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Dr. Paul Price
Dr. Paul Price
Articles  | Author's Website |

Intuitive Surgical, Inc.- Operating with Options

January 09, 2009 | About:
Intuitive Surgical [NDQ:ISRG] Jan. 9, 2008 Close: $101.80

52-week range: $99.75 (Jan. 8, 2009) - $357.98 (Apr. 10, 2008)

Intuitive Surgical developed and launched the da Vinci Surgical System for non-invasive surgical techniques. In 2000 it became the first robotic surgical system to be cleared by the FDA for general laparoscopic* surgery.

*Laparoscopic surgery, also called minimally invasive surgery (MIS), band aid surgery, keyhole surgery, or pinhole surgery is a modern surgical technique in which operations in the abdomen are performed through small incisions (usually 0.5-1.5cm) as compared to larger incisions needed in traditional surgical procedures. Laparoscopic surgery includes operations within the abdominal or pelvic cavities, whereas keyhole surgery performed on the thoracic or chest cavity is called Thoracoscopic surgery. Laparoscopic and Thoracoscopic surgery belong to the broader field of endoscopy.

ISRG had its IPO on June 13, 2000 at a split adjusted price of $18 per share. As with many IPOs back then the company was not yet profitable and after a quick surge to $38.10 the share price retreated to the single digits during parts of 2001 – 2003 before becoming solidly profitable in 2004.

The da Vinci System has been a major success since then and earnings per share have been on a major growth track. Here are the per share numbers since 2004 as reported by Value Line. 2008 figures include estimates for Q4 ended December 31, 2008.

Year …… Sales ….....… C/F …… EPS …..… B/V ….… Avg. P/E

2004 …… 4.06 …...… 0.89 …… 0.67 …… 9.20 …….... 33.6x

2005 …… 6.28 ...…… 2.79 …… 2.51 ….. 12.23 ….….. 25.5x

2006 ……10.05 …..... 2.21 …… 1.89 …...15.90 ….….. 56.4x

2007 ……15.62 …...…4.10 …… 3.70 …... 23.10 ….…. 50.7x

2008 ……22.55 ...……5.60 …… 5.11 …... 31.38 ….…. 46.6x

After the close on Thursday Jan. 8th the company announced lowered guidance [reflected above] for Q4 and into 2009 due to reduced levels of capital spending by hospitals in response to the weak economy. The previous estimate for 2008 had been $5.40/share. Value Line’s November 28th issue looked for $7.15 in 2009 but now the estimate range is for between $5.44 and $6.50.

Intuitive’s shares hit a new 2-year low on the news and finished today at $101.80 – down 71.5% from last April’s highs. Shares that traders were willing to buy at 66x forward earnings are now being shunned at less than 20x the reduced expectations.

If the drop in the sales and earnings growth is a function of the economy as indicated then this should be a temporary problem. The company held over $408 million in cash as of September 30, 2008 with under 40 million shares outstanding. They have no debt – short or long term.

The number of procedures able to use non-invasive techniques keeps expanding giving da Vinci systems lots of room for increased sales.

As a value investor I hate paying even 19 – 20 times earnings so here’s an option strategy that allows for a much lower break-even point, plus time for the economy to mend and for the stock to regain investor support.

…………………………………................……… Cash Outflow …......…… Cash Inflow

Buy 100 ISRG @ $101.80 ………........……… $10,180

Sell 1 ISRG Jan. 2011 $85 Call @ $43 …….........……………......………. $4,300

Sell 1 ISRG Jan. 2011 $85 Put @ $23 ………………………............…... $2,300

Net Cash Out-of-Pocket …………………............…………. $3,580

If ISRG shares stay above $85 through expiration date in Jan. 2011:

(They are 16% above that price right now at $101.80)

Your $85 Call will be exercised.

Your shares will be sold for $8,500.

Your $85 Put will expire worthless (a good thing for you as a seller).

You will have no further option obligations.

You will hold $8,500 for your original cash outlay of $3,580.

That’s a cash-on-cash return of 137% in less just over 2 years.

This ‘best case’ occurs if the shares go up; stay unchanged or even if they drop by up to 16% from your starting price.

What’s the risk?

If Intuitive Surgical shares are below $85 in January 2011 you would be forced to buy and pay for an additional 100 shares for $8,500 more cash.

You would end up owning 200 shares total.

Your break-even point on the shares purchased at $101.80 is that price

less the $43 call premium = $58.80 /share.

Your break-even on the put is the $85 strike price less the $23 put

premium = $62 /share.

Your average net cost would be the average of the two prices

above = $60.40 /share.

As long as ISRG shares are above $60.40 you will not show a loss.

That protects you even if the shares drop by 40% from your staring price.

Intuitive Surgical shares have not traded as low as $60 since the middle of 2005 when EPS were less than half their current level and book value was only 40% of the present value.

If all goes as expected, the shares will be ‘called’ and the ‘put’ will expire in January 2011. That means all taxes would be deferred until you file your 2011 tax return in April of 2012.

If you like the stock and would be satisfied with ‘capping’ your maximum return at just 137% in less than 25 months this might appeal to you.

Disclosure: Author is long ISRG shares and short ISRG options.

About the author:

Dr. Paul Price


Visit Dr. Paul Price's Website

Rating: 4.3/5 (8 votes)


Dr. Paul Price
Dr. Paul Price premium member - 8 years ago
Maybe Barrons is reading GuruFocus...

From today's issue of Barrons:

The Day the Robots Stumbled

LAST WEDNESDAY, ROBOTIC-SURGERY PIONEER Intuitive Surgical warned of a December-quarter shortfall. Opening sharply lower on Thursday, the shares rose and then subsided, ending the week some 15% lower on the news. At 101.80, this onetime momentum stock looks better than it did last summer when Barron's panned it at $322 ("Robot Dreams," July 28, 2008).

Back then, the Sunnyvale, Calif.-based innovator went for 50 times estimated earnings. Investors can now get the stock (ticker: ISRG) for 20 times some 2009 estimates, not a big premium over the mid-teens longer-term growth rate predicted by JPMorgan analyst Tycho Peterson. "There are a lot of people that have been doing work on the name," he says. "If you can take a fundamental long-term view, it's an exceptional franchise."

The stock is off some 68% since our story.

Peterson has remained one of the more cautious analysts, with a Neutral rating and a target price that he's now cut from 150 to 122. Others were more ebullient last year, when Deutsche Bank's Tao Levy had a target of 365 and Lazard's Sean Lavin aimed for 420. Executives at Intuitive kept raising guidance, even as recently as October.

Demand must have changed abruptly. The company says it sold just 55 robots domestically in the normally strong December quarter, after selling 71 in the September quarter. Robot revenues rose just 5% from the Dec. 2007 quarter. Surgeons did perform 60% more procedures than a year ago, producing a jump in sales of supplies, but that lifted total revenues only 22% in the quarter, instead of the 35% growth that most analysts expected. Intuitive didn't return our calls.

JPMorgan's Peterson notes that the company could buy back some of its stock, with part of its $20-a-share cash hoard. "I was talking to people who were going to buy on the open [Thursday]," he says, "because the bad news is now out." Hospitals won't spend much this year. But now that this robot maker has lost momentum, it looks like a value play.

Dr. Paul Price
Dr. Paul Price premium member - 7 years ago
Intuitive Surgical reported better than expected earnings today and is now trading about $214/share.

The trade can be unwound very profitably now or you can wait for expiration and get the full gain (with tax deferment until April 2012).

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GuruFocus has detected 5 Warning Signs with Intuitive Surgical Inc $ISRG.
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