Pulsion Medical Systems is a small German company that designs and manufactures medical devices. The company's key product, which comprises 90% of its operating profit, is a line of monitors and catheters that measure blood flow, heart beat and oxygen supply in critically ill patients. Doctors and nurses in critical care units relay on Pulsion's devices to accurately track the key vital signs of their highest risk patients. 

In the late 1990s, the company pioneered a technological breakthrough that materially improved the speed, accuracy and reliability of the measurement of blood flow and related parameters (a field called Hemodynamics). This product's superior features allowed Pulsion to grow rapidly at about 17% annually over the last 10 years, and to attain a 50% share of its addressable market niche.

We expect Pulsion to generate sales north of 30MM Euros in 2010 and to expand revenues at a healthy clip of 8-10% over the next business cycle. Growth is based on continued expansion in Pulsion's core Western European market at a rate of 5-7% as customers replace their older devices and as Pulsion gains further market share from weaker competitors that lack critical scale to support efficient sales forces and continued product education. Growth in Emerging Markets is trending at much higher rates as Pulsion expands the awarness to its superior product and as standards of care continue to advance mostly in Asia.  The USA market represents a huge opportunity, which is not included in our 8-10% top-line growth number, in the event that Pulsion succeeds in educating doctors to switch away from the older Hemodyanmic standard that currently prevails in North America. 

Pulsion's business is structured on the razor/razor-blade model. The company's monitor reads data from a proprietary catheter that doctors and trained nurses insert into patients' femoral arteries. Consequently, each monitor that the company installs in intensive care units generates a recurring stream of sales of the consumable catheters. Revenues from catheters benefit from high margins and in total comprise about 80% of Pulsion's gross profit. Overall, the company boasts high gross margins of around 66% and its profits are relatively insulated from macroeconomic cycles. After expenses for research and development and SG&A, Pulsion currently generates operating margins of around 17%, with incremental margins of 50-60%. Limited capital intensity combined with very strong incremental margins translates into strong value creation for shareholders as Pulsion grows.

While Pulsion is a high quality company with a recurring razor/razor-blade revenue stream and strong competitive moats, and is growing its operating income at a rate of 15-20%, the company is currently trading at only 4x EV/EBITDA 2011E and 5.5X EV/EBITDA-CapEx.  To comprehend why the market is offering such a compelling opportunity to own Pulsion, it is helpful to review the history of the company.

In 2007, a new management team took the reins and initiated a strategy of growth-at-all-costs. With a fixation on showing top line expansion regardless of profitability and returns, management pushed the sales organization to focus primarily on increasing sales of monitors. These sales carried a higher immediate impact on revenues compared to consumables and therefore supported management's goal of demonstrating top-line acceleration, despite the inferior profitability relative to catheter revenues. In addition, to drive hardware growth, management hired sales people with little experience in critical care medicine. Historically, Pulsion had recruited experienced critical care nurses as sales representative and support associates. Ex-nurses can relate to end users at the hospitals and offer in-depth understanding of user need and continuing education for the product. By diluting the quality of the sales team and incentivizing the sales of monitors more so than catheters, Pulsion suffered from diminishing returns and profitability. 

Deterioration in bottom line results followed, and in 2007 Pulsion ended the year with operating losses despite revenue growth of 16%. In 2008, Pulsion again ended the year with little operating profit, and the company's stock tumbled by 80% from its peak in mid-2007. Realizing that Pulsion's troubles were self inflicted, one of the company's largest shareholders, a German-based family office, initiated a proxy fight to oust management. After a prolonged process, the family office took control of the board in late 2009. The new chairman of the board promptly fired the management team and hired an interim CEO charged with reversing the course of the company. 

The turnaround plan for Pulsion was simple and centered on returning the company to profitable growth. New management immediately refocused sales efforts on consumables rather than on hardware alone. Expenses for sales representatives with no critical care experience were curtailed and channeled back into support teams of ex-nurses. Combined with the stabilization of the macro environment and somewhat renewed confidence by end customers, Pulsion began to turn the corner. 

Examining Pulsion's financials, it is obvious that the turnaround is working with top-line growth tracking at around 9% and EBIT margin expanding at 400bps on an LTM basis.  While turnaround stories often relate to low quality businesses that remain weak after their "turnarounds," in Pulsion we see a high quality company that dominates an economically attractive market niche. Pulsion has a reason to exist and flourish in the future and its past troubles are temporary in nature rather than structural. 

Despite the clear improvement in Pulsion's business, the share price has continued to trend lower since 2007 while dragging along at the bottom until August 2010. Based in Germany and traded on the Deutsche Borse with a small market cap and limited trading volume, Pulsion is not covered by any meaningful sell-side firm. Few investors heard about the company and even fewer seem to care about it. Consequently, despite the company's improving financial results and the simple logic behind the success of its turnaround, Pulsion's stock still does not reflect the value of the fundemtnal business.

The combination of 8-10% top-line growth over the next business cycle and incremental EBIT margins of 50-60% should allow Pulsion to generate earnings of around E0.7-0.8/share by 2014E.  Applying a target forward P/E multiple of 14x, which appears reasonable given the earnings growth, implies that Pulsion will be worth between E9.5-11/share within the next 3 years, or upside of 240% to 280% from the current stock price.  We can currently buy the business for about 4x EBITDA with little downside to the underlying business, and expect to generate an IRR of 33-40% within the next 3 years.

**notice that price listed in table on top of writeup is 4.05 Euros, not dollars.