C.R. Bard (NYSE:BCR) has a problem; specifically, a growth problem. While the company has #1 or #2 market share in markets that make up over 80% of its revenue, a hugely consumables-oriented business, and a solid legacy when it comes to margins and returns on capital, Wall Street is a “what will you do for me tomorrow?” sort of place, and Bard’s poor organic growth has kept a lid on the stock when so many other med-techs have enjoyed big runs.
Perhaps that can change, though. For starters, Bard has the opportunity to leverage past R&D and M&A with new products like a drug-coated balloon and an atrial fibrillation ablation system. Bard is also looking forward to a large cash settlement from Gore, a settlement that management has already earmarked in part for further growth-oriented M&A. This gives investments an interesting dilemma with these shares – the shares are only slightly undervalued on an “as is” basis, but factoring the settlement and potential leverage from that settlement (M&A that generates even more revenue, profits, and cash flow) makes the shares quite a bit more interesting.
Like Elvis, growth has left the building
Talking about weak growth rates in med-tech is almost cliché. Nevertheless, it’s relevant, as Bard logged only 1% constant currency growth in the past quarter. The vascular business was down about 3% on weakness in biopsy, stents, and grafts, while urology, oncology, and specialty surgical were all up from 2% to 5%. With this unimpressive top line performance and various challenges (including the new device tax), margins are weaker, with both gross margin and operating margin down from the year-ago period.
Making matters worse, the relative performance wasn’t so great. Johnson & Johnson (NYSE:JNJ), Covidien (NYSE:COV), Boston Scientific (NYSE:BSX), and Cook Medical continue to nip at Bard’s heels here and there across the range of its products.
Here’s where Bard’s prior dominance is perhaps not so helpful. While it’s true that about three-quarters of the company’s revenue comes from products priced at $500 or below, it’s also true that Bard’s products often carry premiums to their rivals. Even if Bard can argue that the price-performance trade-off favors their products, the reality is that we’re in a new, tougher world when it comes to device pricing and Bard’s pricing history arguably makes it more vulnerable (even if it’s just perception more than reality). To that end, Bard has seen more than a few recent quarters of 100bp or more in pricing pressure.
It also doesn’t help that a meaningful percentage of the business is not really growth-oriented. Products like PTA dilation catheters, vena cava filters, PICCs, and Foley catheters tend to follow the overall level of procedure volumes, and it’s hard for Bard to gain all that much more share at present. That puts more pressure on company management to develop products that address new problems and/or can gain share – products like below-the-knee peripheral vascular devices, new soft tissue devices, new oncology products, and so on.
When will Gore pay up?
One of the biggest potential deltas (that is, source of change) for Bard is a large settlement/judgment from Gore for willfully violating Bard IP some time ago. At this point, Bard is looking at a cash inflow of more than $500 million after-tax, with the possibility of ongoing royalty income. Gore is still contesting the judgment and award, but most analysts seem to agree that Gore is unlikely to secure more than token victories in the appeal process.
Bard management has already pledged to put at least 50% of that sum to work in M&A. As you might imagine, there are specifics to be had at this point, as Bard doesn’t even know when it’s going to get the money. Nevertheless, I wouldn’t be surprised to see the company look for technologies in the peripheral vascular, electrophysiology, oncology, or soft tissue arenas. Even though specifics are non-existent at this point, I’m inclined to give Bard the benefit of the doubt – deals for Lutonix and Medivance haven’t generated substantial revenue yet, but the products and market opportunities look quite promising over the next three to five years.
It’s worth noting, though, that investors shouldn’t count all of the Gore eggs before they hatch. First, Gore could still win some meaningful victories in the appeal process – victories that could significantly cut back its obligations to Bard. Second, Gore will likely try its best to redesign infringing products so as to minimize royalty payments. Third, timing is still a big unknown and delays in receiving the cash (and redeploying it) can impact the valuation.
Last and not least, Bard has its own litigation to worry about, specifically ongoing cases tied to mesh products used in pelvic floor procedures. Analysts estimate potential liabilities in the $300 million to $400 million range, and while the payment dates are likely a ways into the future, it’s still a meaningful potential issue to consider.
a good core business, with some growth opportunities
While Bard has seen a significant deceleration in growth (from a 10-year growth rate of almost 9% to a three-year rate of 5%), this is still a strong, high-quality business, with impressive market share in multiple markets.
Within vascular, Bard has roughly 20% share in its addressed markets, with higher share in areas like dilation catheters offsetting weak spots like electrophysiology (roughly 10% share). Bard has shown itself to be a very formidable competition to Covidien, JNJ, Abbott (NYSE:ABT), and Boston Scientific in peripheral stents, and a serious competitor to Gore in grafts.
This is also an area where new products could add meaningfully to revenue. The company has the Lutonix drug-eluting balloon in clinical trials, and this could be worth several hundreds of millions of dollars in a market worth close to $1 billion. Bard is also working on its mesh ablation catheter for a-fib, and hopes to become a player alongside the likes of JNJ, St. Jude Medical (NYSE:STJ), and Medtronic (NYSE:MDT) in the coming years.
Other businesses like oncology, urology, and surgical are hardly also-rans either. The company’s strong share in urology (about one-quarter across the board) may not be worth as much to investors given the low growth of products like Foley catheters and the unimpressive performance of the StatLock catheter securement device, but markets like incontinence and temperature management may yet have more growth than expected.
I likewise believe Bard has the potential to continue growing in surgery. Covidien, JNJ, and Boston Scientific all have meaningful presences here, and Covidien and JNJ are particularly strong in energy-based devices, but this should be a growth market in the U.S. and Western Europe over the next decade or two, with good leverage opportunities for Bard.
The bottom line
On its own, Bard is a middling investment candidate today. Revenue growth of 3% to 4% and free cash flow growth of about 6% suggest standalone value of around $110, and those growth estimates may actually be too aggressive for the business (unless products like the drug-eluting balloon and ablation catheter do well). Add in the Gore settlement/judgment, though, and things get more interesting. The net cash value of the award itself would add about $6 to $7 to Bard’s fair value, and that’s not including the potential long-term value of reinvesting those proceeds in growing businesses.
If somebody told me today that Bard was worth $120 on the basis of the existing business and future unspecified M&A, I wouldn’t argue. That doesn’t point to huge upside, then, but I would also argue that Bard has pretty limited risk given how well-publicized Wall Street’s issues with low organic growth prospects have been. Accordingly, Bard isn’t a bad investment idea today, but just don’t expect a lot of excitement from the company.
Stephen Simpson CFA is a former sell-side and buy-side analyst who focuses most of his professional attention on financial and investment writing. In addition to a decade of work as an analyst, Mr. Simpson has worked as a wet-bench biomedical researcher and a consultant in the med-tech industry, as well as writing on a freelance basis for over 10 years. He can be reached via email at firstname.lastname@example.org.