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Holly LaFon
Holly LaFon
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David Rolfe Comments on Edwards Lifesciences

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April 16, 2018 | About:

Edwards Lifesciences (NYSE:EW) was our top contributor in the first quarter. Honestly, we couldn’t be much more pleased with the way fundamental developments have played out during our ownership of the Company. As you know from our earlier commentary, the primary driver for the Company is Transcatheter Aortic Valve Replacement (TAVR), where the Company has a significant market leadership position. As a reminder, TAVR is a much less invasive alternative to open-heart surgery for the replacement of the aortic valve, in which the new valve is put into place through a catheter, typically inserted via a tiny pinprick in a patient’s leg. The aortic valve is generally replaced due to a condition known as Aortic Stenosis (AS), which is a narrowing of the valve, which restricts blood flow within the heart. TAVR has seen successive waves of growth as the procedure has been approved first for patients for whom surgery was not a viable option, then for patients at high- and medium-risk of complications from surgery. The Company is also working on approvals for low-risk patients and for patients currently showing no symptoms of AS. Our research has led us to believe, from the beginning, that the Company’s publicly-stated intermediate-term expectations for the size of the potential patient population and market opportunity were vastly understated. We believed that both physicians and patients have tended to delay addressing potential heart valve issues due to the rather traumatic prospect of open-heart surgery. With a much less invasive option now available for treatment, we have believed that the pool of potential patients would prove to be much greater than anyone could have tracked previously, especially among patients who were “less sick,” for lack of a better term. As initial approvals have been for patients already known to be the “most sick” – specifically, patients already known to be suffering from severe AS, and who have other complications that make open-heart surgery a risk – the addressable patient population in the early stages of TAVR rollout has been fairly predictable. However, as approvals move toward “less sick” patients over time, we firmly believe the addressable patient population will repeatedly surprise to the upside. Therefore, it has been gratifying to see this part of our thesis already playing out. In just the past year, the Company has increased its guidance for the total TAVR market by 2021 from $5 billion to greater than $5 billion, also noting that the opportunity beyond 2021 is significant. Specifically, they have said that they believe the prevalence of AS is larger than they previously had anticipated, meaning that treatment rates are much lower than they had anticipated. Furthermore, activity from competitors in the TAVR market has turned out to be more benevolent than we had expected. Medtronic’s CoreValve remains the #2 competitor, and it is growing slightly faster than Edwards in TAVR, since it came to market later and is capturing some share, as Edwards no longer has the market to itself. This is exactly as we have expected. We also anticipated that Boston Scientific’s Lotus valve, which has had some quality issues and has been off the market for several quarters, would reenter the market and capture modest share as a #3 option, as our research has indicated that this valve is better than the other two companies’ offerings in specific situations but is not comparable in

the majority of situations. We also assumed that pricing would decline across the TAVR space as Boston’s product came to market, because Boston would try to compensate for an inferior product with lower pricing. However, since our initial purchase, the following events have occurred: 1) Boston has repeatedly struggled to get Lotus back on the market; 2) both Medtronic and Boston have basically admitted that Edwards has the best product, and the other two will be slugging it out for second place; 3) Boston has claimed (optimistically, according to our research) that its product is just as good as Medtronic’s, so they will have no need to resort to a price war in order to capture share. These are all very positive developments in relation to our initial expectations. In rough terms, we originally had expected something like a 45-45-10 eventual market share split between Edwards, Medtronic, and Boston Scientific, and with a degradation in pricing; instead, Boston still hasn’t managed to get back on the market yet, and we could eventually be looking at something as positive as a 60-20-20 split with little or no pricing degradation, if Boston is to be believed – although, as previously noted, we are skeptical of some of Boston’s projections. Finally, we would note a couple of slightly less significant developments. First, an early ruling in some TAVR patent litigation between Edwards and Boston just went in Edwards’s favor; we see this litigation as routine for the industry and believe it is most likely to end in some fairly benign cross-licensing agreements between the companies, but this early ruling may point to a more positive outcome than we had expected. Next, although we still see significant long-term opportunity in TAVR, we are getting closer to the Company’s next growth drivers in transcatheter mitral and tricuspid valve repair and replacement, areas estimated by the Company to be at least a $3 billion market opportunity by 2025. The Company expects to launch at least one new product in these areas in each of the next three years. Looking specifically at the stock, although investors with shorter-term time horizons have occasionally fretted over minor decelerations in TAVR growth rates—which have been nothing more than a function of mathematical realities, when the Company has lapped periods of the unleashing of pent-up demand after launching new patient populations in high-risk and intermediate-risk situations—we have focused on the long-term growth opportunities and have been able to build our position at attractive prices. As we say with pretty much every one of our positions in the current market, the stock’s valuation clearly is not cheap; in the tenth year of a valuation-agnostic bull market, very little is, by any reasonable historical standards. However, in a market where most stocks trade beyond the top end of historical valuation ranges, Edwards at least is trading firmly within the middle of its normal range during the current bull market, in the mid-to-high 20s on a forward P/E basis. Edwards also is generating very healthy double-digit percentage revenue growth (16% in 2017) as well as improving profitability, with consistent EPS growth over 20%. We continue to view this as good value.

From David Rolfe (Trades, Portfolio)'s Wedgewood Partners first quarter 2018 shareholder letter.

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Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

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