ObamaCare for Investors 101: Part B Information (OCR), Transformation (VAR) and ObamaNation – The Takeover Basket (ECLP, EM, SXCI, CERN, QSII, CPSI) Tickers: OCR, VAR, ECLP, EM, SXCI, CERN, QSII, CPSI In our first ObamaCare for Investors Commentary, we were bullish on Omnicare (NYSE: OCR) as it is the leading Pharmacy Benefit Manager (PBM) for elderly patients, the most rapidly growing demographic in the United States. As it has moved down a point in the current sell-off in the market, we remain bullish on the potential for appreciation in OCR as it is seriously undervalued, compared to its competition. Today’s recommendation is for the second (Transformation) portion of this series, Varian Medical Systems (NYSE: VAR). VAR is undergoing a major change in its business strategy, virtually unnoticed by industry analysts and investors. While maintaining its dominant and highly profitable position (over 60% market share in the US and world market) in manufacturing -big iron-linear accelerators for the radiation therapy (radiotherapy, radiation oncology) sector in cancer treatment, it is transforming itself into an Informatics leader in this sector as well.
VAR is the only company in the radiation therapy/oncology market that develops, installs and services all the crucial steps for the radiation therapy process with in house solutions for the nine elements below, increasing margins and developing and maintaining intimate relationships with their solid customer base. It has 55-65% market share globally and 70% share in North America. VAR continues to invest 7% of its sales revenues on R&D and increase its sales ($1.7 billion in 2007, $2.07 billion in 2008 and guiding to another 4-5% sales gain in 2009). More importantly, it has increased its profitability as well ($2.19 in 2008 vs. $1.83 in 2007, guiding to $2.60 – $2.65 for 2009). Based on this guidance, VAR’s PE is less than 16 times forward earnings at today’s closing price of $41.44, well below its customary 20+ PE. New cancer patients are expected to increase globally to 15 million per year, growing by 50% by the year 2020. While other manufacturers of medical equipment have suffered major setbacks in sales and margins under the threat of health care reform and nationalization, VAR chugs along, and at the same time is investing in managing workflow and Electronic Health Records (EHR) for all specialists treating cancer. As we continue to emphasize, these products are endorsed by the Obama administration and Congress as part of the solution for reducing health care costs and eliminating errors.
VAR is speeding up and streamlining the workflow and delivery of the radiotherapy process, which can involve as many as 175 steps for initiating a patient treatment, and 75 steps in the 30 or so succeeding patient interactions and treatments, and involving 6 or more specially trained personnel. The steps in the radiation therapy process include:
1) Examination of the patient,
2) Treatment planning,
3) Treatment simulation,
4) Quality assurance for devices and software used in treatments,
5) Delivery of the radiation therapy,
6) Verification and confirmation that the treatment was delivered correctly,
7) Recording the history of the treatment,
8) Transmitting the information regarding the treatment to referring clinicians, including medical oncologists, primary care physicians and hospitals, and
9) Obtaining reimbursement based on accurate and compliant documentation for the services. The new Varian ARIA Oncology Information Management product line is directed to streamlining these steps and reducing the cost of personnel and manually carrying out each of these processes. It also can communicate the data electronically to treating physicians. Ultimately, this product line can reach and manage the patient records for all specialists treating cancer patients so they can operate a filmless and paperless cancer clinic or practice.
No competitor in the existing Electronic Health Record (EHR) vertical has this expertise, capability or reputation with these customers. In addition to its medical accelerator and related products, VAR has continued to develop new and unique products for diagnostic imaging, for internal use and the OEM markets including proprietary technology for fluoroscopic and static digital radiographic systems (DR), the fastest growing portion of medical, dental and veterinary imaging as well as medical and industrial x-ray tubes. These businesses contribute over $300 million in annual sales, and may grow to $300-500 million over the next few years, with very attractive margins in the range of 50%. VAR innovations in radiation therapy have included RapidArc radiotherapy technology to reduce treatment times to two minutes or less, DynamicTargeting image-guided radiation therapy (IGRT) to pinpoint a moving target, SmartBeam Intensity-modulated radiation therapy (IMRT) to tailor the dose to spare healthy tissue adjacent to the tumor being treated, dynamic adaptive radiation therapy (DART) to adapt treatments to changing needs, Eclipse treatment planning system, image-guided brachytherapy, and most recently, an advanced proton therapy system, focusing on delivering the highest dose to the specific tumor shape to avoid critical structures.
These have all led to VAR customers returning for new and upgraded systems, service contracts and are an ideal launching pad for their ARIA Oncology Information Management System electronic records product line. All of these have been developed at VAR since 2000 and are marketed and sold directly by them. Now VAR is marketing its exciting entry into the new stereotactic radiosurgical product space. It sells Novalis TX (it partners with BrainLAB for this one), but has its own internally developed product as well, called Trilogy. These $3 million systems permit the precise localization of tumors with unique and advanced 3D imaging systems, guiding the delivery of higher dose radiotherapy to brain tumors and other malignancies and diseases, such as trigeminal neuralgia. In contrast to its competition, VAR is developing gating capabilities to precisely localize tumors despite motion due to breathing. This will facilitate the non-surgical treatment for patients with peripheral lung cancer, as is currently being done with some of the world foremost surgeons. Initial successes at several well-known centers are encouraging, and offer the opportunity to reduce the number of required patient treatments from thirty (30) with current schemes to only five (5) visits. Using its proprietary technologies developed over the years, VAR also created a Security and Protection Division (SIP) that performs cargo screening at borders and ports, and non-destructive testing of various industrial materials. Of importance is VAR’s service business, which creates attractive recurring revenues that are approximately 25% of its sales, or about $450 million per year, with very good margins that we estimate to be in the range of 50%. It acquired the GE service business for accelerators in 1997 and has maintained that installed base.
GE notoriously shut down their division and exited this attractive business after paying dearly for the previous AECL/CGR radiation therapy product line of medical accelerators, leaving VAR as the dominant player in the game. VAR’s nearest competitor, the Swedish company Elekta, has ~25% global market share, with Siemens, AccuRay (NASDAQ: ARAY) and TomoTherapy (NASDAQ: TOMO) each having about 5% market share. None are even close to gaining on VAR in sales, technology, innovation, customer loyalty or its transformation to an Informatics company. The ARIA product line is targeted to equal the sales of hardware in the not too distant future, with higher margins. China, you ask? Yes, VAR is there, too. While its management downplays the opportunity there, consider that in 2007, VAR acquired Pan Pacific Enterprises, Inc. for distribution of x-ray products in China, and opened a manufacturing facility in Beijing in 2008.
ales there represented less than 5% of its 2008 sales, it increased by 50% in 2008. Consider that the largest group and one-third of the smokers in the world are Chinese men, increasing to nearly two-thirds of all men there, as we pointed out in our August 2009 Lung Cancer Commentary. This accounts for the most rapidly increasing population of lung cancer patients in the world. Think about the market opportunity for a company that has its radar focused on improving throughput, and goal of reducing the number of costly and sophisticated radiation therapy personnel requirements through innovative software. VAR has the fastest and most efficient delivery system for radiation therapy, and technology aimed at non-surgical and more cost effectively treating peripheral lung cancers, and has the potential for a monstrous market for its products. This could provide a market opportunity by the year 2020 for VAR linear accelerators in China, nearly the same size as the current 3,000 installations in the U.S. Our thoughts, not Varian’s. This is not your mother’s Varian, not the same company that was founded in 1948, and divided in to three distinct companies in 1999 – instruments (VI), semiconductors (VSEA) and Varian Medical Systems (VAR). This is Varian Medial Systems. It is an innovation driven hardware and software medical company, with the largest and dominant market share in the world for its markets. Service revenues are growing, and earnings continue to ramp up. VAR is ideally positioned to benefit from the coming U.S. health care reform, which will emphasize improved workflow, efficiency and costeffective treatments. Neither ObamaCare nor the stock market’s whims and consumer – economy fixations, should seriously impact VAR. They have no equal in their markets, and are constantly innovating and improving margins and China awaits.
We are bullish on Varian, the consistently profitable billion dollar pure play in the outpatient and nonsurgical treatment of patients with cancer. Financial Ratios for Companies Mentioned in this Report: Omnicare Inc. (OCR): Current price $23.17 52 wk range $19.14 – $30.81 Market Cap ($MM) $2,770.00 EPS (FY08) $1.32 Revenue ($MM) FY08 $6,310.6 Cash per Share $1.82 Varian Medical Systems Inc. (VAR): Current price $42.74 52 wk range $27.10 – $64.00 Market Cap ($MM) $5,370.00 EPS (FY08) $2.19 Revenue ($MM) FY08 $2,069.70 Cash per Share $3.11 Eclipsys Corp. (ECLP): Current price $19.78 52 wk range $7.39 – $22.08 Market Cap ($MM) $1,120.00 EPS (FY08) $1.81 Revenue ($MM) FY08 $515.80 Cash per Share $1.97 Emdeon Inc. (EM): Current price $15.63 52 wk range $14.81 – $18.25 Market Cap ($MM) $1,800.00 EPS (FY08) $0.12 Revenue ($MM) FY08 $853.60 Cash per Share $0.71 SXC Health Solutions, Corp. (SXCI): Current price $45.56 52 wk range $10.40 – $48.85 Market Cap ($MM) $1,150.00 EPS (FY08) $0.65 Revenue ($MM) FY08 $862.90 Cash per Share $2.89 Cerner Corp. (CERN) Current price $74.64 52 wk range $30.37 – $75.41 Market Cap ($MM) $6,050.00 EPS (FY08) $2.26 Revenue ($MM) FY08 $1,676.00 Cash per Share $3.70 Quality Systems Inc. (QSII): Current price $62.38 52 wk range $25.70 – $64.16 Market Cap ($MM) $1,780.00 EPS (FY08) $1.44 Revenue ($MM) FY08 $186.50 Cash per Share $2.47 Computer Programs & Systems Inc. (CPSI): Current price $41.49 52 wk range $21.30 – $42.32 Market Cap ($MM) $455.26 EPS (FY08) $1.43 Revenue ($MM) FY08 $119.70 Cash per Share $2.19 Source: Revere Research. Data as of September 28, 2009 Disclosures And Legal New BioMedicine, LLC, is not a market maker and does not perform underwriting or manager services.
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