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David Rolfe Comments on Varian Medical Systems

April 18, 2014 | About:

Varian Medical Systems (VAR) has been a staple in our portfolio since the fall of 2005. The stock has rebounded smartly, up +31% from its April 2013 lows through the first quarter. Varian continues to be the global market share and technological leader in the radiation oncology business. Unfortunately, the incidence of cancer continues its deadly growth. In the U.S. alone, the American Cancer Society projects that some 1.7 million people will be diagnosed with cancer. Expectations of new cancer cases around the world are approaching 25 million over the next three decades. Of these new cases, approximately two-­‐thirds will be treated with some sort of radiation therapy. Varian has been at the forefront of linear particle accelerator since the late 1940's. Today the Company's installed base numbers over 7,300 LINACS across the globe – a 60% market share. As impressive as that may sound, the availability of state-­‐of-­‐the-­‐art radiation therapy (radiosurgery and proton therapy) outside of the U.S. is woefully low. The developed world has access to 35 to 110 LINACS per million people over the age of 65. In the U.S., it's 110 LINACS per million. Western Europe and Japan is 35 to 65 per million. In India, Africa, Eastern Europe and Southeast Asia there are between 1 and 20 machines per million. In China there is less than 10 machines per million. Complementing the Company's long-­‐term growth opportunity in radiation therapy is the secular trend in the "digitization of radiology," which is a key driver of their lucrative software and flat-­‐panel services business, plus their X-­‐ray tube replacement business that sells into the installed base of competing LINACS. The Company's initiatives to drive greater productivity continue to bear fruit. In 2013 sales per employee increased 14% and operating income per employee increased 20% over 2012 levels. Such productivity has helped the Company offset the continuing losses as they rollout their proton therapy machines. Cutting edge technologies such as proton therapy are one of the many reasons why cancer survivorship rates are up to nearly 70% from 50% from just the 1970's. You will be hearing much more about the marvels of proton therapy in the years to come. The key benefit of proton therapy over the latest x-­‐ray technology is that proton beams, due to proton's relatively larger sub-­‐atomic mass, can be controlled and stopped at the tumor. Conventional X-­‐rays particles cannot be 3 stopped and risk damaging surrounding healthy cells. Due to the exceptional accuracy of a proton beam, the oncologist can more safely deliver much higher doses of radiation (hypofraction), which kills cancer faster with fewer treatments. Furthermore, tumors that are close to vital organs are ideal for proton therapy. These include head and neck, breast, lung, gastrointestinal, prostate and spine. Proton therapy is also ideal for children to avoid longer-­‐term side effects of traditional radiation therapy. The advantages of this therapy have been known since the 1940's, but the cost of commercialization has been a nearly insurmountable hurdle. The Varian proton therapy equipped facility at the Scripps Proton Therapy center in San Diego just went online in January. This $220 million, 102,000 square-­‐foot, facility is only the 15th proton therapy facility in the U.S. At its core sits a 95-­‐ton superconducting cyclotron where the proton beam is generated using oxygen and hydrogen to create a plasma stream. Protons are then extracted and accelerated to roughly 100,000 miles per second. Such miracles of science and technology (Cincinnati Children's Hospital just recently placed a proton order) come at considerable costs. The Company needs to get the costs of such systems below $25 million in order to drive any meaningful growth and profitability from proton therapy. Given Varian's long and exceptional history of innovation with LINACS, combined with proton therapy's high barriers to entry, we believe the Company is well-­‐positioned to eventually reap a substantial proportion of any potential financial rewards generated by this ground-­‐breaking technology. Stericycle continued its steady streak of growth. Last quarter earnings per share were up 12%, driven by a 13% increase in revenues, compared to the December 2012 calendar quarter. Stericycle is able to methodically deliver such growth through a unique combination of organic and inorganic means. For instance, during the quarter they closed eight acquisitions that will generate roughly $34 million in incremental annual revenues. As for the Company's competitive positioning, the regulated medical waste industry market opportunity is roughly $10.5 billion spread across a highly fragmented competitive field, consisting of regional or local players, with none generating revenues above $100 million.

From David Rolfe (Trades, Portfolio)'s Wedgewood Partners first quarter 2014 commentary.


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