ABIOMED, Inc (ABMD) – Medical Appliences and Equippment

With an example of just one stock I picked out today I want to show you why it might be interesting to invest in small caps.

I know. Small caps are risky. They can go up quickly but they can go down even quicker. But I believe it was Peter Lynch’s strategy to pick a handful of small cap stocks and to invest in them equally. With passing time it should be obvious to you which one of these stocks is a winner and which one is a looser. You sell the lagers and you reinvest all the money into the winning stocks.

Having said this, had you invested in Abiomed in 2005, you would’ve had an average annual return of 30+%. That’s a 30-bagger in 13 years time. Let’s look at the company now.

Stock name: ABIOMED
Ticker: ABMD
Industry: Health Care
Trailing P/E: 127.32
P/B: 26.08

Price 2018: $384.36
Price 2005: $11.88

The history of the company goes back to 1981. The sole purpose of the company was to come up with the world’s first artificial heart. Abiomed is stationed in Danvers, Massachusetts. It employees around 1000 people. Abiomed, Inc., is a leading provider of medical devices that provide circulatory support. They make products that enable the heart to rest by improving blood flow and performing the pumping of the heart. The company has a very able CEO, Michal R. Minoque. He is an ex infantry officer. He spent 11 years with GE healthcare. Under his leadership Abiomed market cap grew by 4000% since 2004. And the company featured in 2017 as the 4th out of 100 fastest growing company in the world. With the heart disease being the number one killer, its seems to be a profitable business to be in.

Is ABMD a good buy now? Analyst estimate that the earnings per share will grow 38% per year in the next five years. I will be more conservative. I will assume 20% EPS growth per year. If this is the case, then ABMD fair value should be around $33 per share. When we include 30% margin of safety we will come at $23 per share. It seems definitely overpriced. It is not a bargain for a value investor. As a matter of fact, Abiomed would indeed need to grow annualy at ca. 40% for the next 5 years to justify it’s stock price. But Abiomed is a story of growth. So we should look at it from a growth perspective.

How to Evaluate A Stock

1. Growth

Lets look how fast the company has grown. And what was the catalyst for its growth. According to Dorsey, companies can grow through different avenues:

  • Selling more goods and services
  • Rising prices
  • Selling new goods and services
  • Buying another company

Total revenue of the company showed a steady upward trend. From $158M in 2013 to $445M in 2017. Which is a net increase of 287M or an average annual growth of ca. 23%. Their earnings per share demonstrate as well an upward trend since the year 2012. Abiomed’s sales stem mostly from selling one product line: Impella (heath pomp and blood flow devices). Its sales increased from 748 devices in 2013 to 1.138 devices in 2017. The company admits that its future sales will come primarily from Impella devices. It’s gross margin increased from an already impressive 80% in 2013 to 84% in 2017. Abiomed sells its product to hospitals and healthcare providers. The company has helped around 50,000 patients in the U.S. by providing its devices.

Where does this growth came from?

In 2005 the company acquired Impella heart pump cardio system in Germany. With this acquisition the company focused more on heart recovery instead of heart replacement. In 2014 Abiomed acquired another company. A German heart pump maker, ECP. According to chief technology officer “This acquisition of ECP will assist in augmenting our existing intellectual property.” Related to the ECP acquisition Abiomed acquired AIS GmbH Aachen Innovative Solutions. Abiomed found a way to stay in equilibrium when it comes to its growth and its financial stability.

Minoque said:

“Financially, our discipline has allowed us to be profitable in an earlier stage, have no debt and have a very strong cash position. But that happens when you focus on those things. It’s a lot of work and it means that you defer investing in things like [building an expansion] until you get to a certain level”

The goal of these acquisition was to spur the company’s growth and to strengthen its intellectual property. And it has done this by taking on little or no leverage.

But it is not only acquisitions that the company relies on. Its holy grail lies in its patents and innovative technology. The number of patents since 2013 increased by 155. The patents in waiting since 2013 increased by 154. The company spends as well more on R&D. Since 2015 Abiomed increased its spending by 30.4 M. The patents, trademark, trade secrets, copyright, intellectual property and know-how gives the company some competitive advantage.

The company is however subject to international, state and local regulations. The future success of its Impella platform hangs on the FDA approval. The last thing to think of is that the cardiovascular medical industry is dynamic and competitive. Abiomed has to compete with other healthcare companies such as Medtronic and Edward Lifesciences.

In my opinion their prospects are interesting. Abiomed has a future growth plan. They want to help patients with certain types of heart attacks such as ST elevation myocardial infraction (STEMI). This should limit the heart-muscle-damage during the heart attack. They plan to bring new products on the market. Such as Impella RP.  And they want to improve the existing products. Abiomed enters new markets as well. Like Japan. It has managed to get approval from the Japanese Ministry of Health for its Impella 2.5 and Impella 5 heart pumps.

The company has had rapid growth, almost no leverage and they have solid future plans. As long as their patents get approved by the FDA, and their products get the CE Market approval (which allows for commercial sales), and their products will be widely accepted by physicians and hospitals, and they will be able to successfully fend off the competition, Abiomed’s growth can be sustainable in the long run.

2. Profitability

Lets look how much profit the company generates relative to its capital invested.

Abiomed has no debt. It has managed to finance its growth by its generated net income and by issuing new shares. Its Return on Assets (ROA) is fluctuating but it is positive since 2012.  The same goes for the Return on Equity (ROE). Since 2012 Abiomed has proven to be successful at controlling its costs. Since 2013 the operating margin shows an upward trend as well. Since 2013 free cash flow shows a steady linear increase.  It gives Abiomed financial flexibility as to the financing of its new acquisitions and future investments. If a company can convert at least 5% of its sales to free cash flow, the company should not come into financial troubles. Abiomed is able to convert 14% of its sales to free cash flow. Up till now Abiomed return on equity is 12.70 and it has a lot of free cash flow. So it may be worth putting the company on the watch list.

3. Financial Health

As of March 31 2017 the company has no long term debt outstanding. Their marketable securities consisted of U.S. Treasury, government backed securities and corporate debt invest. Abiomed pays has no interest expense.

4. Management

“Go for a business that any idiot can run – because sooner or later, any idiot is probably going to run it.”

– Peter Lynch

When it comes to a health care company not every idiot can run it successfully. So you would be better off to look at the jockey and not the horse in this case. Mr Minoque is Abiomed’s jockey. He is the company’s Chief Executive Officer, President and director since 2004. In 2005 he was appointed to Chairman of the Board and Directors. Mr. Minoque has an extensive expertise. He worked 12 years at General Electric. Before that he served in the U.S. Army as an infantry officer. He is a co-founder and chairman of MVP Vets (Mentoring Veteran Program).

Abiomed achievements under his tenure:

  • company’s stock price increase by 2000% within 5 years
  • no debt
  • achieved more than 30 regulatory approvals for the Impella product lines
  • revenue increase by 35% from 2016 to 2017
  • operating margin increase from 19.8% in 2016 to 20.2% in 2017
  • successful capital expansion in U.S., Germany and Japan
  • focus on the improvements of the patients outcome
  • Abiomed provides clinical research data on its PCI (digital community). It has more than 1,900 active users

To assess if the management is competent you can have a look what it does with its retained earnings. Companies have several options according to Yacktman (investor):

  1. Reinvest
  2. Acquisitions
  3. Buyback
  4. Reduce Debt
  5. Pay more dividends

We already know that the company reinvested its earnings in debt repayment and acquisitions (Cardio Systems & ECP). Abiomed does not pay dividends. It is a growth company so all the money goes back into its business. It pays more on research and development so it can stay competitive. Abiomed repurchased its own shares numerous times. In 2012, the time of negative sentiment and investigation of 2.5 Impella devices, the Board approved to repurchase 15 M of its shares. The company expands its markets (germany, U.k., Canada, France, Japan, Singapore) and its patients base. This checks all the main points. The management does a good job at running the company.

What about Management Compensation?

To learn about that I encourage you to read the proxy statement. When you do that you will learn the following:

  • the executive officers compensation consist of base salary, cash bonuses and equity grant. The latter is the biggest component of the executives pay.
  • executives are payed based on performance. Each year they are evaluated based on the company’s goals (revenue, profits, market capitalization and publications). If the goals are not met it can have a direct effect on bonuses, stock options and restricted stock.
  • each director and executive is required to own common stock.
  • the company openly states that there are no family relationships among its directors an executive officers
  • Mr. Minoque is not afraid to admit its mistakes. he said “Abiomed is a great company because we failed…” He referred to the FDA investigation in 2012.

Risks

Overall I like the company; its future prospects (more and more people suffer of heart disease), its expansion plans, its four principles “recovering hearts, saving lives, leading in technology and innovation, growing shareholder value and sustaining winning culture.”Most of all I like what Mr Minoque has done to Abiomed. He transformed its market cap from 872.70M in 2013 to 17.06B in 2018.

But would value investor consider it a bargain today. At this point I don’t think so. It would have been a bargain had you invested in Abiomed around 2012. The stock went from $13.35 to $384.36 in 2018. You would have 2000+% return on your investment. But lets say you have put your money in the company in 2004, when Mr. Monoque became CEO, today you would have around 30% return on your investment annually (averaged). That’s pretty good, but also shows that sometimes you have to wait a little while for the ‘big return’:

abiomed_chart
YAHOO! Finance Chart

Because of high growth expectations, Abiomed’s stock is pretty volatile. It’s current stock price and its future can be easily influenced (negative news, earnings, trials, competition and patents). In 2012, for instance, the FDA started its investigation into the company’s  marketing and labeling practices of the Impella 2.5 heart pump. The stock dropped more than 30%. But in 2013 the FDA dropped the investigation. The stock began to regain its position.

Note on aquisition

There was some news recently that the company might be acquired by a bigger player. However, in the 2017 Annual Report, the company states that acquisition by third party can be made difficult to realize because of the certificate of incorporation and because of the Delaware General Corporation Law. The company acknowledges that “even if doing so would allow our stockholders to receive a premium over the prevailing market price of our stock.” The point of this is to encourage a dialogue between the acquiring third party and the Board of Directors and to allow the Board to listen to other proposals that would aline more with the shareholders interests.

Sometimes you need one good investment like Abiomed, in your life. But you have to be able to stomach such volatility. As Peter Lynch said “the key organ in your body is your stomach, it’s not your brain.”


Sources:

Abiomed (2017). Annual Report.

Abiomed(2017). Proxy Statement.

Pat Dorsey (2004). The Five rules for successful stock investing. Wiley Publishing.

Medical Design & Outsourcing (2018). How Abiomed became a major medical device company. Retrieved from: https://www.medicaldesignandoutsourcing.com/abiomed-cracked-big-100/

Sean Williams (2013). This News Should Get Your Blood Pumping. Motley Fool. Retrieved from: https://www.fool.com/investing/general/2013/02/21/this-news-should-get-your-blood-pumping.aspx

Abiomed (2014). Abiomed Announces Acquisition of ECP to Broaden and Strengthen Existing Intellectual Property and Product Platform. From Press Release.

Zacks (2012). Abiomed Declares Share Repurchase. Retrieved from: https://www.zacks.com/stock/news/87038/abiomed-declares-share-repurchase

Don Seiffert (2012). Abiomed stocks plunge on news of federal investigation. Boston Business Journal. Retrieved from: https://www.bizjournals.com/boston/blog/mass-high-tech/2012/11/abiomed-stocks-plunge-on-news-of-federal.html