SonoSite, Inc. Medical Imaging Devices | NASDAQ Ticker: SONO SonoSite Found the Needle in the Hay Stack We establish our initial BUY recommendation for Sonosite, Inc. (SONO) based on the company’s strategic financial management, strong brand image in medical fields, a favorable position for greater market penetration, and a good outlook for short-term and long-term steady revenue growth as a result of the acquisitions and health care reform. Given these factors, we justify SonoSite is undervalued. Our valuation targets a $54.01 share price, resulting in a 52.14% upside from the current market price of $35.50. Strong Financials: SonoSite has maintained good financial standing that will position the company for growth. The company has recently paid down long-term debt and in January 2010 and June 2010 confirmed to repurchase stock worth $89 million and $50 million, respectively. We anticipate SonoSite to strengthen its cash flows. SonoSite is the “Gold Standard” for hand-carried ultrasound: Sonosite’s first-mover strategy into the hand-carried ultrasound market shaped the industry. The company’s technologically forward, dynamic products combined with their valued customer service have provided SonoSite with an established brand image – described by one medical practitioner as the “gold standard” for hand-carried ultrasound. • • Greater Potential for Market Penetration: Hand-carried ultrasound units are now fulfilling the same tasks that larger and more expensive ultrasound units do, especially in the cardiology and diagnostic fields. As the technology of the smaller, hand-carried ultrasound units have become more powerful, these units have replaced the roles of the larger, cart-based ultrasound units. Additionally, hand-carried ultrasound units can be implemented in medical fields, such as point-of-care services, that are typically not suited for larger cart-based units. SonoSite has been influential in bringing hand-carried ultrasound into new medical fields because of the unit’s advanced visualization technology that expands the applications of the units. Additionally, SonoSite’s education program and customer relations work with medical practitioners to adopt the technology quickly and implement these devices in the field immediately. • • Steady Revenue Growth: Despite a weak year in 2009, SonoSite has maintained a strong revenue growth trend. Numbers for the first three quarters of 2010 expand on previous growth trends, with YTD growth exceeding 11%. In addition, SonoSite possesses several lucrative government contracts and strong international sales that will ensure strong growth while the domestic economy recovers. Long- term growth drivers will include the acquisition of smaller related companies, such as CardioDynamics and VisualSonics, which will maintain the innovative nature of SonoSite. We predict VisualSonics will play an important role in SonoSite’s future growth as the company looks to adopt the technologies of VisualSonic’s into their hand-carried ultrasound units. • • Changes in the Healthcare Industry: The healthcare industry is currently in a state of reformation. Current economic and political conditions are resulting in strong downward pressure on overall healthcare costs. We believe that this will work in SonoSite’s favor because the HCU units that company produces are 25% less expensive than the next comparable imaging systems. Additionally, SonoSite’s advanced imaging technologies, notably needle visualization, have the potential to enhance safety within the field, and so therefore reduce litigation costs. As hospitals and health insurers look to reduce expenditures, SonoSite is able to meet demands with cheaper units, better imaging, and safer procedures. This provides SonoSite a competitive advantage and positions the company to benefit from health care reform, which we predict will result in steady future revenue growth. Team 5 52-week Price Range $25.65-$37.68 Average Daily Volume (3m) 71,463 Beta 1.1 Dividend Yield (est.) -- Shares Outstanding 13.48M Market Capitalization 498.02M Institutional Holdings 105.2% Insider Holdings 1.77% Book Value Per Share $10.41 Debt to Total Capital 22.6% Return on Equity 6.5% Sources: Google Finance, SONO, Team 5 estimates Daily Stock Price Versus Comparable Group Average Source: Yahoo Finance 0 5 10 15 20 25 30 35 40 SONO Group Average Rating BUY Price Target : $54.01 Price, 23 Feb 11: $35.50 Upside (%): 52.14 This report is published for educational purposes only by students competing in the Pacific Northwest Investment Research Challenge, part of the CFA Institute Global Investment Research Challenge. Important disclosures appear at the back of this report
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SonoSite, Inc. Medical Imaging Devices | NASDAQ Ticker: SONO
SonoSite Found the Needle in the Hay Stack We establish our initial BUY recommendation for Sonosite, Inc. (SONO) based on the company’s strategic financial management, strong brand image in medical fields, a favorable position for greater market penetration, and a good outlook for short-term and long-term steady revenue growth as a result of the acquisitions and health care reform. Given these factors, we justify SonoSite is undervalued. Our valuation targets a $54.01 share price, resulting in a 52.14% upside from the current market price of $35.50. Strong Financials: SonoSite has maintained good financial standing that will position the company for growth. The company has recently paid down long-term debt and in January 2010 and June 2010 confirmed to repurchase stock worth $89 million and $50 million, respectively. We anticipate SonoSite to strengthen its cash flows. SonoSite is the “Gold Standard” for hand-carried ultrasound: Sonosite’s first-mover strategy into the hand-carried ultrasound market shaped the industry. The company’s technologically forward, dynamic products combined with their valued customer service have provided SonoSite with an established brand image – described by one medical practitioner as the “gold standard” for hand-carried ultrasound.
• • Greater Potential for Market Penetration: Hand-carried ultrasound units are now fulfilling the same
tasks that larger and more expensive ultrasound units do, especially in the cardiology and diagnostic fields. As the technology of the smaller, hand-carried ultrasound units have become more powerful, these units have replaced the roles of the larger, cart-based ultrasound units. Additionally, hand-carried ultrasound units can be implemented in medical fields, such as point-of-care services, that are typically not suited for larger cart-based units. SonoSite has been influential in bringing hand-carried ultrasound into new medical fields because of the unit’s advanced visualization technology that expands the applications of the units. Additionally, SonoSite’s education program and customer relations work with medical practitioners to adopt the technology quickly and implement these devices in the field immediately.
• • Steady Revenue Growth: Despite a weak year in 2009, SonoSite has maintained a strong revenue
growth trend. Numbers for the first three quarters of 2010 expand on previous growth trends, with YTD growth exceeding 11%. In addition, SonoSite possesses several lucrative government contracts and strong international sales that will ensure strong growth while the domestic economy recovers. Long-term growth drivers will include the acquisition of smaller related companies, such as CardioDynamics and VisualSonics, which will maintain the innovative nature of SonoSite. We predict VisualSonics will play an important role in SonoSite’s future growth as the company looks to adopt the technologies of VisualSonic’s into their hand-carried ultrasound units.
• • Changes in the Healthcare Industry: The healthcare industry is currently in a state of reformation.
Current economic and political conditions are resulting in strong downward pressure on overall healthcare costs. We believe that this will work in SonoSite’s favor because the HCU units that company produces are 25% less expensive than the next comparable imaging systems. Additionally, SonoSite’s advanced imaging technologies, notably needle visualization, have the potential to enhance safety within the field, and so therefore reduce litigation costs. As hospitals and health insurers look to reduce expenditures, SonoSite is able to meet demands with cheaper units, better imaging, and safer procedures. This provides SonoSite a competitive advantage and positions the company to benefit from health care reform, which we predict will result in steady future revenue growth.
Capitalization 498.02M Institutional Holdings 105.2% Insider Holdings 1.77% Book Value
Per Share $10.41 Debt to Total Capital 22.6% Return on Equity 6.5% Sources: Google Finance, SONO, Team 5 estimates Daily Stock Price Versus Comparable Group Average
This report is published for educational purposes only by students competing in the Pacific Northwest Investment Research Challenge, part of the CFA Institute Global Investment Research Challenge. Important disclosures appear at the back of this report
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Earnings/Share Mar. Jun. Sept. Dec. Year P/E Ratio 2009A $0.05 $0.02 ($0.01) $0.13 $0.19 160.79x 2010A 0.08 0.12 0.07 0.22E 0.49E 69.67x
SonoSite, Inc. develops, manufactures, and distributes hand-carried ultrasound (HCU) systems for broad range of clinical and treatment settings. SonoSite manufactures four product lines, The NanoMaxx™ (introduced July 2009), the M-Turbo ® system and the S Series™ (introduced October 2007), and the MicroMaxx ® system (introduced in 2005) offer broad application products for point-of-care treatment in hospital and private physician markets. The NanoMaxx Ultrasound Tool supports a range of examinations and procedures, including thoracic assessment for hemothorax, hydrothorax and pneumothorax, vascular access, needle aspirations, and injections, as well as abdominal, cardiac, nerve, obstetrics/gynecology, musculoskeletal, small parts, and vascular scanning. The M-Turbo system is used in clinical and procedural guidance applications at the point-of-care, such as abdominal, nerve, vascular, cardiac, venous access, small part, and superficial imaging. The S Series ultrasound tool is one of the only products sold specifically for mountable applications. The series consists of market specific devices based on the S platform. The products are unique in that they can be attached to a cart, wall, or ceiling. The MicroMaxx System is used in anesthesia, cardiology, critical and acute care, emergency medicine, obstetrics/gynecology, preventive cardiology, radiology, surgery, vascular application, and non-invasive hemodynamic parameters for tracking and evaluating cardiovascular health. SonoSite designs a comprehensive array of products for applications where ultrasound has not typically been used in the past, such as emergency medicine, surgery, critical care, internal medicine, musculoskeletal, and vascular access procedures. SonoSite’s HCU systems can be cost effective by eliminating the need for more time intensive, invasive and expensive procedures, allowing for earlier diagnosis of diseases and conditions. The company also offers an array of accessories for its products including mobile docking stations, multiple transducer connections, image transfer and management software, printers, video recorders, auxiliary monitors, storage devices, carrying cases, and disposable supplies. In addition to its HCU and accessory product lines, SonoSite also develops programs in ultrasound education. The company sells its products directly to healthcare practitioners and institutions, as well as through independent third-party distributors and strategic alliances in the United States, Australia, Canada, France, Germany, India, Italy, Japan, Spain, the United Kingdom, Africa, Asia, China, the Middle East, and Latin America. SonoSite, Inc. was founded in 1986 and is headquartered in Bothell, Washington. Industry Analysis and Competitive Positioning
The ($4.9 billion) medical ultrasound market is divided into four segments: cart-based units, hand-carried units (HCU), hybrid units, and pocket-sized units. Current trends indicate the portable ultrasound market – consisting of the HCU, hybrid, and pocket-sized units – is growing faster than the cart-based market. This is attributed to the following factors: 1) Because of the global economic recession, customers are demanding cost effective portable ultrasound units to replace costly substitutes; 2) advances in technology have blurred the line between cost effective high-end portable units and costly low-end cart-based units; and 3) portable-units better meet the needs of high-growth medical fields, which include the point-of-care, interventional, diagnostic, and cardiology medical fields. Competition within the broader medical ultrasound industry is fierce. In 2008, the big names – GE Health Care, Philips, Siemens, and Toshiba – accounted for 76 per cent of the ultrasound market. However, within the portable ultrasound industry, specifically the HCU market, SonoSite has maintained 64% of the global market share, with GE Healthcare in a distant second place. Given that SonoSite maintains roughly two-thirds of the HCU market share and our estimates that SonoSite’s total revenue for 2010 will be between $240 to $270 million, our prediction for the size of the HCU market, despite certain analysts’ higher estimates upwards of $1 billion, is currently roughly $375 to $451 million. Increased competition from GE Healthcare, Philips, Toshiba, and Zonare, among others, indicates that the HCU market is growing rapidly. However, our projected models for industry growth for 2011 indicate that SonoSite will likely lose market share to increased competition, yet will maintain positive sales growth. While SonoSite may lose between 4-7% of the HCU market share, more conservative estimates of the industry indicate that the market will reach upwards of $500 to $530 million in 2011 as a result of increased competition from companies in the market. Based on these projections, the growth rate of the HCU market from 2010 to 2011 is 13-19%. Because the HCU market is relatively small in comparison to the greater ultrasound market – and could at this point be considered a niche market – competition from larger
• Point of care • Interventional • Musculo-Skeletal • Other Diagnostic
+10%
• Cardiology 5-10%
• OBGYN • Radiology <5%
• Vascular Only Declining Market
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companies, such as GE Health Care, is still in its nascent stage. SonoSite’s market share in the HCU market will likely remain insulated from intense competition for the next three to five years. Vast Potential in Portable Ultrasound Market By 2012, the world's ultrasound medical equipment, spare parts and maintenance services market is estimated to reach $4.7 billion. While certain analysts’ predictions projected the HCU market to grow in excess of $500 million in 2007, our industry analysis indicates that the HCU market has slowed as a result of the global economic downturn, especially in the U.S. economy. We establish that the HCU market is just now reaching $500 million, but that growth is expected to remain steady at between 15-20% for the next three to five years. The HCU market will remain dynamic over the next 5 years as clinicians face increasing demand for portable ultrasound exams. Traditional ultrasound large, expensive cart-based systems are being replaced by compact, low cost portable systems, upsetting the market share of established companies. This disruption will continue as technology in portable products improve and take on more demanding tasks in the existing markets. New products, such as pocket portables like GE’s V-scan, are developing to compete in the low-end markets, threatening the market share of current portable ultrasound suppliers, such as SonoSite. Global Population Aging, HCU Applications Will Become Integral as Elderly Population and Chronic Diseases Increase Growth in medical imaging field will also continue as the global populations are aging worldwide, accompanied by a concurrent rise in chronic disease rates. As a result, we expect the portable ultrasound market to grow significantly during 2010-20 because of the ever-increasing applications for portable ultrasound devices. In the US alone, there is an estimated 215 million people between ages 65-74, and 19-21 million between 75 and 100. While Emerging Market Economies (EMEs) are considered to be relatively “young” countries compared to advanced economies, the population aged over 65 is expected to grow rapidly: EMEs will have a total of 415 million people aged over 65 by 2020 compared to 299 million people in 2010, with the average old-age dependency ratio {(# of people aged 65+) / (# of people aged 15-64) x 100} rising to 14.6% by 2020 from 11.4% in 2010. The elderly will have higher health care requirements and healthcare systems in most EMEs need to be upgraded. In the long term, consumer-spending patterns will shift with expenditure on health and medical services increasing. In China, for example, consumer expenditure on health and medical services as a percentage of total consumer expenditure will rise to 13.0% by 2020 compared to 9.1% in 2010. Because we expect exponential growth of the elderly population, we estimate that this growth will coincide with strong positive performance in the ultrasound market, but more specifically in HCU applications, sales, and point of care use in hospital and clinical settings, especially as large EME populations grow older and require better imaging as a component of care packages. Emerging Market Growth Will Invariably Continue to Fuel Portable Ultrasound Growth We believe the growth rate for the HCU market in 2011 to be approximately 13-19% globally, with faster growth in Asia and North America. The HCU market is the fastest growing segment of the broader ultrasound imaging market. The emerging markets grew by 50% in 2007, and are expected to approach 70% by 2010. The BRIC (Brazil, Russia, India and China) countries will account for over 60% of the increase in aggregate consumer spending within emerging market economies (EMEs) between 2010 and 2020. Of this, China alone will account for more than a quarter of the total increase in consumer spending between 2010 and 2020. Another market that is growing is the Middle East. For example, countries such as the United Arab Emirates (UAE) are forecasting massive orders for imaging modalities, projecting $1 billion in spending in the next five years. There are many unknown variables that may influence (positively or negatively) the HCU growth in EME’s such as currency exchange rates, central bank policies, and the potential of healthcare reform in the BRIC. Despite these unknown variables, we expect to see strong growth in the next 12-18 months in the HCU market in EME’s, ranging from 11.5% to 18.5%. This estimate will invariably increase as HCU suppliers, such as SonoSite and GE Healthcare, increase hospital and clinical applications in the point of care medical field. Point of Care Highest Growth Potential in HCU Market The most prominent application for portable ultrasound devices, specifically for HCU devices, is in point-of-care (POC) treatment solutions. HCU units have increasingly found their way into emergency rooms, and the portability and ease of HCU systems has recently held a strong appeal over cart-based systems. However, the HCU industry is still in its nascent stage of growth in the POC industry. We expect the applications of HCU to increase as new ultrasound treatment approaches continue to gain momentum. As HCU products evolve and become more efficient and useful in these applications, HCU suppliers will likely focus more resources specifically toward the POC industry, especially as estimates for the POC industry are expected to grow above 10% per year.
Emerging Market Growth
215
235
205 210 215 220 225 230 235 240
EME Population Aged 65+ 2010-2020
EME Population Aged 65+ 2010-2020
200 210 220 230 240
United States Aging Population
Figures in Millions
United States Aging Population Figures in Millions
50% 2007
70% 2010
+75% 2010-2015
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Company Analysis and Competitive Positioning Strengths, Weaknesses, Opportunities, Threats SonoSite is Strategically Positioned in Portable Ultrasound Market SonoSite is well positioned in the hand-carried, portable ultrasound market. The company pioneered the HCU market, establishing a strong brand image that has continued to provide SonoSite with a strong position. In addition, smaller, start-up firms will experience high barriers to entry into the HCU market as a result of tough competition from SonoSite and larger companies, such as GE Health Care, Siemens Health Care, and Philips Health Care. While these larger companies have more available resources and can offer a cheaper price per unit to the customer than smaller firms, such as SonoSite and Zonare, they have been slow to claim market share. This indicates that SonoSite is a trusted brand within the HCU market, but may also represent that the HCU market is not large enough for the larger companies to take interest. For these reasons, we believe SonoSite is strategically positioned to experience strong growth in the next three to five years. After this period, we predict the larger companies to become more competitive as the HCU market grows. Head Start and Effective Implementation Propel SonoSite into Market Leader Position SonoSite has firmly cemented itself as the “Gold Standard” for HCU devices. Because of their reputation for producing the highest quality medical imaging devices and superior customer service to implement their products with ease, educate their customers quickly and effectively, they have established a dominant position in the HCU market over competitors. SonoSite is constantly seeking new channels to fuel innovation in their imaging products, and their ability to effectively develop breakthrough research and technology for their current products as well as acquiring technology externally through acquisitions of companies such as Cardio Dynamics and Visual Sonics. SonoSite will face increased pressure as new market entrants such as GE Healthcare, Philips, and Toshiba compete for control of HCU market share. As long as SonoSite does not let product innovation or market position complacency allow them to lose their strategic positioning advantage, we expect SonoSite to lose minimal market share and benefit from the increased attention new market entrants will unequivocally bring to HCU devices and technology. Expectation of Active “Value” Acquisition Strategy and Strategic Partnerships In the last 12 months SonoSite has strengthened its market share through a proactive “value based” acquisition strategy, acquiring both CardioDynamics (Aug 2009) and Visual Sonics (June 2010). SonoSite is strategically employing an active acquisition strategy to maintain innovativeness in the industry. SonoSite’s strong sales and revenue resilience during bear market conditions has enabled it to acquire firms at a discounted cost (relative to the costs of acquisition prior to the 2008 crisis) strengthening their research and development value, and increasing their market hold in the HCU sector. We believe that these acquisitions will improve SonoSite’s intrinsic value. In October 2010, SonoSite anchored a partnership with the NBA as the sole provider of ultrasound to the league’s athletic trainers and medical staff. While we do not expect that this partnership will translate directly into significantly increased revenue immediately, we note that future partnership moves with other athletic association’s (i.e. MLB, NFL, NHL) could directly impact revenue and profit growth, and indirectly strengthen SonoSite’s industry image as a leader in point of care ultrasound. SonoSite Must Maintain Diverse Distribution Channels and Minimize Barriers to Expanding HCU Applications In order to effectively reduce operational risks stemming from a narrow distribution network, SonoSite must actively engage in proactive diversifying of their sales and distribution channels. Complacency and subsequent failure to do so would allow new entrants to dominate the newly established distribution networks and severely limit SonoSite’s ability to stay in its competitive position as the market-share leader. We expect that SonoSite will be highly proactive in engaging with and capturing new domestic and international HCU markets as they become available and subsequently grow. Concurrently, SonoSite must continue to make the expansion of HCU applications a top-level priority. SonoSite is exposed to a great deal of risk if they do not continue to develop diverse applications and engage in partnerships with external organizations who demand top tier portable ultrasound care. However, we expect not only SonoSite, but the entire HCU market to continue to aggressively research, develop, and expand the medical applications for portable ultrasound, thus limiting the risk SonoSite potentially faces from barriers for HCU applications and expansion. SonoSite Face Uncertainty Regarding Healthcare Legislation Reform Domestically and Internationally SonoSite is potentially threatened by drastic changes in the healthcare and insurance reform stemming from legislative reform, as many medical device corporations are. It is imperative to note
Portable Ultrasound
Systems
Cart Based Ultrasound
Systems
• Hand Carried Ultrasound
• Hybrid Ultrasound • Pocket Ultrasound
$4.9B
$450m
8%
Size of the Hand-Carried
Ultrasound Market
Entire Medical Ultrasound Market Size Hand-Carried Ultrasound Market Size
US HCU Growth • 13-1
9%
Global HCU Growth 15-20%
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that these changes could have a detrimental effect on SonoSite’s sales, revenue and profitability. However, despite this regulatory risk, we expect that the current legislation will financially bolster SonoSite position. This is because as healthcare searches for more cost effective methods of care, SonoSite’s products offer HCU units that are 25% less expensive than the next comparable imaging systems. In short, we expect that changes in healthcare legislation will affect SonoSite and the HCU market, however, we expect SonoSite to be more resilient to changes in cost and market dynamics than comparable competitors. Financial Analysis SonoSite has Consistently Maintained Profitability SonoSite has historically maintained strong financial strength, which we believe will continue into the future. Evident in the company’s income statement, SonoSite has maintained a high gross profit margin of 71 per cent – 27.4 per cent higher than the peer group average of 55.8 per cent. Additionally, SonoSite’s 2010 gross profit margins increased 2.4 per cent over last year’s gross margin percentage. Furthermore, SonoSite’s operating returns on assets (OROA) is 10.7 per cent – 79.43 per cent higher than the comparison company peer group’s average of 5.9 per cent. This ratio illustrates that SonoSite’s management, compared to the industry peer group average, has been more effective at using the company’s assets to generate earnings. SonoSite’s return on equity (ROE) is 6.5 per cent – also above the peer group average, which is 4.9 per cent. These ratios cement our belief that SonoSite has consistently maintained strong profitability through effective financial management, and will likely continue to do so. SonoSite Continues its Solvency & Liquidity According to SonoSite’s balance sheet and statement of cash flows, the company has maintained positive cash flows while paying down long-term debt. SonoSite’s debt ratio is 22.6 per cent – 42 per cent above the peer group average of 15.9 per cent. While the company’s debt ratio is higher than the peer group average, SonoSite has historically been able to pay its immediate and long-term obligations. We believe that SonoSite’s long-term debt will continue to diminish throughout our 2018 forecasted period. This assumption is based on the expectation of SonoSite to strengthen its cash flows as a result of increased revenue streams from VisualSonics and a statement from the company that they will not be seeking further acquisitions. SonoSite’s 4.42 current ratio is another measure of the company’s liquidity. Compared with the peer group average of 4.38, SonoSite is leading. Additionally, according to an acid-test ratio that measures the company’s ability to pay short-term liabilities without selling inventory, SonoSite’s financial integrity is intact at a ratio of 3.68 – 4.1 per cent above the peer group average ratio of 3.51. Arguably, part of SonoSite’s strong acid-test ratio is the fact that the company’s inventory turnover is lower than the peer group average. The reasoning, we believe, is because SonoSite uses a “pull” system, in which they maintain low inventory by manufacturing only what its clients order, thereby decreasing overhead costs and further effectively managing use of company assets. SonoSite Expected to Remain Stable into the Future SonoSite targets a revenue growth of 13% to 18% for 2011. Our estimate for SonoSite’s revenue growth through 2018 is 12.5%. This estimate is calculated based on the following long-term and short-term predictors: 1) A strong, 92.01% correlation between the company’s historical growth and average GDP growth broken down by geographic region; 2) estimated growth of 13% to 19% for the HCU Industry over the next three to five years; 3) growth drivers that include anticipation that U.S. hospitals will increase capital budgets by 6.5%, predictions of future consistent growth from CardioDynamics and VisualSonics acquisitions, and higher growth from emerging markets and the increasing trend of an aging population; and 4) increased strategic partnerships and contracts in the U.S. and international markets.
Valuation We used a combination of Free Cash Flow to Equity and P/E models to determine our target price of $54.01. Comparison of SonoSite’s price-earnings ratio to that of similar companies in the industry indicates that the market expects greater earnings growth in the future from SonoSite. On average, the peer group P/E ratio was 26.89 over the last year. SonoSite stands out with an average of 22.83. This indicates that the market expects substantially greater earnings growth from SonoSite than from any of its competitors. We believe this is because of SonoSite’s strategic acquisitions as well as its dedication to technological advancements in the field of hand-held ultrasound equipment. By acquiring smaller competitors, SonoSite has now integrated needle-visualization technology that is unprecedented into its hand-held units. With an increasing transition from less expensive cart-based ultrasound systems to lighter and smaller units, SonoSite has a unique position as perceived by the market, which is expressed through its P/E multiple.
0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70
Return on Invested Capital
Operating Return on Assets (OROA)
Return on Equity Ratio
0.00 2.00 4.00 6.00 8.00
10.00 12.00
Sonosite Liquidity
Current Ratio
Acid Test ratio
Inventory Turnover Ratio:
22.83
3.37
26.89
2.60
0 20 40
Price to Earnings
Price-to-book
Average for Peer Group SonoSite
0.710
0.036 0.55
8
0.042
Gross Profit
Margin
Net Profit Margin
Profitability Ratios Average SonoSit
4.423
3.668
2.148
4.380
3.524
3.517
Current Ratio
Acid Test ratio
Inventory Turnover
Liquidity Comparison
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Out of the companies to which we directly compared SonoSite, only two exhibited price-earnings ratios that consistently surpassed those of SonoSite. This confirms our rating of SonoSite shares as a worthy investment. Our valuation depends on strong revenue growth as well as economic recovery, which was demonstrated in the fourth quarter of 2010. We also expect current market conditions in the health care sector to positively affect SonoSite’s market price as its products become more widely accepted. The ability of SonoSite’s management to effectively market the possible reductions in litigation risk that its product provides is crucial to continuing success within the currently turbulent regulatory climate of the health care industry. Given that this is successful, we see net income rising from $9.2 million in 2010 to as much as $30 million by 2013. Despite these impressive gains, SonoSite’s stock is already aggressively priced relative to its underlying balance sheet numbers, we view the rise in stock price as the attainment of acknowledged potential. We projected revenue by breaking down sales in each macroeconomic area and assessing the correlation between revenue growth and corresponding GDP growth in each area, for which we found a correlation upwards of 92 per cent over the last 5 years in each area. We then found the covariance and used it to predict sales for each area as a multiple of IMF GDP predictions until constant growth in 2018. In order to maintain a conservative estimate, forecasts were taken down one standard deviation. Investment Summary Our FCFE targets a $54.01 share price, resulting in a 52.14% upside from the current market price of $35.50. Because of the lack of realistic public comparative companies we used multiples to evaluate SonoSite, all of the multiples we used with a variety of comparable public companies resulted in a fairly low market value price. We disregarded the price to sales multiple which resulted in a price of $33.56 and operating cash flow multiple of $23.06. When looking at the financials and the positive outlook the numbers were presenting along with the limited comparability of companies used in the multiples, these numbers were not effective in determining the future of SonoSite’s equity value. Yet, the FCFE used financials that followed GDP growth and SonoSite’s sales growth across various markets. We predicted SonoSite’s revenue growth because it’s about 92% correlation among GDP growth in markets SonoSite was selling their products. HCU market growth, we predicted to grow between 13-19% from 2010-11 and around 15-20% for the next five years, this resulted in SonoSite’s revenue growth to be about 10.4-11.6% per year, with the use of GDP growth and HCU market growth. SonoSite has supplemented our view by open market purchases of $89 million for 2010 at a price of $30 per share and will plan to purchase another $50 million next year to remove the shares off the open market and increase each shares value. SonoSite did this because the company believes the stock is undervalued while their revenue growth and products are advancing in strong form. The recent acquisition of Visual Sonics technological advancements could continue and advance SonoSite’s competitive edge in innovative high quality imaging devices. We believe this was a good investment for SonoSite and adds to the value of the stock price. We believe SonoSite will continue its revenue growth, capture developing markets and continue its strong brand name with its high quality imaging products. Investment Risks Operational Risks: SonoSite may be unable to expand the market for their products. This may be caused by clients not being willing to take the time to be properly trained, as well as the lack of desire for new physicians to use their products. SonoSite may be unable to compete effectively with major global competitors with a greater financial infrastructure and resources, such as GE Healthcare, Siemens and Phillips. These companies possess large R&D staff, more experience and brand recognition, and existing contracts and relationships with customers. These competitors may also be able to produce product bundles or other services that SonoSite is unable to provide or afford. SonoSite may fail to innovate and produce new products and procedures. Because they are totally reliant on the sales of HCU units, if they fail to create new products they could quickly lose market share and revenue. Production delays such as suppliers failing to produce parts in a timely manner could lead to delays in production and sales. Changes in relationships with suppliers could lead to decreased sales. SonoSite is reliant on technology that it licenses from ATL and is used in all HCU systems. Failure to keep licenses and access to proprietary technology could lead to a loss of revenue and or product.
Potential Factors Affecting EME and BRIC Sustained Growth Rates:
Currency Exchange
Rates Healthcare
Reform Central Bank Policy
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Credit Risk: The acquisition of VisualSonics and CDIC could have been overvalued, which would lead to a decrease in overall profit and operations. Efforts to integrate future acquisitions could result in significant disruptions that outweigh potential benefits. Intellectual Property Risk: A large portion of SonoSite's value is derived from intellectual property and proprietary technology used in the design and manufacture of its ultrasound imaging systems. This represents two potential investment risks. First, failure to protect existing intellectual property rights, both domestically and abroad, could lead to other companies’ exploiting SonoSite's technology and ultimately decreasing their market share. Second, existing and future litigation either initiated by or against SonoSite could cause significant damage to SonoSite's business. Such litigation could result in significant litigation costs, delays of product release and shipment, diversion of resources, as well as significant financial liabilities. Regulatory Risk: Increased reliance on group repurchasing programs and U.S. governmental agencies could lead to increased pricing pressure and competition in which SonoSite may not be able to compete. If health care reimbursement policies such as (Medicare, Medicaid and private insurers) change, market acceptance of products may be reduced. Timely regulatory approval, both in the US and abroad, could lead to potential product delays and decreased revenue. Healthcare reform legislation, as well as general government pressure to contain healthcare costs, represents a large risk for SonoSite. Such a risk would include an excise tax on medical device manufacturers that would go into effect in 2013 and result in as much as a 2.7% tax on total revenues. Exchange Rate Risk: A large portion of SonoSite's revenue is from foreign sales. Failure to properly hedge exchange rate risk, as well as unforeseen fluctuations, could lead to decreased revenue. Economic Risk: Current economic conditions could constrain sales of costly medical HCUs produced by SonoSite. Also, general economic pressure for decreased health care spending could potentially lead to a drop in SonoSite's revenue.
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Appendices
Figure 1: Income Statement In thousands 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Proceeds from issuance of convertible senior notes, net - - - 217,606 - -
Retirement of convertible debt - (30,492) (62,406) - - -
Repayment of long-term debt (8,865) - - - - -
Purchase of call options - - - (28,612) - -
Proceeds from sale of call options - 1,646 6,417 - - -
Proceeds from issuance of warrants - - - 19,546 - -
Purchase of warrants - (1,514) (5,934) - - -
Net cash (used in) provided by financing activities (130,151) (29,789) (56,347) 214,634 12,167 9,862
Effect of exchange rate changes on cash and cash equivalents
(448) (2,470) 1,105 (1,728) (978) 1,533
Net change in cash and cash equivalents (104,375) (26,193) 20,557 143,028 18,864 9,537
Cash and cash equivalents at beginning of year 183,065 209,258 188,701 45,673 26,809 17,272
Cash and cash equivalents at end of year 78,690 $183,065 $209,258 $188,701 $45,673 $26,809
Source: SONO
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Figure 4: Ratio Analysis
Source: Source: SONO, Team 5 Estimates
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Figure 5: List of Companies in Comparison Peer Group The following companies were chosen as a comparison peer group based on the following criteria: 1) Operate within the medical imaging industry; 2) Relative market size to SonoSite; and 3) financial and operational activities are made public. Analogic Corporation Accuray Incorporated ZOLL Medical Corporation Angio Dynamics, Inc. Merit Medical Systems, Inc. Given Imaging, Ltd. Abaxis, Inc. Greatbatch, Inc. Orthofix International NV Coceptus, Inc. Natus Medical, Inc. Cantel Medical Corp. China Medical Technologies, Inc. (ADR) Note: SonoSite’s main competitors – GE Healthcare, Philips Healthcare, Siemens Healthcare, and Toshiba – are large companies with private healthcare divisions. As a result, financial and operational activities regarding these healthcare divisions are not made public.
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• Chinese Healthcare & Medical Services as % tot consumer expenditure
$4.9B $450m 8%
Size of the Hand-Carried Ultrasound Market
Entire Medical Ultrasound Market Size Hand-Carried Ultrasound Market Size
P/E Multiples
Abaxis 35.82
Accuray 493.14
Analogic Corp. 46.19
AngioDynamics 32.05
Centel Medical Corp 35.1
Conceptus Inc 42.73
Given Imaging 31.31
Greatbatch 11.57
Merit Medical Systems 86.23
Natus Medical Inc 36.41
Orthofix International NV 19.1
Zoll Medical Corp. 5.78
China Medical Tech Inc. 43.93
P/E Multiple for Sonosite 70.72
0 100 200 300 400 500 600
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200 210 220 230 240
65-74
65+
United States Aging Population Figures in Millions
United States Aging Population Figures in Millions
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200 210 220 230 240
65-74
65+
215
235
EME Population Aged 65+ 2010-2020
EME Population Aged 65+ 2010-2020
Portable Ultrasound
Systems Cart Based Ultrasound
Systems
• Hand Carried Ultrasound
• Hybrid Ultrasound • Pocket Ultrasound
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Emerging Market Economy Growth
Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serves as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Ratings guide: Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Investment Research Challenge and Global Investment Research Challenge Acknowledgement: Pacific Northwest Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with Pacific Northwest Investment Research Challenge, CFA Institute or the Global Investment Research Challenge with regard to this company’s stock.
