Urbem's 'Quality Strategy' Series: The Installed Base

A good source of bond proxy

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Jan 07, 2020
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An installed base (a base of continually-functioning installed products that keep generating revenue for the company that made them) could be a good source of predictable income for investors. Each installed unit acts as a bond proxy by generating “interest payments” for shareholders from after-market transactions such as services and consumables. An installed unit doesn't “mature” until the unit gets replaced.

To maximize shareholder value, the core job for management is straightforward: to increase the recurring cash flow per unit (i.e. the interest payout) as well as the switching cost (i.e. the time to maturity). It would be even better if the business could find a way to grow its installed base and issue more bond proxies. It can do this by expanding geographically, launching new products or tapping into adjacencies.

Take a look at Intuitive Surgical (

ISRG, Financial), the global technology leader in robotic-assisted, minimally invasive surgery. Its da Vinci surgical system has an installed base of over 5,000 units across hospitals worldwide, which is still growing annually at a double-digit rate. The company builds a wide and deep moat through a high switching cost and reputation. Once trained to get comfortable with one technology, surgeons and hospitals tend to stick with it. Additionally, there are about 6 million procedures performed and 18,000 peer-reviewed scientific articles published about the da Vinci system, creating a significant barrier for new entrants to compete effectively.

Intuitive Surgical generates recurring sales from instruments, accessories and services, which represent more than 70% of the company's fiscal 2018 total revenue. As a result, each new system sold to hospitals could transform into far more additional sales starting in the near future. In the meantime, as more medical residents are trained on the system, the usage increases, and so does the recurring income per unit, as a portion of the fees is charged on a per-procedure basis.

Specialty measurement expert Waters (

WAT, Financial) is another excellent example of a company growing its installed base. As a pioneer of analytical workflow solutions, the company provides the indispensable instrument systems for drugmakers like Bristol-Myers Squibb (BMY, Financial) and Pfizer (PFE, Financial) throughout their research and manufacturing processes. The business builds its economic moat through a long-standing reputation in liquid chromatography and mass spectrometry technologies and now earns approximately 50% of its revenue from after-market items, including chemistry and services.

Waters has been continuously spending on product innovation to seize opportunities in adjacent verticals, such as biopharmaceutical, material science and clinical diagnostics. We also note that the company’s business enjoys several long-term industry tailwinds (e.g. an aging population, an increasing emphasis on wellness and rising regulations on food safety) to further stretch its installed base.

By checking the historical performance, we see that both Intuitive Surgical and Waters generated a high and stable free cash flow return on assets over the past ten years (see below).

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Disclosure: The mention of any stock in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Intuitive Surgical and Waters.

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