operations. Many believe Boston Scientific overpaid for Guidant’s services at $27 billion, a price that was seven times enterprise value to EBITDA. Boston Scientific, as a result, incurred huge levels of debt, increasing its historical debt nearly eightfold, and that was where its earnings first began to come under substantial pressure. Under a mountain of debt, the company suffered from a series of high-profile product recalls and manufacturing problems. Its key markets turned sluggish as the global economy weakened. Most of all, the Guidant acquisition spelled the recognition that an integrated sales force could not bring about lowered selling costs without an accompanying loss in revenue.
Boston Scientific had been stuck with $4.26 billion in debt. Its debt-to-equity ratio is now 62.3%, an unhealthy number for a healthcare company. Boston Scientific, moreover, owns far less cash than it has accumulated debt. The company carries $352 million in cash, a small number compared to its $4 billion debt. While the firm has paid off $3.6 billion debt in the last few years and was able to cover its interest expense, fewer resources are available for technological advances, especially compared with competitors, Meditronic included. Since the Guidant acquisition, other competitors like Abbott Labs (ABT) have taken advantage of Boston Scientific’s shortcomings in the interventional cardiology market and St. Jude Medical (STJ) in cardiac rhythm management. If Boston Scientific fails to invest in innovation due to its debt burden, the stock’s upside could be limited.
Boston Scientific Could Exceed Market Expectations
Currently, six analysts for TheStreet rate Boston Scientific a buy, one analyst rates it a sell, and 14 rate it a hold. It is easy to be cautious on a company like Boston Scientific with a recent history of bad management that contributed to its negative financial numbers in many critical areas that was considered as a good business. With its newest management largely untested, it is logical to be skeptical about Boston Scientific. However, at the current valuations, the worst is already priced in the stock. Even in light of the negative developments surrounding Boston Scientific, the stock could be a buy right now given the historical low valuation, the potential in its technological assets and favorable external economic trends.
Disclosure: Brian Zen has positions in BSX.
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