Edwards Lifesciences (NYSE:EW): Downgraded to Neutral from Conviction Buy at Goldman Sachs

Goldman Sachs is downgrading Edwards Lifesciences (NYSE:EW) to Neutral from a Conviction Buy. Their price target remains at $60.

Goldman notes their estimates and price target are unchanged. Since being added to the Americas Conviction Buy List on January 8, 2010, EW is up 22.5% vs. the S&P Healthcare Equipment Index of 1.1%. While on the Americas Buy List since October 28, 2009, EW is up 42.4% vs. the S&P HC Equipment Index of 12.1%. Over the past 12 months, EW is up 67.0% compared to the S&P HC Equipment Index up 27.7%. The firm continues to see Edwards as one of the most compelling growth stories in MedTech; however, they think this is reflected in the stock at current levels.

Current view
Goldman says their thesis on EW has been that the market had not accurately captured the long-term earnings potential for transcatheter valves (TCV). In 2010, losses from investment in TCV mask the underlying earnings power of the business. Assuming $0.29 of losses on TCV in 2010, the base business would generate EPS of $2.14, growing at around 12%. Applying a 15X multiple to these earnings (1.25X PEG, consistent with group average) yields a base business valuation of $32. Therefore, they estimate that 41% of the current share price is related to TCV. Until they see further evidence to support clinical success, they think the upside will be limited, absent strategic activity. To be clear, Goldman says they are not making a call on the PARTNER trial data (to be presented in late September). In fact, the most recent data they have seen on TCV have been encouraging (European SOURCE data), although it may be hard to draw direct conclusions to the US study. They would become more constructive on evidence of share gains vs. Medtronic, additional clinical data, or a pull back in the stock.

Notablecalls: While purely based on valuation, this is kind of an interesting call from Goldman Sachs.

- Edwards Lifesciences has been a pioneer in developing better heart valves for open surgery. The stock has been a very nice performer over the past 10 yrs (up around 1,000%) and especially good one since 2008, up over 100% while the rest of the market tumbled.

- The strenght exhibited by EW over the past couple of years is mainly tied to a product called SAPIEN. It's a transcatheter heart valve that can be delivered through a small incision in the groin known as the “transfemoral approach,” the same approach that a surgeon would use, for instance, to implant a stent. Bascically, it's a minimally invasive approach to replacing damaged heart valves.

Today if someone has a valve that needs to be replaced, docs either open the chest or make smaller incisions in between the ribs. Nonetheless, it’s a 3- to 5-hour procedure and individuals will be in the hospital for five to seven days. And even though the success rate for these operations is very high for those who are over the age of 65, open-heart surgery is not the best option for many patients.

So, the SAPIEN has the potential to open up a whole new $1-3 billion market & Edwards would be the leading player. The device and a similar one from Medtronic (MDT) are approved in Europe and went from zero to multi-hundred million in revenues just in a couple of years.

In U.S. Edwards is expected to have a 2-year lead over Medtronic in launching SAPIEN. With the device carrying 80-90% gross margins, this one is bound to generate a lot of growth for the co.

- Most of the valve patients that receive these devices are elderly and are over the age of 65, and therefore qualify for Medicare. And since the government is paying for these procedures (~80% of them), there will be very little financial impact, even in case of an economical downturn.

This is another reason why investors have been flocking to Edwards. It's defensive.

- There have been constant chatters of Edwards being a takeover candidate.

With a $6bln+ market cap, there are only a handful of players that would be up to the challenge. Another reason why I think EW is not currently a takeover candidate is valuation. The thing is trading 15x EBITDA and around 30x EPS, which is sky-high.

Clearly, the market has baked in a lot of the future success of SAPIEN.

- While EW looks like to be a great defensive growth story, the valuation surely looks full. There are other names in the sector that have gotten hit recently, while EW has kept going up. Now we may see some roation - out of EW and into other names.

So the Goldman downgrade here makes at least some sense.

I would not be surprised to see EW down a couple of pts today, towards the $53 level & possibly lower.


Longer-term though, EW still looks like a keeper.