Taipan Microcaps September 1998
Invest in the ground floor of future
surgeries - robotic doctors!
This company's robotic hip-replacement
surgeon is so quick and painless... there's a 9-month waiting list in Europe
to see the mechanical wizard!
by Brian Hicks
There are times when being younger than my fellow stock pickers is an obvious advantage: I'm more willing to speculate in the microcap sector.
Take Taipan's next recommendation, for instance. Integrated Surgical Systems (RDOC - NASDAQ) is a company developing a robot - called ROBODOC - used to perform hip replacement surgeries.
That's right - you're reading this correctly: The next time you go under the knife, the doctor might be R2D2.
Sure, I've seen the 1977 movie Demon Seed, where a computer/robot named Proteus takes over a scientist's house, holds his wife captive, and finally impregnates her, trying to create the perfect, intelligent life. (Don't ask me how fertilization occurred.)
That's Hollywood. I deal in hard numbers and more reliable equations, like supply and demand.
In Europe, where Integrated Surgical Systems has installed 16 ROBODOCs, more than 2,700 patients have "gone under the robot." And get this: ROBODOC is so good at total hip replacement, there's a 9-month waiting list at a Frankfurt hospital.
That's what I call demand. And why not...
Hip replacement surgery is gruesome - hammer and chisels are used to gouge
a hole in your femur bone! I'm told by those who've had hip replacement
surgery that it was the worst pain they've ever experienced.
For starters, the doctor begins by sawing off the ball from the top of the thigh bone that fits into the hip socket. If he's having a difficult time sawing, the surgeon will try to knock the ball off with a heavy mallet.
Once the ball is removed, the surgeon makes room for the implant. Using a hammer and chisel, the doctor begins chipping away at your femur bone. Hopefully the patient has been drinking milk, because many times the femur will crack or completely shatter from the intense banging.
The implant -- consisting of a long, heavy spike and ball - is then hammered into the thigh bone. And here's where the real problems begin. The implant usually fits so poorly in the cavity that on average, less than one-quarter of the prosthesis comes in contact with the bone. This makes it difficult for new bone tissue to anchor itself to the implant.
Sometimes bone just rubs against other bone. That's the real pain - the incessant grinding of bone on bone.
As a result, hip replacement surgery often needs to be redone after 5 to 10 years.
Throw away the hammer and chisel
Integrated Surgical's ROBODOC Surgical Assistant System is a computer-controlled
surgical robot which takes much of the pain out of the standard hip replacement
operation.
This is how the robot does it:
The surgeon begins by taking a three-dimensional CT scan of the patient's femur - the large bone running from the hip to the knee. The surgeon transfers the image to Integrated Surgical's computer workstation - the ORTHODOC.
While viewing the 3-D image, the doctor chooses the correct hip implant for the patient from a variety of choices stored in the computer's memory. The information about the patient's hip and the implant is stored in the workstation.
In the operating room, the surgeon exposes the patient's femur (I won't get into the gory details again). The computer relays detailed instructions to the robot about the size, shape and location of the implant cavity.
Then ROBODOC precisely drills a cavity into the patient's bone. The surgeon retains full control of the robot's operation, using a remote-controlled device with a "stop" button. When the robot is finished shaping the cavity about 20 minutes later, the surgeon fits the implant and completes the 90-minute surgery.
A tape of the planned surgical procedure, developed by the ORTHODOC, guides the surgical robot arm of ROBODOC to accurately mill a cavity in the bone, thus allowing the surgeons to properly orient and align the implant - helping them sculpt bones to within one-tenth of a millimeter.
The hip replacement market:
more than US$3.1 billion, annually!
The worldwide orthopedic market (which includes power surgical instruments,
prosthetic devices and bone growth stimulants) was approximately US$7 billion
in 1997. This number includes US$4 billion in the U.S. alone (constituting
57% of the worldwide market) and approximately US$1.8 billion in Europe
(constituting roughly 23% of the worldwide market).
In 1997 there were more than 600,000 total hip replacements and over 400,000 total knee replacements. In the U.S. alone, surgeons perform over 300,000 total hip replacements annually.
Nearly 200,000 of these are cemented, and the majority of these will need to be replaced again in five to 10 years after the first operation. This is due to the eventual failure of the acrylic cement's bond to the patient's bone, resulting in loosening and pain. In 1997, there were about 32,000 hip revision surgeries in the U.S.
Hip hop
The growth in hip and knee surgeries is expected to be in the range of 4
to 7 percent annually over the next several years. Continued growth in hip
replacements and knee replacements is expected to come from the graying
of the American, European, and Japanese populations.
In each case, citizens are living longer and remaining active well into their 70s and 80s. Plus, earlier generations of implanted prostheses have reached an age where replacements are becoming necessary, resulting in an increased demand for hip and knee revision surgery.
And how about these numbers: There are approximately 15,000 orthopedic surgeons in the U.S. and over 5,000 hospitals performing orthopedic surgeries that have, or have access to, a CT scanner. Of these, nearly 1,000 hospitals perform over 150 orthopedic surgeries per year.
There are presently 800 hospitals in Germany that have a CT scanner and perform the vast majority of orthopedic surgeries. Since the procedure for performing total hip replacement surgery using the ROBODOC requires a CT scan of the patient prior to surgery, these are the primary centers that would consider the purchase of a ROBODOC system.
According to industry sources, there are an additional 1,000 hospitals in the rest of Europe that perform a significant number of orthopedic and traumatic surgeries. So there are a total of 1,800 hospitals in Europe that are likely to consider acquiring the ROBODOC unit.
Boom Boom Boom...
And besides, the over-65 population is expected to more than double from
its 34 million today to over 77 million in 2040 - when one in every five
Americans will be over 65. This is the baby boom population, who are beginning
to turn 50.
As this segment of the population grows older, more of these deteriorating hips and knees will need replacing. In other words, just in the U.S., there will be an ample and growing supply of hip replacement recipients.
Growth will come in the upper end, with the 80-and-over population expected to more than double from 3 million in 1990 to over 7 million in 2020. This population will double again to 14 million by 2040.
European vacation
Thanks to a more streamlined regulatory approval process, Integrated Surgical
Systems received certification to sell ROBODOC in the European Community.
The system is already registered for distribution in Italy, France, the
Netherlands, and Germany. So sales thus far have been only in Europe.
ROBODOC has been used in Germany since 1994 in more than 700 hip replacements. Worldwide, doctors have successfully performed over 1,500 total hip replacements.
Although the company is expected to control the European market, the big boost in sales will come from the U.S. market - where more than 300,000 total hip replacements (more than half of the world's THR surgeries) are performed each year.
In February 1996, Integrated Surgical filed a 510(k) submission for the ORTHODOC Presurgical Planner. However, since the ROBODOC is not substantially equivalent to any other approved product, the FDA will also require the company to file a PMA.
Support From Big Blue
Integrated Surgical Systems has been helped in the development of ROBODOC
by IBM. In 1990, IBM invested US$10 million in Integrated to design, develop,
and manufacture prototypes of ROBODOC. As a result of their investment,
IBM holds the right to purchase up to 27% of the company's outstanding shares.
The success of ROBODOC and the support of IBM has allowed Integrated Surgical to bring to the market another robotic surgical device - the NeuroMate systems. NeuroMate is used in brain surgery, and to date, more than eleven systems have been installed in the U.S., France, the U.K., and Japan. More than 1,800 patients have been operated on by the NeuroMate system.
Just a market cap of US$23 million
In terms of market cap, ISS is a true microcap of just US$23 million. So
it's definitely a speculative stock... especially in this volatile market.
But Integrated Surgical is the kind of speculative microcap I love. A company with support from a major player (IBM), large insider holdings to the tune of 60%, and trailing revenues of US$7 million.
Besides, the bloodbath in the small-cap market has absolutely devastated the valuations of microcaps. RDOC's 52-week high is US$9.13. The stock currently trades at US$4.25 - off 55% from its high.
And since it's trading at these distressed valuations, the fundamental ratios of this stock are looking too appetizing.
Integrated Surgical has a book value of US$2.25. Trading at US$4.25, RDOC trades just 1.8x book value. This definitely isn't a speculative-type ratio.
With a market cap of US$23 million, RDOC trades just 3.2x sales!
Three times revenues and 1.8x book. These are rock bottom valuations for speculative medical device stock.
Coming FDA approval
Besides the small-cap sell-off, institutional investors are looking for
ROBODOC to get closer to FDA approval. FDA approval should be coming within
12 to 18 months.
And with FDA approval, RDOC's stock should swell to above US$15 - which would give Integrated Surgical a market cap of roughly US$84 million. US$84 million is still extremely low. A market cap above US$100 million is not out of the question.
Wafer-thin float
Integrated Surgical has 5.6 million shares outstanding. Only 2 million are
in the float. Buying RDOC has to be very disciplined. Don't push the stock
to extreme levels. Buy it under US$5.
I'm predicting the small-cap market will bounce in the next 3 months to begin a new rally... and go on to take out new highs. Since RDOC has sold off to its current distressed valuations, the stock isn't going lower. You could see RDOC above US$7 by the end of the year... and above US$10 by next summer.