Friday, October 14, 2011

Nuance Communications and the Cloak of Invisibility

One of the first things they teach you in business school is that railroads failed to to understand they were in the transportation business, not the railroad business, and, this shortsightedness caused their demise. Nuance Communications (NUAN) CEO Paul Ricci must have taken copious notes in class because with their recent purchase of Swype, they have catapulted themselves from a voice recognition company to an input organization. I think this is a big move for them because it expands what the do as an entity.

"To "swype," a person traces across keyboard letters in a continuous motion to comprise a word. Swype says its input method lets people do more than 40 words a minute, and says the application is meant to work across not just phones and tablets, but also game consoles, kiosks, televisions and other screens.", explains Donna Howell in a recent Investor's Business Daily article. The posting goes on to interview FBR & Company analyst Danial Ives and he reports: "Swype is licensed by a number of Android-based device makers, and that Swype has signed with 15 manufacturer partners and is on 50 million devices shipped in the last 18 months.".

That's a lot of smartphones, and, let's not forget that Apple (AAPL) is a player in that arena, too. In fact, they recently released their much ballyhooed iPhone 4S with the usual media circus in tow. The technology and investing press have written extensively about the device, and, the big selling point of the communicator is its voice-recognition wizardry, more commonly known as Siri. Nothing has been confirmed, but, Nuance Communications purportedly has the technical know-how that is the backbone of this game changer.

An October 5th, TechCrunch posting by MG Siegler reports: "Siri does not work without Nuance. Though they initially tried Vlingo, Nuance was found to be the better technology. In fact, Siri was still using Nuance right up until Apple pulled the old standalone app from the App Store yesterday.". Apple stands for ease of use and quality, and, my take is that if they did indeed partner with Nuance, they made the right choice. This is because, "Dragon (the Nuance voice engine) happens to be almost universally regarded as the best voice recognition software," according to SmartMoney.

With the cognoscenti on board, Nuance appears to have the leading position in providing all forms of input as we know it. A Vulcan mind meld, or, telepathic texting could be next with the exotic software they produce, especially at the rapid pace technology is evolving. To insure their position, the inner sanctum of the company has reached its tentacles into the acquisition space the last few years, and, as a result, is buying smaller firms. Companies like Equitrac, SVOX, Webmedx, and, Loquendo, were obtained not only for their software, but for their patents. In the Q2 conference call, Mr. Ricci explains that they have about 4,000 patents and patent families, and, this was before absorbing the above mentions companies.

As we've moved from predictive text to voice activated mobile computers, one thing is apparent, and, that is not one company alone can do it all. These wireless communication devices are a symphonic whole of many efforts. "The nature of the Mobile business is changed to one where our engagements with a number of important partners has become more extensive in co-development.", explains Ricci in the more recent Q 3 conference call, "...I think that's a trend that will continue.". The CEO doesn't specifically cite any one partner, and, in fact, seems to keep his cards close to his vest. My guess is that he is talking about Apple, but that's just conjecture.

In my last article on Nuance, I gave a lot of detail on their business model, and, in order not to be redundant, will opt not to give a breakdown of their overall operation. A 10-K comes out once a year, and, I really can't add anything to the conversation that I didn't say in the last posting. However, I would like to emphasize that the company is a major player in electronic medical record transcription products and services, and, may be a big benefactor of the HITECH Act. The HITECH Act is part of the government's Stimulus Plan where thirty billion dollars has been slotted to modernize medical records through 2020.

Besides discussing the move from touch-tone transmissions to audio sensitive devices in the last post, I also talked about the valuation of Nuance. My belief was that it was expensive on a Price/Cash Flow basis, and, since they hadn't been profitable in ten years, I was going to sit on the sidelines. Well, I'm happy to report that after a decade of being in the red, they have finally moved into the black, and, looks like this trend will continue. In addition, in the seven months since the article was written, the stock has gained 33%, rising from $18 to it's current price of just about $24. Heavy-duty profits in a market that has gone nowhere in 2011.

Even with the impressive gains, Nuance seems to be running on the cool side as we take its temperature. Some of this can be attributed to the lackluster market. Consensus earnings estimates on Yahoo Finance give it $1.35/share for 2011, and, $1.57/share for 2012. That gives us a current P/E Ratio of 18, and, going forward, a P/E Ratio of 15. Very reasonable valuations for a stock that has a growth rate of 16% for next year, and, a five year CAGR (compound annual growth rate) of 13%. We're talking about PEG Ratios at about one which is a fire-sale price for a growth company.

Analysts seem to like the stock as much as I do. Out of the 19 companies that cover Nuance, 15 have a buy or strong buy, three say to hold the stock, and, only one says to sell. What Nuance probably needs to kick it into high gear is a "Qualcomm (QCOM) moment". You may remember back in the dot com bubble when a PaineWebber analyst put a $1,000 price target on the stock. Retail investors would be all over it. As is, Main Street isn't aware of Nuance because its products and services are ubiquitous. If Siri on the new iPhone 4S turns out to be a success, then that would be a marketing and public relations bonanza for the company.

Sunday, October 9, 2011

Athenahealth and the "Meaningful Use" Clause

Athenahealth (ATHN) is a bit of a loose cannon in the HCIT (healthcare information technology) sector because it is the only company that offers cloud-based services. In fact, that's all they do. Competitors like Allscripts Heathcare Solutions (MDRX) and Cerner (CERN) may be living in the past with their legacy software systems. In investing circles, Athenahealth has gone from B-List actor to celebrity status in the last two years. Their technical wizardry in the software-as-a-service category has traders eating it up as the stock has advanced from $21/share to its current price of $60.

There's an old adage that "timing is everything", and, one of the reasons for the stock's skyrocket up is the HITECH (Health Information for Economic and Clinical Health) Act which is part of the government's stimulus plan. Long story short, Uncle Sam is giving money to healthcare providers to modernize their medical records. Thirty billion dollars has been slotted to to reimburse each physician up to $64,000 if they increase the use of EMRs (electronic medical records).

In a recent Forbes essay, Athenahealth CEO Jonathan Bush gives some off the cuff remarks about the program: "The government made doctors an offer they couldn’t refuse: go become a “meaningful user” of electronic medical records and get a bonus. Don’t, and see your Medicare rates cut. Of course, the only EMRs that doctors know about are the legacy software-based systems that they looked at and rejected fifteen years ago. Already making less than ever before, they are faced with the prospect of being told go buy one of these dogs (legacy EMR products), lay out a bunch of cash (gov: “we’ll get you back”), slow down your practice in learning the new technology and make even less money.".

This "meaningful user", or, "meaningful use" concept CEO Bush talks about is a pay-for-performance clause in the HITECH Act. You must be able to prove to the government that you are meeting their criteria before you get reimbursed. I've got no beef with the government, but they've been know to drag their feet. It's a big bureaucracy, and, delaying payments could put a damper on the uptake of this program. That would put pressure on the earnings of companies like Athenahealth.

According to a September 2nd, 2011, Investor's Business Daily article by Reinhardt Krause, Athenahealth, Cerner In Hot Pursuit OF HITECH Funds: "No matter what happens with ObamaCare or Medicare cuts, HITECH spending is forecast to continue...Medical software firms have responded by releasing new products compliant with HITECH regulations. The programs also help hospitals and doctors document "meaningful use" of new EMR/EHR systems. The systems automate the recording of patient data in daily activities, and they deliver required information to government health agencies.".

In a recent press release, CEO Bush talks about Athenahealth's new Dashboard service, and how it will not only help physicians, but the business prospects for the company. Dashboard was obtained via a recent acquisition of Proxsys, and, Bush believes they have the answer to simplifying the "meaningful use" clause. Proxsys is a provider of services focused on the front end of the revenue cycle. In other words, they automate the check-in procedure at hospitals in connecting to insurance companies through cyberspace, and, keeps the physicians updated in regards to HITECH Act requirements:

"In working hand-in-hand with our providers every day it’s become abundantly clear that achieving Meaningful Use is very complex, far more complex and labor intensive than most people could ever have imagined, and by pulling back the covers with this new dashboard we are hoping to get the industry talking about how to best help our nation’s physicians become Meaningful Use compliant.".

That sounds great for the company because it makes things easier for medical professionals, but the big question remains, will it increase the top and bottom lines? Athenahealth has a knockdown, drag-out fight ahead of them. They are the underdog in this space. They only have a 3% market share in the addressable 620,000 physician base in the United States, and, 50% of these doctors are affiliated with hospitals who have already allocated their initial HITECH software spending in their legacy systems.

In going back to the previous Investor's Business Daily piece, the article also interviews Citigroup analyst George Hill who says: "It's no longer a "green-field opportunity" for medical software firms because first-stage hospital contracts have been doled out...It's key for the medical software business to get a greater share of hospital spending as they move to stages two and three of meaningful-use requirements, which take effect is 2013 and 2015.".

Although investors are getting worked up about the stocks in the healthcare information technology sector, and, have jacked up the price for Athenahealth, it may be due for a pause. It's had a nice run up, and, the next stage of the HITECH Act doesn't come to fruition for two more years as previously stated. Since it's a cloud pure play, I don't paint it with same brushstroke as I do with its rivals in the legacy software sector. I think it should be valued along with contemporaries like (CRM). What I mean by that is they deserve a premium valuation since they are riding the wave of the future with software-as-a-service.

My last article on Athenahealth was published on March 6th, and, in that posting I thought the stock was out of my comfort zone in regards to the P/E ratio, so I took a pass on it, although I stated it was a good company. Since that writing, the stock has been the life of the party rising 33%. You would have left money on the table if you'd followed my advice. It should be noted that I haven't recommended any stocks for eons because I believe the market is like a ticking time bomb. That said, I still think Athenahealth is over priced, so let's look at the numbers.

Yahoo Finance consensus earnings estimates are for $.84/share for 2011 and $1.14/share for 2012. At a price of $60, that gives us P/E ratios of 71 and 53 respectively. Growth rate for both next year, and, as a five year CAGR (compound annual growth rate), we're looking at roughly 35%. That calculates out to a PEG Ratio of 1.5 for 2012. As a momentum investor, you'd be hard pressed not to like this trade. As a value investor, there will probably be a better price going forward despite my belief that it deserves a premium valuation. After all, you are betting on the government coming through with the reimbursements in a timely fashion.

Although the company has been minting money, analysts aren't overly impressed at this juncture. In fact, there has been very little change in analysts opinions from my original article over six months ago: six have a buy or strong buy, eleven say to hold, and, four give it a sell. That's not a ringing endorsement. Because of the uncertainty in the implementation of the "meaningful use" proviso, which was just launched on April 18th, I would wait until after the next conference call on October 21st, before putting any money to work.

Tuesday, October 4, 2011

Illumina and Next-Generation Genetic Analysis

Twenty years ago expressions like artificial intelligence, virtual reality, and, the world wide computer matrix were something out of some far-flung science fiction movie. No more. They are part of our everyday lives in the world as we know it. Genetic engineering can also be included in this category, and, that's where Illumina (ILMN) comes into play. They develop and manufacture tools for analysis of genetic variation and function, aka, gene sequencers. They have a 60% share of the estimated $950 million Next Generation Sequencing market.

Turn back the clock to early 2009, and, Illumina CEO Jay Flatley discusses one of the primary uses for mapping out the human genome in a Sunday Times of London posting, Genetic Mapping of Babies by 2019 Will Transform Preventive Medicine: "Every baby born a decade from now will have its genetic code mapped at birth...A complete DNA read-out for every newborn will be technically feasible and affordable in less than five years, promising a revolution in healthcare...a genome sequence should be available for less than $1,000 in three to four years.".

Well that time is now. 23andMe is a Silicon Valley company backed by Google (GOOG) that offers genomic sequencing for under $1,000. According to a September, 30th, 2011, Motley Fool story, The Real Winners of $1,000 Exomes, they use Illumina gene chips. The article also goes on to say: "The service will compete with Illumina's whole genome sequencing, which starts at $7,500 for medically relevant sequencing.". You can infer from the last quote that Illumina has the superior product, but for how long? Additionally, will the lower priced competition cut into profits and margins?

Granted, we are a long way from all newborns getting their DNA sequenced from not only a cost issue, but a privacy perspective. Think of the 1997 movie Gattaca. I'm a believer that each and every one of us will be getting our DNA sequenced in the not too distant future because the Pharmaceutical industry is probably lobbying for it. Personalized medicine is a byproduct of genomics where you can see if a patient is predisposed to certain diseases. It can save and extend lives, but there is a certain dystopian aspect to it if it isn't regulated properly.

My last article on Illumina was posted on March 1st, 2011, and, I discussed their dynamics as a player in personalized medicine, as well as my conviction that the stock was overpriced. At that date, the stock was selling for $70/share, and, has since come crashing down to $39, a loss of over 40%. It was taken to the woodshed. I'm not clairvoyant. It had a high, P/E Ratio, the market has corrected, Illumina missed an earnings number, and, now there are worries about government stimulus funding to their clients in the academic industrial complex. That spells spontaneous combustion on Wall Street.

The stimulus funding must make management break out in a cold sweat because 80% of Illumina's clients are in academia. However, you wouldn't know it from Dr. Flatley in the April 26th, 2011, Q1 conference call: "In general, we believe our funding environment is stable. We're no longer directly tracking stimulus-related funds as they become more challenging to parse out but believe that, that funding should benefit our customers through the end of next year.". That's a fairly significant cushion.

CEO Flatley goes on to say: "Recently, the 2011 NIH (National Institutes of Health) budget was passed with about a 1% reduction in spending from 2010 levels, but waiting the worst case scenarios product and congressional negotiations, and remaining in line with our expectations. Overall, we believe that the allocation within the NIH budget will continue to favor genetic analysis tool and in particular, next-generation sequencing.". To his point, earnings did increase from $1.06/share in 2010 to a projected $1.47/share in 2011 according to Yahoo Finance.

Illumina was selling for $70 at the time of that conference call, and, continued to climb until early July when it hit $76. I'm not a short-term momentum player (although it's nice to have momentum in your portfolio), and, there's a shopworn bit of investing wisdom that when momentum is working, it works, when it doesn't, it doesn't. Right now it's like the stock was invaded by an alien microbe, or, hit with a Biblical plague. In the snap of a finger investors cut it loose as a punitive measure.

Although the fire has gone out of Illumina, my take is that they are an excellent company, and, this may be a good entry point for patient investors. Based on earnings estimates for 2011 and 2012, the P/E Ratio for Illumina is 27 for the current year (which is almost over), and, 22 going forward. Earnings growth for next year is expected to be 25%, and, 31% based on a 5 year CAGR (compound annual growth rate). Just using the much more conservative growth rate of 25%, we get a PEG Ratio of under one. That's what you're looking for if you are a value investor.

Analysts seem to like Illumina. Out of the 22 analysts that cover the security, 15 have a buy or strong buy rating, 6 have a hold, and, only one says it is an underperform. However, these figures are about the same from three months ago when the stock was selling for twice its value, so take that for whatever it's worth. Buying the stock now may be an act of larceny, but only if the government gravy train keeps on rolling for their clients.

Saturday, October 1, 2011

Hologic: First Mover Advantage in 3D Mammography

Hologic (HOLX) is a high-profile company in women's healthcare needs. In fact, it is the goodwill ambasador for the sector. Its four operating segments break down to: Breast Health (45%), Diagnostics (33%), GYN Surgical (17%), and, Skeletal Health (5%). A significant body of work. Although all of these business divisions are important to the overall health and well being to women on a world wide basis, this posting will primarily concentrate on the Breast Health segment. Reason being is because this is where the primary thrust of future growth will come from, and my impression is that this will be the catalyst to propel the stock higher where investor psychology is concerned.

We are all aware that battle lines have been drawn in the fight against cancer. Breast cancer is a hot button issue for women because it comes on fast, and, moves quickly, unlike prostate cancer for men which is a slow moving malady. The medical community has come a long way with preemptive strikes against tumors in the form of screenings which continue to improve as technology marches ahead. In other articles I emphasize that we are in a new era. The album, 8-track and cassette are souvenirs of bygone days. If Hologic has anything to do with it, the traditional mammography will be in that category, too. Their products are on the cutting-edge.

In February of this year, the FDA approved Hologic's Selenia Dimensions 3D tomosynthesis device, and, they began to sell the units immediately. It's the face of the franchise now. Selenia Dimensions is the first 3D system anointed and appointed globally, done here first in the United States, the medical technology innovator of the universe. "...this product was approved on the basis that it's superior to 2D digital mammography.", said CEO Robert Cascella in the May 2nd, 2011, 2Q conference call. He goes on to explain, "I want to remind everybody that the adoption on tomo (tomosynthesis) will take time.".

This is a big problem for Hologic investors because the stock is already under pressure with the global recession. In my February 27th, 2011, article "Hologic: A Little Patience is Required", I stated that it would take a few years for the stock to get rolling. The equity is down 25% since that writing; the wind got sucked out of it. As altruistic as the company and their products are, they are still in a large interconnected web known as the global economy. Hologic is also in the smaller ecosystem of medical technology, which needs products to be approved on a national level, then implemented on a per hospital basis.

For example, in Europe Hologic is increasing their global footprint. "...with respect to international activities, we're seeing great inroads to 3D and 2D systems sold abroad.", explains CEO Cascella in the 2Q conference call. "The clinical trials we've been maintaining are all underway in Europe, including Norway, Italy, France and the U.K., and these have really been designed to gain public sector support and help really spur market adoption on a worldwide basis of this technology. We still expect results from these trials some time over the next 12 to 24 months.".

In addition to the product needing to be approved in other countries, there is also the normal business cycle after the authorities grant the approval. Hologic executives state in the August 1st, 2011, Q3 conference call that it is usually a six month sales cycle. Peter Soltani who is the General Manager of Breast Health reports: "I think it is strongly a typical capital cycle. People have to budget for it...There is an implementation phase. They have to have rooms ready. They have to have folks trained. So it isn't a decision making process that happens overnight.".

There's a long way to go until 3D mammography really starts to ramp up. You're kidding yourself if you think the green-lighting of a product means instantaneous revenues, especially with these big ticket items. In the United Sates, people are out of work, and, as a result, have no health insurance, and, are cash-strapped for regular screenings. It will take time. Maybe into 2013. At that juncture, perhaps some of the global sovereign debt crisis will be behind us, and hospitals will be in better position to upgrade their facilities.

As is, the company expects to sell only 500-700 units domestically in the next two years. They already have an installed base of 9,000 2D systems which can be upgraded, although management believes most of the 3D sales are coming from new customers, not clients upgrading from the 2D units. However, they are only at the beginning of the cycle, and, have a lot going for them.

  • First and foremost is their first mover advantage. Competitors GE, Phillips and Siemens (SI) will have a difficult time catching up, especially if the 3D mammogram systems are in demand by doctors and patients.
  • Secondly, Hologic has launched a direct-to-consumer awareness program. To paraphrase the CEO in the Q2 conference call: in January, they formally kicked off their efforts in all targeted markets with advertising appearing in many leading women's magazines, online websites, television spots and social networks. This coupled with word-of-mouth advertising has increased awareness.
  • Thirdly, ACR (American College of Radiology) has approved a $50 incremental reimbursement for the tomosynthesis test adding incentive for clients to upgrade from 2D to 3D.
  • Fourth, they currently have the 'secret sauce' in tomosynthesis, and, management believes that the 3D Dimensions system has the potential to become the standard of care in mammography screening.
  • Lastly, they made inroads into the immature Chinese market by acquiring Healthcome, a leader in analog mammography. This enables them to introduce entry-level digital mammography systems to the Chinese and emerging markets, with prospects to upgrade to 2D and 3D products.
I don't use rigorous econometrics to evaluate securities, just your basic P/E multiples and PEG Ratios. Although I do examine other ballistic evidence such as revenue growth, short interest, and, the debt situation, I just find the earnings are what really count to a long term investor. I think it tilts the odds in your favor in evaluations, if you can believe in what CEOs and analysts are projecting. However, you have to go by something other than a technical chart if you a fundamentalist investor. Enough said.

If we pull back the curtain on Hologic, Yahoo Finance earnings estimates are $1.25/share for 2011, and, $1.40/share for 2012. The last closing price for the company on Friday was $15.21, which gives us P/E ratios of 12 and 10.8 respectively. Very reasonable valuations for a company that is slated to grow 12% next year. Back of the envelope calculations give us a PEG ratios of about one. That's where you want them to be if you are looking for bargains in the market.

Under normal economic conditions, I would buy a stock like Hologic. It's at a reasonable valuation, and, is in good position to not only advance itself as a company but to save the lives of others. In fact, I've owned it in the past, and, would like to own it again. However, I believe the market is not done correcting, and, will continue to cave. That's the only reason I'm not long on it. You may feel otherwise.