Monday, August 2, 2010

Volcano - A Stock I Would Love To Love

Another one of my former coverage names reported last week - cardiovascular imaging specialist Volcano (Nasdaq: VOLC). Even though I love almost everything about this name, you will see in the end that it is not a recommendation of mine.

So, how was the quarter?

Revenue jumped 36% to almost $74M, and that is a fine start. IVUS console revenue was up 16% to $11M, IVUS catheter revenue was up 29% to $41M, and FM revenue was up 49% to $11M. Also, the Axsun telecom business did pretty well too - "other" revenue climbed 93% to $4.3M

I do not have too much to complain about here, and my long-time readers will appreciate how rare that is. The company definitely had some juice in the gross margin line (due to higher catheter sales, as well as the sales transition in Japan), and operating results were quite good.

On top of that, it is a pretty attractive overall picture. The company continues to build its momentum against Boston Scientific (NYSE: BSX) in the IVUS space, and BSX is basically just managing that business like a declining cash cow; I really do not see any meaningful drive to innovate or reinvigorate its platform to compete with VOLC. On the FM side, doctors continue to adopt the procedure and although a lawsuit from St. Jude (NYSE: STJ) is a threat and a distraction, this is pretty typical for the medical technology industry (especially in the early sorting-out years of a sector).

Longer term, there is a lot to like here. The company is building a dominant IVUS business (somewhere north of 70% market share for new placements) and gaining share in the rapidly-growing FM market as well. Longer term, technologies like OCT (where St. Jude is also competing), forward-looking IVUS, image-guided therapy, and now intracardiac echo (which the company is gaining through another acquisition) should help boost that growth rate and make VOLC a significant player in invasive monitoring and imaging.

Now the bucket of cold water - I cannot get around the valuation. Even plugging in 20% revenue growth for five years and a FCF margin that moves up to 15% in 2015, I cannot get a price target much beyond $20.50.

Still, the stock is trading at an EV/revenue multiple of 4 and these stocks routinely trade in the 4x-8x range. Moreover, I would be amazed if this company does not get a takeout bid sometime in the next year or two (look at Abbott Labs (NYSE: ABT), Siemens (NYSE: SI), Philips (NYSE: PHG), GE (NYSE: GE), and maybe Medtronic (NYSE: MDT), Johnson & Johnson (NYSE: JNJ), or Covidien (NYSE: COV)). So, investors who can stomach the risk could certainly take the position that institutional investors pretty much ignore cash flow analysis for med-tech stocks (which is true) and simply play the valuation ratio trade.

I do not have any problem with that ... but I do not think I will be joining them. I love Volcano as a company and it was a pleasure to follow them as an analyst. But since John Dahldorf (their CFO and a good guy) cannot write me a check and compensate me if the stock goes down, I think I will pass on it for now.

Disclosure - I own shares of JNJ

No comments: