Tuesday, September 26, 2006

Color on warning: Advanced Medical Optics (NYSE:EYE)

- Several firms are commenting on Advanced Medical Optics (NYSE:EYE) after the co revised its guidance last night:

- Wachovia notes that for the third straight year, AMO management dropped a "surprise" on the street by pre-announcing a soft Q3 revenue result ($255M) at and lowering its 2nd half revenue and EPS guidance citing, in order of importance: 1) Slower market development of the PIOL market esp. internationally, 2) weaker than expected domestic LVC volumes (mgmt. stated they had expected procedure growth of 3-5% for 2006, given H1:05 was ~flat Y/Y, this
suggested a meaningful acceleration of growth in H2:06 which didn't materialize and now mgmt. is looking for a ~flat 2006 in procedure growth), and 3) intl. reimbursement challenges and EU physician strikes. While these were the challenges cited by management relevant to some of their internal parameters, the firm notes they had largely anticipated the first two (and largely confirmed these thoughts coming out of the most recent ESCRS meeting) and the third point strikes as a bit odd given the surgeon strikes were largely over by August and were not cited as factors when they were ongoing in Q1 and Q2. Meanwhile, reimbursement challenges are hardly new and they do not believe there were any material "new" events in Q3 relative to the previously cited challenges by management on the Q2 conference call or from the reimbursement changes made in Japan this past March.

Firm's read through the pre-announcement (~$255MM in Q3 revenue, 20% LVC, 32% vision care and 48% cataract) suggest more is going on than delineated in management's explanation and that in fact AMO's base cataract business (phaco, visco, disposables and monofocal IOLs, or some combination thereof) continues to lose share to Alcon. As they have noted in previous notes they believe the most recent financial update suggests the company is struggling (apparently unsuccessfully) to move up the value chain in the cataract implant business
segment as it "rationalizes" older generation products.

Even at a reduced price the firm is inclined to stay on the sidelines and reiterate their Market Perform rating. While mgmt. has finally faced near-term reality of the PIOL and domestic LVC market, they believe the company's new 2007 guidance has the distinct potential of continuing the trend of over promising and under delivering. Firm maintains their preference for ACL and believes AMO's preview reflects the realities of ACL's dominant, premier global ophthalmic franchise and ACL's ability to continue to capture market share.

- Merrill Lynch suspects Advanced Medical Optics will remain under pressure today following downwardly revised sales and EPS targets for 2006 and 2007. Despite the reduced outlook, they continue to believe AMO is an attractive investment and view the weakness as an opportunity to either establish or build upon a position in the stock at a compelling valuation. As such, they reiterate Buy rating.

After reducing their price objective to $54 from $57, AMO still offers a potential gain of nearly 20% from current levels, while incorporating a discounted multiple to compensate for additional risk. Indeed, they view AMO's valuation as particularly attractive, with its PE at a significant discount to three of its four comps, while providing a healthy EPS CAGR of 15%. As such, AMO remains one of firm's favorite mid cap stocks and represents good growth at a reasonable price, despite the tempered outlook.

Bear thesis lacks vision; AMO a story worth sticking with Admittedly, AMO has struggled while trying to reposition itself for future growth, providing detractors with seemingly greater credibility. But bears seem to miss the point that AMO is undergoing a strategically smart transformation that should enable the company to achieve greater success over the long term. Thus, despite some unexpected disappointments along the way, they continue to believe AMO will reward investors who are willing to stay the course.

Notablecalls: EYE will surely get hit today. Would not be looking to play a bounce until the stock crosses the -10% level.

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