Guidant: Primed to Pump Profits?
By Robert Gold
Guidant (GDT ), founded in 1994 through a combination of five medical-device units of Eli Lilly & Co. (LLY ), stands among the world's leading developers and marketers of medical devices. It has sizable market-share positions in the categories of cardiac-rhythm management, coronary and peripheral vascular stents, congestive heart failure, and specialized surgery categories. We at Standard & Poor's recently upgraded our investment opinion on the stock to 5 STARS (buy).
One of the more volatile, yet promising, therapeutic categories in which the company competes is in the treatment of coronary artery disease (CAD), a potentially fatal restriction of blood flow due to the formation of atherosclerotic lesions. More than 6 million Americans have been diagnosed with CAD, and nearly 2 million patients annually undergo minimally invasive CAD interventions (angioplasty, stenting, or atherectomy) each year across the globe. Given the size -- and the continued growth prospects -- of this market, it's no surprise that Guidant competes with several other medical-device manufacturers in this lucrative area.
The company offers various products through its vascular-intervention segment to treat CAD, though coronary stents represent the bulk of the unit's sales -- and 30% of the company's total 2001 sales. These devices are metal tubes or coils mounted on a coronary-dilatation catheter and permanently deployed at a blockage in the coronary artery.
Guidant's Multi-Link family of stents currently holds the leading position in the U.S., with about 50% of an estimated $1.3 billion market, well ahead of rivals such as Johnson & Johnson (JNJ ) at 21%, Medtronic (MDT ) at 16%, and Boston Scientific (BSX ) at 13%. For 2002, we look for vascular intervention segment sales of $1.3 billion, but expect modest contraction to $1.1 billion in 2003, due to the expected emergence of new technologies, as explained below.
The major challenge to coronary angioplasty procedures involving the implantation of a stent is clinical restenosis, the re-narrowing of the blood vessel at the site of the initial treatment. This outcome generally requires another surgical procedure within six months of the initial procedure. It's estimated that about 20% of patients suffer from restenosis, and follow-up surgery to replace the stent can cost approximately $20,000.
For this reason, Guidant is positioning itself to participate in the promising market for drug-coated stents. These devices are simply bare metal stents coated with anti-cancer agents that can prevent cell growth at the site of the vessel lesion. Clinical studies have shown that these devices can lower restenosis rates from the existing 20% to a range of 0% to 8%, depending on the drug being evaluated and the format of the trial.
Guidant's most promising drug-coated stent program uses the anti-cancer compound paclitaxel (Taxol). This program is being conducted along with privately held Cook Inc., who licensed the compound from Angiotech Pharmaceuticals (ANPI ). However, Boston Scientific also licensed paclitaxel from Angiotech, and has sued under the belief that Cook does not have the right to effectively cross-license the drug to Guidant. In order to circumvent the courts, Guidant has decided to purchase Cook in a $3.0 billion stock deal that we believe will allow the company to proceed with its clinical trials, as it will no longer be a third-party licensee of paclitaxel.
We assume that the company will enter the market in the third quarter of 2003, about six months after an expected launch by Johnson & Johnson. In the meantime, sales of bare metal stents are likely to erode modestly across the industry.
Initial clinical trial results of these products by Johnson & Johnson, Boston Scientific, and Guidant have been strong enough that Medicare has taken the unprecedented step of establishing reimbursement guidelines for the devices before the FDA has formally approved them. Based on the rates established by Medicare, and S&P's expectation that the market will almost entirely move to drug-coated stents over the coming three years, we feel that the stent market has the potential to expand from its current level of about $2.8 billion to about $5.5 billion by 2004 yearend.
KEEPING THE PACE.
At that point, we assume Guidant will have an approximate 25% to 30% share of the market, translating into an annual revenue run rate of around $1.4 billion to $1.7 billion. Gross margins on these new devices are expected to be nearly 70%, with average selling prices of about $3,000 per unit. On average, 1.4 stents are used in a stenting procedure.
The vascular-intervention segment's offerings are rounded out by angioplasty systems and accessories, including dilatation catheters, guide wires, guiding catheters, atherectomy catheters and related products (14% of 2001 sales).
Guidant's cardiac rhythm management products include implantable cardioverter defibrillator (ICD) systems (27% of 2001 sales) used to treat abnormally fast heartbeats, and cardiac pacemakers (22%) that are used to manage irregular heartbeats. While the pacemaker market is growing a modest 5% annually, ICD markets are presently expanding at nearly a 20% pace, and Guidant generated second quarter growth of 37%. Growth in ICD markets in the second half of the year is projected at about 40%. This reflects the highly successful launch of the Contak CD Easytrak system, a product designed to treat congestive heart failure that was approved by the FDA in early 2002. We are looking for ICD sales of $970 million and pacemaker sales of about $620 million in 2002. In 2003, these categories should generate sales of $1.2 billion and $650 million, respectively.
Within the non-coronary product segment (7% of the company's 2001 sales), Guidant sells peripheral vascular stents, along with guide wires, catheters, and products for specialized cardiac surgery. We believe that these areas will contribute about $215 million to sales in 2002, and $300 million in 2003.
In total, we see 2002 revenues advancing 15%, to $3.1 billion, moderate gross and operating margin expansion, and a $0.05 per share benefit from the elimination of goodwill amortization charges, supporting a 30% EPS gain to $2.05. In 2001, Guidant reported operating income per share of $1.58, which excluded $0.24 in stock option grant expense. Revenue growth in 2003 should continue to be fueled by rising demand for cardiac rhythm management and other product areas outside of vascular intervention, but the company's growth rate should accelerate markedly upon the anticipated launch of drug coated stents in the latter portion of 2003.
At current valuation levels of 16 times our 2002 EPS forecast and 3.4 times estimated 2002 sales, Guidant is priced at sharp discounts of 41% and 26%, respectively, to its peers. We believe this gap reflects uncertainties regarding the Boston Scientific litigation. However, we feel the Cook acquisition will allow the company to proceed with its paclitaxel-coated stent development program and emerge among the leading players in this market in 2004. Assuming Guidant's 2003 price-earnings ratio moves closer to its peers, we have established a 12-month target price of $50, nearly 50% above the current quote.
Analyst Gold follows health-care equipment stocks for Standard & Poor's