Tuesday, February 22, 2011

Sonosite is a High Grow Healthcare Play

Sonosite $SONO is a leading player within a high growth niche area of healthcare. The company specialises in hand carried ultrasound systems and, is the leading player in the US in this area. SONO is competing with some very big companies like GE , Philips and Siemens but it has demonstrated the capability to lead this market. As such, this stock is a genuine takeover candidate for these companies or a larger company like Mindray.

Sonosite are involved in miniaturising and simplifying ultrasound for Point of Care (PoC) medicine. The company was spun out of a larger US company in 1998 and until now has established over sixty thousands installed users. The company's solutions are sometimes described as 'portable ultrasound' but this description does not allude to some of the growth drivers for Sonosite. Before going into them, it is useful to see how Sonosite is performing right now.

Sonosite SONO Q4 Results

Turning to the recent Q4 results
  • Q4 Revenues of $89.3m vs. $83.7m estimates
  • Including Non-Recurring Charges EPS was 41c vs. 36c estimates
  • Full Year Revenues of $310-325m vs. $312m estimates
  • Full Year gross margins stable at around 71%
  • Operational expenses of $184-186m
  • Tax rate of 34%
  • Analyst are forecasting EPS of $1.20 for 2011
Listening to the conference call the management are seeing a 50/50 split between international and US sales in 2011. International growth is seen as stable but low growth in Western Europe, however the emerging market and BRIC economies are seen as faster growing. A combination of organic revenue growth, new product launches in the second half and growing contribution from the Visual Sonics acquisition will increase the top line by 13-18% according to Sonosite.

One interesting aspect of this growth is that it will be more back end loaded, so investors can expect a 40/60 split of revenues in the two halves, with revenues in Q2 and Q3 being higher than in previous years. Margins are likely to stay stable because Sonosite is in-what the company sees as- the first of a three year sales cycle. Typically this means that sales costs, R & D and promotional activity are higher in the first year. After which, operating margins will expand in the next couple of years.

Sonosite estimates that it either held or gained market share in its major markets and the management do not appear to be planning any acquisitions for 2011.

Sonosite Growth Prospects

The growing usage of portable ultrasound for emergency procedures (where portability is an issue) is one area of growth as is increasing usage for certain medical procedures. In particular, advances in portable ultrasound technology are seen as creating a market for the machines to be used in procedures that would otherwise be covered by computed tomography (CT) or magnetic resonance imaging (MRI).

For example, patients who need on going antibiotics or chemotherapy will have a Peripherally Inserted Central Catheter (PICC) placed in them and, portable ultrasound is ideal for helping the nurse visually see how the instrument should be placed. Similarly, nurses use the machines to guide them in injecting anesthetics near peripheral nerves prior to surgery. For this type of hospital usage, Sonosite claims to be the clear leader with GE its main competitor.

Another growing usage is for detection of breast cancer, as ultrasound gives very high

Sonosite also cites Mindray as being a competitor in some of its markets and, they could be potentially an acquirer because Sonosite and GE have already settled a law suit. Furthermore, Sonosite should be attractive to the likes of Philips or Siemens who could immediately gain scale in the US by buying SONO.

Sonosite Evaluation

The stock trades at a share price of $36.94 which gives it a market cap of $498m and an Enterprise Value of $497m which makes it a small cap growth play. Analyst estimates are for EPS of $1.20 and $1.64 for 2011 and 2012 respectively. This hardly makes the stock cheap on a PE basis.  However, net income is only one side of the story, because SONO have been booking losses via buying back convertible debt. Furthermore, Sonosite is a highly cash generative business.

Given the numbers in the guidance above, it is entirely feasible that, for 2011, Sonosite will record $225m in gross margin and 40.4m in operating income. Assuming losses on debt repurchases similar to 2010 would give pre-tax profits of $29m and $19.1m in net income. Given traditional operating cash flow conversion, Sonosite could generate $33.5m in operating cash flow and around $31m in free cash flow (FCF).  This equates to a foward FCF/EV yield of  6.2% based on a current price of $36.94

This looks too cheap, so I bought some with a $45 price target.


iData Report, "U.S. Market for Ultrasound Equipment 2010"

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