Intuitive Surgical (ISRG, Financial) is a medical technology company that manufactures the da Vinci Surgical System, a line of robotic surgical equipment used to conduct cardiac, urological and cancer related minimally-invasive surgeries.
Business Model: They generate revenue from both the initial sales of the da Vinci Surgical Systems and recurring revenue, derived from sales of instruments, accessories and service revenue. The da Vinci System sells for $1 million to $2.3 million depending on the configuration and represents a significant capital investment for the customers. They sell additional equipment as add-ons to the basic system and also derive revenue by supplying replacements and consumables. The da Vinci Surgical System translates a surgeon's hand movements at the controls into corresponding mirco-movements of surgical instruments positioned inside a patient on the operating table, allowing for precision movement and fine surgical manipulation. Despite high upfront costs ($1.0-$2.3 million), the machine's ability to improve operating time, reduce post surgical complications and shorten hospital stays have made the system a cost effective investment among large hospitals.
Recurring revenue has grown at an equal or faster rate than system revenue. Recurring revenue increased from $276.4 million, or 46% of total revenue in 2007 to $419.6 million, or 48% of total revenue in 2008 to $561.7 million, or 53% of total revenue in 2009 to $752.7 million, or 53% of total revenue in 2010. The increase in recurring revenue relative to system revenue reflects continuing adoption of procedures on a growing base of installed da Vinci Surgical Systems. We expect recurring revenue to become a larger percentage of total revenue in the future. The installed base of da Vinci Surgical Systems has grown to 1,752 at Dec. 31, 2010 compared to 1,395 at Dec. 31, 2009, with 1,111 at Dec. 31, 2008 and 795 at Dec. 31, 2007.
As of Sept. 30, 2011 there have been 2,031 unit shipments worldwide — 1,478 in the U.S., 357 in Europe, and 196 in the rest of the world.
Buybacks
Nov 2011: $500m authorization to buy shares
Feb 2011: $400m authorization to buy shares
Jul 2010: $150m authorization to buy shares
Mar 2009: $300m authorization to buy shares
The company has no debt and $900 million in cash (as of September 2011). The balance sheet of ISRG is fabulous.
Have these share buybacks made any dent in the outstanding shares? Not really. The number of shares has increased from 18 million in 2001 to 40 million in the trailing twelve months (TTM). The share count dipped a bit to 39 million in 2009 (probably due to the buyback in 2009) but it jumped back up to 40 million by 2010.
Where are these additional shares coming from? In the fourth quarter of 2003, the company sold 5,750,000 shares of newly issued common stock in an underwritten public offering at a price of $14.50 per share. The company received net proceeds of approximately $77.7 million, after deducting the underwriting discount and offering expenses. But apart from that, all the other shares seem to be coming from stock awards and options awards.
Each of these plans contains an evergreen provision whereas the authorized shares are automatically increased concurrent with the company's annual meeting of shareholders. So, on average there has been an increase of more than 1 million shares outstanding each year.
Apart from that, there is also the 2009 Commencement Incentive Plan which awards equity to new employees and is made without shareholder approval. In 2011 so far they have awarded a total of 257,000 stocks.
It is then not difficult to find that the share count of ISRG has increased like this. The following graph shows the situation:
Beating estimates
The company has constantly beaten estimates, quarter after quarter. The following data is taken from Yahoo Finance.
As we see, the estimate for the next five-year growth is 20%, which is almost half of what it was in the past five years.
Valuation
ISRG has the following ratios:
If one wants, one can do a DCF calculation. But for such a growth stock it seems unreasonable to do so (and would be very imprecise). Few will argue that above valuation is very rosy (of the order of 30% growth for the coming five years at least).
What we want to do is infer the reasons for the buyback and see if it helps the shareholders.
Is this is buy signal?
The answer is a definitive no. The reasons are as follows:
Business Model: They generate revenue from both the initial sales of the da Vinci Surgical Systems and recurring revenue, derived from sales of instruments, accessories and service revenue. The da Vinci System sells for $1 million to $2.3 million depending on the configuration and represents a significant capital investment for the customers. They sell additional equipment as add-ons to the basic system and also derive revenue by supplying replacements and consumables. The da Vinci Surgical System translates a surgeon's hand movements at the controls into corresponding mirco-movements of surgical instruments positioned inside a patient on the operating table, allowing for precision movement and fine surgical manipulation. Despite high upfront costs ($1.0-$2.3 million), the machine's ability to improve operating time, reduce post surgical complications and shorten hospital stays have made the system a cost effective investment among large hospitals.
Recurring revenue has grown at an equal or faster rate than system revenue. Recurring revenue increased from $276.4 million, or 46% of total revenue in 2007 to $419.6 million, or 48% of total revenue in 2008 to $561.7 million, or 53% of total revenue in 2009 to $752.7 million, or 53% of total revenue in 2010. The increase in recurring revenue relative to system revenue reflects continuing adoption of procedures on a growing base of installed da Vinci Surgical Systems. We expect recurring revenue to become a larger percentage of total revenue in the future. The installed base of da Vinci Surgical Systems has grown to 1,752 at Dec. 31, 2010 compared to 1,395 at Dec. 31, 2009, with 1,111 at Dec. 31, 2008 and 795 at Dec. 31, 2007.
As of Sept. 30, 2011 there have been 2,031 unit shipments worldwide — 1,478 in the U.S., 357 in Europe, and 196 in the rest of the world.
Buybacks
Nov 2011: $500m authorization to buy shares
Feb 2011: $400m authorization to buy shares
Jul 2010: $150m authorization to buy shares
Mar 2009: $300m authorization to buy shares
The company has no debt and $900 million in cash (as of September 2011). The balance sheet of ISRG is fabulous.
Have these share buybacks made any dent in the outstanding shares? Not really. The number of shares has increased from 18 million in 2001 to 40 million in the trailing twelve months (TTM). The share count dipped a bit to 39 million in 2009 (probably due to the buyback in 2009) but it jumped back up to 40 million by 2010.
Where are these additional shares coming from? In the fourth quarter of 2003, the company sold 5,750,000 shares of newly issued common stock in an underwritten public offering at a price of $14.50 per share. The company received net proceeds of approximately $77.7 million, after deducting the underwriting discount and offering expenses. But apart from that, all the other shares seem to be coming from stock awards and options awards.
| Plan | Shares reserved |
| 2000 Equity Incentive Plan | 2,580,000 |
| 2000 Non-employee directors stock options plan | 150,000 |
| 2000 Employee Stock Purchase Plan | 500,000 |
| 2003 Equity Incentive Plan | +980,763 |
| 2003 Non-Employee Directors' Stock option Plan | +55,821 |
| 2003 Employee Stock Purchase Plan | +166,176 |
| 2002 Equity Incentive Plan | +982,375 |
| 2002 Non-Employee Directors' Stock option Plan | +54,562 |
| 2002 Employee Stock Purchase Plan | +102,182 |
Each of these plans contains an evergreen provision whereas the authorized shares are automatically increased concurrent with the company's annual meeting of shareholders. So, on average there has been an increase of more than 1 million shares outstanding each year.
Apart from that, there is also the 2009 Commencement Incentive Plan which awards equity to new employees and is made without shareholder approval. In 2011 so far they have awarded a total of 257,000 stocks.
| Month | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov |
| Option (in k) | 28.3 | 19.1 | 13.3 | 11.7 | 40 | 16.39 | 17 | 18.9 | 36.4 | 23.7 | 32.2 |
| Strike price | 267 | 333 | 372 | 329 | 348 | 343 | 368 | 358 | 380 | 364 | 432 |
It is then not difficult to find that the share count of ISRG has increased like this. The following graph shows the situation:
Beating estimates
The company has constantly beaten estimates, quarter after quarter. The following data is taken from Yahoo Finance.
| Earnings History | Dec 10 | Mar 11 | Jun 11 | Sep 11 |
| EPS Est | 2.25 | 2.49 | 2.71 | 2.76 |
| EPS Actual | 3.02 | 2.59 | 2.91 | 3.05 |
| Difference | 0.77 | 0.10 | 0.20 | 0.29 |
| Surprise % | 34.20% | 4.00% | 7.40% | 10.50% |
| Growth Est | ISRG |
| Past 5 Years (per annum) | 40.44% |
| Next 5 Years (per annum) | 19.54% |
As we see, the estimate for the next five-year growth is 20%, which is almost half of what it was in the past five years.
Valuation
ISRG has the following ratios:
| Price-to-earning | 38 |
| Price-to-sales | 10.7 |
| Price-to-book | 7.3 |
| Price-to-cash-flow | 31 |
| PEG | 1.6 |
If one wants, one can do a DCF calculation. But for such a growth stock it seems unreasonable to do so (and would be very imprecise). Few will argue that above valuation is very rosy (of the order of 30% growth for the coming five years at least).
What we want to do is infer the reasons for the buyback and see if it helps the shareholders.
Is this is buy signal?
The answer is a definitive no. The reasons are as follows:
- Management’s attempt to buy back shares seems to be an attempt to cover up the pay practice and the subsequent share dilution. As we saw above, management has paid itself and the employees with stocks for a long time and it has resulted in a significant dilution (on the order of more than 40% between 2001 and 2008). In 2009, the management decided to buy back shares in what I conjecture as a way to put a cap on the number of shares to 40 million.
- The company is clearly priced for a very rosy future. To buy back shares at the moment by putting the cash seems like a very bad idea to me. It is hard to imagine that a company with such growth cannot put the money to better use. They can look into acquiring MAKO Surgical (MAKO, Financial) for example.
- The company has never paid a dividend. If they can’t put the money to use, dividends seems like a better idea than buying the stock at the moment. The only reason I can think of why the management is not paying dividends instead of buybacks is the share dilution that has occurred due to the compensation practices at ISRG.
