Description

We are recommending Hologic (HOLX) as a short because it is an expensive, high expectation stock facing increased competition.  The market is anticipating very high revenue growth from its Selenia digital radiography (DR) systems used for mammograms.  However, Hologic will not be able to meet the street’s sales expectations for its DR mammography systems as will now face increased competition from Fuji, which recently received FDA approval for its comparable, but significantly less expense, computed radiography (CR) technology.

 

Company Description

 

Hologic, Inc. (HOLX) manufactures and supplies diagnostic and medical imaging systems which primarily serve the healthcare needs of women. The Company operates in three segments: mammography and breast care, osteoporosis assessment and other. Hologic's mammography and breast care products include film-based and digital mammography systems, computer-aided detection, breast biopsy systems, and breast biopsy and tissue extraction devices. The Company's osteoporosis assessment products primarily consist of dual-energy X-ray bone densitometry systems and an ultrasound-based osteoporosis assessment product. Hologic's other business unit includes its Fluoroscan mini C-arm imaging products, its Esaote line of extremity magnetic resonance imaging (MRI) systems and its photoconductor coating business. During the fiscal year ended September 30, 2006, the Company acquired AEG Elektrofotografie GmbH, R2 Technology, Inc. and Suros Surgical Systems, Inc. Hologic is in the process of developing tomosynthesis, the next generation of mammography technology.

 

 

Price: $46.71

Market Cap: $2,464m

Shares: 52.76m

Debt: $64.16m

Cash: $29.92m

EV: $2,499m

EV/EBITDA (2007E): 17.3x

EV/Sales (2007E): 4.0x

P/EPS 2007E: 36.6x

Mammography (70% of revenue) - This is the company’s largest business unit as well as its growth driver. This segment has been growing at over 50% in the last few years, driven by the company’s flagship product is the Selenia Full Field Digital Mammography machine, which sells for $350,000 a system. Currently, there are about 13,580 mammography systems in the US which include both digital and analog systems. About 1,500 are digital systems and Hologic has a 40% share of the digital systems in the US. Its competitors in digital include GE Healthcare (~55% US digital market share) and Siemens (~5% of US digital market share). In addition to the Selenia digital systems, this segment includes breast biopsy equipment and software used in the detection of abnormalities.

 

Osteoporosis (20% of revenue)- Hologic has been in this market since 1986. Its devices in this segment evaluate a patient’s bone mineral density. This is the company’s legacy business which has been steadily declining as a percentage of the company’s revenues but is still growing at about 10% annually. Nearly 95% of this segment’s revenues are generated by its Discovery and Explorer, dual-energy x-ray absorptiometry (DXA) systems. Hologic competes primarily with GE in the US, as well as with Alara, Norland, Schick Technologies, and Sunlight Medical.

 

Thesis

Hologic is a high expectation stock because of the anticipated growth in sales of its digital mammography (DR) systems. We believe that HOLX will not be able to meet the street’s sales expectations for its DR systems because the FDA lowered the classification of this technology, making it easier for competitors to enter the market and because of increased competition from the CR mammography systems, which have recently received FDA approval.

 

·        Fuji and Kodak’s CR systems are a threat to Hologic’s DR technology.

Fuji and Kodak recently received FDA approval to sell their Computed Radiography systems in the US. CR mammography systems have comparable resolution, and superior economics to DR systems. CR, which has been available internationally, has about 54% share of the global CR and DR market; DR has 46% share. Excluding the US, CR has 76% share of the global CR and DR market. CR has proven to be the preferred technology internationally with an installed base of 2,500 systems vs. an installed base of 750 DR systems. Fuji has recently announced an agreement with Siemens to co-distribute CR mammography equipment in the US.

From our calls, it appears that the quality of the image produced on a CR and DR system is comparable. The breast imaging industry is financially sensitive as Medicare reimbursement rates are low, making the CR system ($150,000) a very attractive alternative to DR ($350,000). Aside from cost, the main difference between CR and DR is slightly better patient throughput with DR making DR a good system for high volume facilities. However, many lower volume facilities can not justify the cost of a DR and those who want to go digital would choose to buy a CR system. We believe that cost benefit is an important factor for lower volume facilities, which are indifferent to throughput.

Among the benefits of CR systems is their versatility. A single CR system can be used for performing both general x-rays and mammographies, giving facilities an extra incentive for purchasing a CR. Hologic’s DR systems on the other hand, can only be used for mammography and the company is phasing out its DR product line for general radiography because of weak sales and operating losses. Doctors prefer a cheaper, viable alternative to the expensive DR technology for general X-rays.

 

·        GE recently received approval for its larger detector plate for its mammography system, which used to be one of HOLX’s main points of differentiation. The larger detector plate no longer gives Hologic an edge over GE which previously could not address this market need.

 

·        The FDA recently reclassified digital mammography from Class III to Class II. This reclassification is a threat to Hologic as it allows CR developers to use the 10(k) process for their devices, a much more expedient method to get FDA approval. This has in effect lowered the barriers to entry into the mammography market for competitors.

 

·        HOLX’s recent acquisitions of Suros and R2 CAD systems may suggest that management is concerned about growth in the core product line. Hologic is paying for both in stock, creating dilution for its shareholders. In addition, there is much speculation that CMS may cut reimbursement for CAD by 50% which would result in a lower selling price for this software.

 

·        Tomosynthesis will be more expensive than DR and will not be an easy upgrade from the Selenia. Many see Tomosynthesis as the next avenue for growth for Hologic. Tomosynthesis is a 3-dimensional imaging process which will create a 3-D image of the breast and allow for better detection of abnormalities. Analysts believe that tomosynthesis is an exciting prospect for the company. While this may be an attractive growth prospect, GE is 6 months ahead of Hologic in developing a system for tomosynthesis. In addition to Hologic not being first on the market, tomo will have lower throughput as doctors will have to look at 60-100 images per breast. This will result in increased storage costs in a financially strapped industry so the penetration of tomo may be limited to large hospitals and research centers.

 

·        In its last earnings call, Hologic increased 2007 Selenia sales guidance from 700 to 850 systems. Based on this increase in guidance, it seems that there is not much upside left if you assume that Hologic’s Selenia placements are 80% of the new digital placements in 2007, this will imply that 35% of the certified mammography facilities in the US will have a DR system by the end of 2007. This is an increase from 22% DR penetration of facilities at the end of 2006. It is unlikely, given the attractive economics of CR and the unattractiveness of DR to smaller facilities, that there will be much room left for greater penetration than is implied by the company’s guidance.

 

 

Risks to Our Thesis

·        We believe there is a slight risk for HOLX to eventually be a target for Siemens due to the fact that they already buy detector plates from HOLX and have a small DR presence in the US.  However, Siemens recently entered into a distribution with Fuji for their CR technology and this indicates that they may not be interested in pursuing a larger DR presence in the US. 

·        HOLX’s recent acquisitions of Suros and R2 CAD will allow the company to bundle these products along with the Selenia system and are the groundwork for upgrading customers to tomosynthesis as well as large margin gains

·        HOLX, GE, and Siemens have developed digital tomosynthesis, a 3D breast imaging system, which could replace digital mammography as a tool for screening breast cancer                        

·        Short term momentum is a risk as digital systems are only at 11% penetration of total units

Catalyst

- Quarterly Selenia unit placement announcement (to be reported on Jan. 24th) could disappoint the market

- Updates from Fuji regarding CR placements as its agreement with Siemens goes into effect at the beginning of 2007 and should show market share gains.