Cancer Blaster vs. Surgical Robot?

The stock market is presenting all kinds of buying opportunities that are making me interested this week, but the one dynamic that stands out most today is the dramatic difference between the performance of two companies in my portfolio that sell high tech products that both do essentially the same thing ... though in very different ways.

Accuray (ARAY) is the maker of the Cyberknife, a targeted radiation machine for cancer treatments that has been called the "Cancer Blaster" by newsletter touts who enthusiastically recommend the stock. Though useful for all kinds of radiation treatments, the argument for this more advanced machine is that it can track moving tumors and spare nearby tissue -- making it particularly popular for prostate and lung cancers (since the lungs, you know, move, and the prostate is in, shall we say, a very delicate area of the body).

Intuitive Surgical (ISRG) is the maker of the da Vinci surgical robot, whose core market is prostate surgery (though other surgeries, including mitral valve heart surgery and gynecological applications, are growing fast). The strongest rationale for fast growth in the use of this robot a couple years ago was that prostate surgery with the da Vinci spared those same "delicate areas" near the prostate in a way that open surgery often did not ... though it certainly also has other advantages over open surgery, and, depending on the surgeon (and who you ask) over traditional laparoscopic surgery.

Accuray is up close to 10% today, Intuitive Surgical is down about 8% as of my last check. Why is that?

Well, it's certainly true that ISRG is much more steeply valued, being one of the top performers on the Nasdaq for all of last year, and there are huge numbers of shareholders, myself included, who have a cost basis several hundred percent below the current price -- that makes these shares a target for profit taking when shareholders start to panic that we're entering a recession and/or a prolonged bear market. Even the most enthusiastic shareholder would have a hard time arguing that ISRG is a bargain, even down $70 from its high, with a forward PE of about 60.

And Accuray is, on the face of it, much cheaper -- this much newer public company (IPOd over the summer last year) has much lighter penetration in the marketplace, and has some competitors who offer somewhat similar products (as opposed to the da Vinci, which has the multipurpose surgical robot space more or less to itself). And it trades at a forward PE of about 20, though there's no track record to encourage investors to believe that those analyst estimates are anywhere near accurate (earnings have fluctuated widely, as has the stock for its brief history).

ISRG got a downgrade today from Wachovia, which noted that hospital capital spending might be at some risk this year and that expectations for this highflier are quite optimistic. That's probably the most immediate reason for the price cut today, though general analyst concern and valuation jitters are probably the reason for the overall price cut from the high of $350 back in December to today's price around $280. ISRG still depends on sales of new systems for much of its revenue, though their recurring revenues from parts and services are growing faster and will be the future engine of the company -- so if they have a bad quarter and sell fewer systems than predicted, it would not be at all surprising if the shares fell dramatically, it has happened several times before.

And I'm not sure about any specific impetus for the ARAY move, though I do know that at least one newsletter is still actively pushing it, and the CEO did speak at the big JP Morgan conference in LA this morning (that conference has been moving stocks right and left, as usual, so that's probably the main move -- I haven't been watching, but perhaps they got a mention on CNBC). Add to that the general urge of investors to move to healthcare as a defensive move, and I guess ARAY is riding the trend.

I'm holding shares in both of these companies because companies that fight cancer will be facing a huge secular tailwind with the aging population over the next thirty years, and devices that are more advanced are popular with hospitals even when they cost millions of dollars -- I've seen the da Vinci advertised by hospitals for years by proud owner hospitals, which has clearly pressured their competitors to pick up the robot, too, and more recently I'm also seeing some ads for the Cyberknife from hospitals around the country. At this stage in their growth, with a more expensive machine that is in many fewer hospitals, I presume that Accuray is likely to get more of a boost from the fact that the Cyberknife still truly gives hospitals a dramatic competitive advantage in drawing oncologists and cancer patients.

So I still like both firms -- ISRG seems to me to be the company with a more dominant presence, though they don't compete directly, and they have a much steadier potential earnings stream due to the importance of "disposable" attachments and accessories for the da Vinci that must be replaced frequently, and they're priced accordingly. ARAY seems to me to have a higher growth potential because, if the value of the Cyberknife continues to be borne out through more studies, they have a huge green field of hospitals who will need to buy it -- but they're cheaper because they have more direct competition, they're newer, and the rely almost entirely on device revenue and have far less hope of a strong recurring income stream from accessories and attachments (though there is some).

Indeed, the newsletter touts talk about ARAY as the "next ISRG," and in some ways that argument is compelling -- ARAY is, by some measures, where ISRG was a few years ago. Whether it will ever get to where ISRG is today is another matter, but I've got a bet in place that both will do very well over the coming decade.

full disclosure: In case it's not obvious, I do own shares of both ARAY and ISRG and do not intend to trade in either in the next week.

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