Intuitive Surgical Stock Leads Robot-Assisted Surgery

A couple of years ago, we pulled back the curtain on how thematic exchange traded funds (ETFs) work. The article came out around the time we were trying to find the best robotics ETF to invest in. This also coincided with the initial release of the Nanalyze Disruptive Tech Portfolio, which has since evolved as we tweak our methodology to be as rules-based as possible. In effect, our portfolio is a thematic ETF of disruptive technologies. One of our goals is to purge the portfolio of other ETFs in order to provide a basket of pure-play stocks under the 12 different categories we cover. 

That means we want to eventually replace the Global X Robotics & Artificial Intelligence ETF (BOTZ) with a company that offers better exposure to the theme. In reality, few ETFs contain a universe of pure-play stocks, and BOTZ is no exception. The top three companies on the list, for example, are either pick-and-shovel plays on the theme or large conglomerates that derive only part of their revenue from robotics. However, the company currently sitting in the No. 4 slot, Intuitive Surgical Inc (ISRG), is a pure-play surgical robotics company that is currently trading at a bargain price thanks to the ongoing bloodbath in tech stocks. This could be a great time to make an investment in a clear category leader with a market cap of about $100 billion and nearly $6 billion in annual revenues.

A Brief History of Intuitive Surgical

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Like most of the cool stuff we have today – GPS, the Internet, and Siri (well, two out of three) – we can thank the shadowy government agency DARPA for the development of surgical robotics. You can get the full history here, but here’s the Cliff’s Notes: Development of robotic systems began in the 1980s but really started to come together in the 1990s. The technology got a boost when the military got interested in using remotely operated robots (robotic telepresence) to treat soldiers on the battlefield. DARPA tapped SRI International, a federally funded institute previously spun out of Stanford University, to help develop the technology. DARPA also funded a private company called Computer Motion, which developed a robotic platform that enabled surgeons to control a laparoscopic camera system using voice control. It received the first FDA nod to use a robotic device for intra-abdominal surgery.

Meanwhile, the eventual founders of Intuitive Surgical acquired the intellectual property from SRI International that would serve as the foundation for the company’s line of da Vinci surgical robotic systems. The first prototype was called Lenny, for Leonardo da Vinci, followed by Mona, a slight nod to the slightly smiling Mona Lisa painted by the human da Vinci more than 500 years ago.

The prototypes that eventually led to the da Vinci Surgical Systems
The prototypes that eventually led to the da Vinci Surgical Systems. Credit: Intuitive Surgical

The Silicon Valley-based company sold its first machine to a German medical center that specializes in cardiac surgeries in 1998. It received full authorization for the da Vinci robotic system in the United States just a couple of years later. It didn’t take long before Computer Motion and Intuitive Surgical began patent battles on both sides of the Atlantic. After three years of legal scuffles, the two companies reached a cease fire and merged in 2003. Computer Vision’s flagship robotic surgical system, ZEUS, was phased out in favor of the da Vinci platform, though it did absorb some of the features of its rival in later models.

What is the da Vinci Surgical System?

The da Vinci Surgical System enables surgeons to perform a wide range of minimally invasive surgeries (also known as laparoscopic) using computational, robotic, and imaging technologies. Surgeons operate the platform while seated at an instrument console, viewing a high-definition 3D image of the surgery site. The surgical instruments are designed to articulate and move with the same dexterity of the human hand and wrist, but without the tremors from alcohol withdrawal by tee time. 

The da Vinci Surgical Systems today.
The da Vinci Surgical Systems today. Credit: Intuitive Surgical

The company currently offers three robotic surgical systems, including two versions of its fourth-generation flagship product – the more robust da Vinci Xi Surgical System and the stripped-down da Vinci X Surgical System. The company has about 70 different instruments that are compatible with these systems, including staplers and energy systems for sealing tissue. The third platform, the da Vinci SP Surgical System, accesses the body through a single incision while the other platforms use multiple incisions. In 2019, Intuitive released the Ion system for lung biopsies, its first diagnostic robotics system. All da Vinci systems include a console, imaging electronics, a patient-side cart, and computational hardware and software.

Robot-Assisted Surgery by the Numbers

The da Vinci Surgical Systems recently reached a milestone of 10 million surgeries, ranging from gynecologic procedures, kidney surgery, gallbladder surgery, thoracic surgery, and weight-loss surgery, among others. There are more than 6,700 da Vinci surgical systems installed in 67 countries, while more than 55,000 surgeons worldwide have trained on the use of da Vinci systems. Some 30,000 clinical studies have been conducted on robot-assisted surgeries, and many have concluded that minimally invasive robotic surgery can result in shorter hospital stays, less postoperative pain, quicker recovery times, and less risk of infection and scarring.

Benefits of robot-assisted surgery.
Credit: Palm Beach Surgical

Not everyone is a fan, of course, especially when your product is used to poke and prod the human body in very (minimally) invasive ways. Intuitive is “currently named as a defendant in a number of individual product liability lawsuits filed in various state and federal courts,” alleging the company’s systems caused personal injury and even death, according to the default language in the most recent 10-Q filing. Unfortunately, this is the cost of doing business in healthcare today. An article last year in the New York Times reported on a study that reviewed 50 randomized controlled trials that compared robots vs humans. The authors claimed that only four of the previous studies demonstrated modest benefits to patients.

Market Leader in Robot-Assisted Surgeries

The same NYT article noted that Intuitive Surgical is the undisputed leader in robot-assisted surgeries. Analysts estimate the company owns about 80% of the market share, with medical device manufacturer Stryker (SYK) reportedly a distant second at about 10% after acquiring Mako Robotics about a decade ago. It’s impossible to say how long Intuitive can maintain its stranglehold on the industry, especially with other large medical device and healthcare companies pushing their way into the market through acquisitions. For instance, Medtronic (MDT) acquired Razor Robotics in 2018, while Johnson & Johnson (JNJ) bought Auris Health in 2019 in the largest robotics M&A deal to date. That doesn’t include all of the other types of robotic surgery companies that have emerged over the years.

Market share of robot-assisted surgery.
Intuitive has maintained its stranglehold on robot-assisted surgery. Credit: Informa

On one hand, it may only be a matter of time before competitors start to chip away significantly at Intuitive’s market share. That’s starting to happen to Tesla, which as recently as 2020 had about 80% of the U.S. electric vehicle market. That’s expected to drop to 56% in 2021, as major automakers like Ford and Volkswagen start rolling out more EVs. Of course, there’s still plenty of market share to go around, with EVs only accounting for about 4% of U.S. car sales. On the other hand, the list of heavyweights in the healthcare industry competing against Intuitive is much shorter, and none of them are pivoting 100% of their resources to compete in robot-assisted surgery. In addition, the industry is maturing. Between 2012 and 2018, use of robotic surgery for all general surgery procedures increased from 1.8% to 15.1%

Intuitive Counts on Consumables

Perhaps a better comparison is Illumina (ILMN), which was founded around the same time as Intuitive and owns about 80% of the genome-sequencing market. The analogy is useful beyond just longevity and market share: Both Illumina and Intuitive Surgical employ the so-called razor-and-blade business model. For those unfamiliar with the concept: A company makes a modest profit selling reusable razor handles but charges a premium for the disposable razors that can only be used a finite number of times before the user buys more. The blades are consumables. In the case of Illumina, about 70% of total revenues come from consumables like reagents, flow cells, and microarrays. Services is another recurring revenue, which makes up about 16% of Illumina’s business, while products only account for 13%.

The breakdown of recurring revenues for Intuitive Surgical isn’t quite as impressive, but the hardware is obviously more expensive, with robotic surgical platforms selling between $500,000 and $2.5 million, depending upon the model, configuration, and where in the world it’s being sold. The company earns between $600 and $3,500 for instruments and accessories per surgical procedure, varying depending on the type and complexity of the procedure. Annual service contracts range between $80,000 and $190,000. In 2021, recurring revenues – consumables, services, and leases – accounted for 70% of revenues while product sales brought in the other 30%.

Intuitive Surgical 2021 revenues versus 2020 revenues.
Credit: Intuitive Surgical

The ratio of recurring revenue to one-time sales revenue last year actually reverses a trend where the former had been slowly climbing. Recurring revenue accounted for 77% of the total in 2020, 72% in 2019, and 71% in 2018. One obvious reason behind the sudden drop is that the company is simply selling more machines. Indeed, the total number of installed da Vinci surgical systems increased 12% to 6,730 at the end of 2021, while total product revenue was up 30%. Another wrinkle in the math involves what Intuitive calls extended-use instruments, a line of consumables that are good for 12-18 procedures versus about 10 for the older instruments. 

Robot-assisted surgery accessories.
Some pretty fancy roachclips. Credit: Intuitive Surgical

The company introduced the longer-lasting instruments at the end of 2020, so last year was the first full year that customers were able to buy fewer consumables. We don’t have the final analysis for 2021, but based on 2019 sales figures, Intuitive estimated the new products would have cost between $150 and $170 million to the company’s bottom line. Considering that total revenues in 2021 were up 22% compared to 2019, we can ballpark that the extended-use instruments reduced revenues between $183 and $207 million. 

Revenues Rebound from the Rona

While the change is not inconsequential, Intuitive Surgical still hauled in a record $5.7 billion in revenue last year. It was particularly encouraging given that revenue actually dropped -2.68% in 2020 – only the second time it has declined in the company’s 20-year history. And, yes, you can blame the Rona.

Revenue history for Intuitive Surgical.
Since 2014, revenues have experienced double-digit growth, except in 2020 when the Rona hit elective surgeries. Credit: Companies Market Cap

Specifically, nonessential surgeries virtually stopped in the early months of the pandemic. The first hit came in early February 2020, when weekly procedure rates using da Vinci systems in China declined by about 90% compared to a month earlier. Europe and the United States followed by the end of March, with the weekly procedure rate initially dropping 65%. The rest of the year was something of a roller coaster, following the ebb and flow of the pandemic waves around the world. A study by Stanford researchers estimated the total volume of surgeries in 2020 ended up only 10% below the 2019 volume. Since 2014, when Intuitive had its only other down year, double-digit growth in revenues has been the norm, so we can chalk up 2020 as an anomaly. 

Conclusion

At this point, it’s hard not to like Intuitive Surgical stock, especially given the stock is down about -20% since the beginning of the year when the market took a collective dump. That gives us a simple valuation ratio (market cap/annual revenue) of about 18, with anything below 40 considered to be fairly valued. Intuitive Surgical is obviously the best robotic surgery stock out there today, but do we really want to invest in surgical robots? That’s the big question. If we do decide to pull the trigger on some ISRG stock, Nanalyze Premium annual subscribers will be the first to know.

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