- William Mayo
I was recently reading a great piece by Grahamites on Gurufocus (“Blind Spots in Investing”. It can be found here) and his cautionary tale about his research process related to DeVita (DVA). One of the real challenges I’ve found to exist in investing is the breadth and depth of research/knowledge that is required to have an advantage in portfolio selection. Grahamites faces the same dilemma all of us face – acquiring valuable knowledge. Let’s face it. In today’s content driven world knowledge is a pretty cheap commodity. In fact, there is far more knowledge than required out there today. But is it the knowledge we need?
Before you get started, I should warn you this article turned out far larger than I originally intended. My initial thought was to scrap it, but it suddenly occurred to me that researching a company and acquiring knowledge really is this involved, complex, and timely. So if you pressed for time, the short and shoddy can be found in the conclusions section.
Industry and Company Knowledge: What Am I Getting In To?
Successful value investors find a way to ask the right questions and sift through the data to acquire truly valuable knowledge. I break such knowledge in to three buckets – breadth, depth and accuracy. If an investor can capture knowledge with these three criteria then they are 90% to the way in finding a great investment opportunity. Equally important to broadly capturing the right strategic knowledge, is getting company specific data - along with market and competitive data - which puts you in the position to know a company as well as the CEO herself. This type of knowledge takes more time and more grunt work than the first. It’s where I’ve found most investment managers fail. They find the concept of investing in a company exciting, but are often bored by the specifics that make it tick and -in the long run - succeed. Knowing that a company has a high return on capital is helpful, but knowing how it achieves those numbers is essential.
Before getting into the nitty-gritty about knowledge, I thought for the sake of today’s discussion, I’d use Nintai Investments’ holding iRadimed (IRMD) as a working example. The company is a wonderful healthcare technology company focused on manufacturing magnetic resonance imaging (MRI) infusion pumps and patient monitors. Since MRIs are huge magnets, it is essential that anything with metal be excluded from the imaging room. iRadimed manufactures both pumps and monitors that meet those safety standards. As we discuss how knowledge is critical for investors to acquire, gather, and synthesize, I will discuss the company, its products, its customers, and its competition in greater detail.
The company is in an industry – health care - that requires an insatiable desire to learn and the capacity to synthesize knowledge. After being able to locate great data, an investor will need to know the breadth, depth, and accuracy of knowledge specific to all the moving parts of the ecosystem that iRadimed thrives in. The essential components of knowledge required - clinical care players, clinical care process, technology requirements, research and development, regulatory review and approval, competitive landscape, pricing and reimbursement models (we will get to all of these in detail later) – means that investors need both a strong structural research process (how to define and get the breadth, depth, and accuracy of research) along with tremendous applied knowledge and industry expertise.
We first purchased the stock in September of 2016. It peaked earlier in 2019 rising nearly 200% from our purchase price before dropping by nearly 50% since then. As of July 2019, we’ve roughly doubled our share price. Was all of that gain due to our research? Certainly not. Did all the knowledge we acquired position us to better understand the investment opportunity? You bet.
The Three Characteristics of Strategic Knowledge
Let’s start with the three dimensional approach that I mentioned about higher knowledge. First is breadth. What I mean by this is defining the limits of the company’s strategy and tactics. Is the knowledge in well-defined siloes or does it bleed into other company functional units or market segments? For instance, a technology company may focus on laser measurement tools but find its markets ranging from home-improvement to general contractors to national defense spending. In the case of iRadimed, the company’s technology and market is completely focused on facility-based MRI machines. Even this itself is quite broad and can include privately held imaging centers, mobile MRI providers, hospital-based imaging units, and research institutions. It does not include other types of imaging (CT-scan, X-ray), new technology requirements (such as prone-based units versus raised or fMRI versus traditional MRI). By placing a firm barrier around your product segmentation (meaning a defined “breadth”), technology requirements, or functional area, an investor can develop a deep expertise for a specific part of the organization or market.
In depth, I am talking about understanding the limited reach within either the customer’s organization or marketplace. For iRadimed, it deals solely with imaging groups. It doesn’t sell into other parts of the hospital, it doesn’t deal with other parts of the healthcare industry other than MRIs. It’s sales force can focus on certain individuals with a specific expertise (such as VP of Imaging) with a very focused financial model and a specific focus on technology components that reside in a specific part of the organization. For instance MRI compliant IV pump parts (sold only to the Imaging Center) are not like light bulbs (sold to general purchasing with customers throughout the organization with hundreds of specific requirements (wattage, dimming, white vs. natural, etc.). As a value investor, this allows me to develop a very deep knowledge of the imaging segment of the healthcare industry.
Finally is the accuracy of the research. Being sharply focused allows an investor to have timely data (pricing, market share, sales growth, gross/net margins, competitive sales data, research and development costs, etc.). An awful lot or time is spent in our field calculating “value”. Bad or stale data can play old Harry with your estimates and lead you far astray from a real versus imagined value opportunity. The smaller the segment that needs to be researched, the less the chance for being far off in your calculations. Additionally, valuable data (whether because its timely or because its accurate or even rarer – both of these) can be an extraordinary competitive advantage in the investment management business. When running a focused portfolio, one great investment can make or break your performance record over the long term.
These three characteristics define the scope of knowledge required to best understand major segments of the business. The will allow you as an investor to then roll up your sleeves and begin capturing data that drives your investment case. Without the first group, the second group of detailed research questions will be muddled, misguided, and provide no value in developing your business case.
Company and Industry Knowledge: The Nitty Gritty
After gathering the strategic knowledge I just discussed, hopefully you found a market and a company that look like something for further evaluation. You now need data - and ultimately knowledge - on every major aspect of what makes a company successful and how it works within a specific industry. Your major concerns at this point are:
- Who do I talk to and what do I read to collect all the information necessary to acquire adequate knowledge required to make an informed investment decision?
- What do I need to know about the company that can inform me about where it will be 10 - 20 years from now – from product and service, profitability, financial, management, and technology aspects?
- What do I need to know about the market/industry that can make my investment case close enough to be helpful in developing long-term investment assumptions?
Let’s start with the company continuing to use iRadimed as an example. What are the key knowledge components of the business we must understand to inform us about long-term value? The first bucket is related to their product. The following questions will allow us to better understand how it works, how long can we expect it to work, and what progress is necessary for it to still be a market leader in 2039?
- What is the development history of the product?
- Are members of the iRadimed team part of that development history? If so, for how long? In what role/capacity?
- Does the team have experience with the end-user community (meaning the healthcare imaging community)?
- Does the product work in both an industrial as well as academic/research setting?
- What is the development time line for next generation development?
Overall, iRadimed’s team was in on the ground floor in the development of MRI compliant pump technology. Roger Susi, founder of iRadimed was also the founder of Invivo Research - the first MRI compliant pump. After selling the company and watching competitors implode, Roger founded iRadimed to drive the technology into the 21st century. The team had deep ties into the imaging community as well as strong relationships with FDA regulators vital for future product approvals. iRadimed’s product works in any MRI facility – whether commercial or academic. In the last several years, iRadimed has broadened its work into the adjacent field of MRI-compliant monitoring systems that work hand and glove with their IV pump systems.
In healthcare, regulatory can be all-encompassing (such as biopharmaceuticals) or not relevant at all (selling over the counter cherry throat lozenges). In this case, iRadimad operates in a highly regulated part of healthcare.
- What products currently have FDA approval and what is the length of their patent protection?
- What has been iRadimed’s history when it comes to FDA submissions and approval rates?
- For instances such as complete response letters, how has the company dealt with these? Have they been successful in overcoming them?
- What new products are under review currently and what does the submission pipeline look like?
- As the company looks at overseas expansion, what is the status of IRMD’s filings in the EU, and Japan markets.
The MRidium pump, the iRadimed 3880 monitor, and the iMagox pulse oximeter are fully approved by the FDA and are being use in the clinical setting today. As of the end of Q1 2019, the company still operates under an Open Warning Letter first received in 2014 related to the MRidium 3860 and 3850 software upgrades. While still open, the FDA gave 510(k) clearance in 2016. In addition, in January 2019, iRadimed received notification that the Agency’s review of their 3880 MRI compatible patient vital signs monitoring system could not be completed as aspects of clinical evaluation reporting, as required by newly issued guidance from the European Union. IRMD immediately suspended shipments of their 3880 patient vital signs monitor to all markets requiring a CE Mark. They are addressing the technical non-conformity, though temporary EC Certificate extends through July 27, 2019.
Competition can be the key driver in how long your investment’s moat maintains its depth or generates high returns on capital. In iRadimed’s case we are lucky in that the company has a true monopoly protected by FDA approvals. That said, it is still critical to understand where competition may be coming from.
- What companies (if any) provide MRI-compliant IV pumps, monitors, or pulse oximeter? If any, what is their regulatory status in US or overseas markets?
- Are there any current filings with the FDA seeking approval for any of the three IRMD products?
- Since Bayer’s departure from the MRI-compliance space, has any other healthcare or technology player discussing the space?
- Has there been any discussion of mergers or acquisitions to try to merge technologies or products?
Competition in the MRI-compliant market has been nearly non-existent since the FDA granted IRMD their 501(k) FDA Premarket license. Bayer’s departure from the market has only tightened IRMD’s monopoly position.
Market Size and Growth
Finding a compounding machine means finding a company in a large and growing market. Understanding healthcare markets can be a little tricky with patents and FDA approvals.
- What is the number of existing MRI machines in the US and globally?
- Where are these machines located as a % of total? Private imaging center? Ambulatory hospital, in-patient hospital, for-profit hospital (Morristown) versus not-for-profit (VA hospital system) research facilities?
- How many MRI’s are retired versus new purchases? Leases?
- What is the average daily use of each machine? Imaging for what therapeutic area? (Oncology, gastro, neuro, etc.)?
- What is the reimbursement ratio public versus private insurance?
Infusion Pump Market
Combining Nintai Investments’ research with iRadimed’s, we think there are roughly 12,000 MRI scanners installed around the globe. iRadimed has a set of safety standards required within the MRI facility, so not all facilities can be identified as a possible client. Many sites purchase multiple pump systems for each MRI screener installed. Based on historical sales and customer pump purchases, IRMD estimates the current global market opportunity represents approximately 18,000 MRI compatible IV infusion pump systems, of which approximately 55% are located in the U.S.
Nintai Investments’ research shows that multi-parameter monitors is a market where mot adoption has taken place. Much like MS Office, IRMD’s focus is on next-gen functionality and hardware replacement. Global sales is estimated by iRadimed to be roughly 1200 units with over three-quarters of sales in the domestic US market. Growth is estimated to be 6-7% annually on a base of $70-$80M in revenue. iRadimed is hoping to get customers to move to a multiple unit purchase model similar to the pump systems.
Sales Outside the Imaging Room
iRadimed is looking to pilot sales forces in both the Emergency Departments (EDs) and Intensive Care Units (ICUS) as many patients in these settings are at high risk of needing MRIs for clinical assessment.
Evolving Commercial Strategy
After extensive conversations with management, channel distributors, customers, though leaders, regulatory officials, etc. we think iRadimed’s two pronged commercialization approach is spot on. Two key conditions drive this: currently IRMD is the only approved MRI compliant solution in the marketplace. This truly is a monopoly. Second, iRadimed for the first time in its history has an MRI-compliant platform with IV pump combined with a multi-parameter monitor. Focusing on these two messages, IRMD is building out a sales force that will look to grow the business in the high single digits for the next 15 – 20 years.
Researching all this data, synthesizing it into actionable data, and then deriving real knowledge isn’t easy. It takes a lot of people to help you understand all of these moving parts. For Nintai Investments, it took approximately 400 hours to talk to a host of individuals and gather any follow up research including trade journals and professional studies, conferences, and peer reviewed papers. Here’s a small selection of that research.
- IRMD Management
- Former competitors: such as Baxter product Associate Vice-President, Executive Director, Sales Directors, Technology Leads, Business Managers, Research and Development, Market Access, etc.
- Hospital Administrators: VP Imaging, Data VP, MRI Ops Team, Safety Council
- Ambulatory MRI Private Center: Executive Director, Technical Lead, Ops Manager, Technicians, Safety Coordinator
- Regulatory: FDA Imaging Lead, Research Coordinator, Consulting MDs
- Managed Care: SVP Imaging Strategies, Executive Director, Reimbursement, Director, Image Resources and Clinical Outcomes
- Medical Research Facility: Executive Director, SVP Technology, Senior Director, Image Services
- GE Health: VP, Research, Director, Image Services
- Canon Health, SVP, Market Strategies and Product Development, AVP, New Technologies.
- Thought Leaders: Harvard Medical School, “The Whole Brain Atlas”, Keith A. Johnson, MD, Professor, Harvard Medical School
- Thought Leaders: Greg Freiherr, The Freiherr Group
- Thought Leaders: Eliot Siegel, MD, Professor of Diagnostic Radiology and Nuclear Medicine, University of Maryland School of Medicine
- Thought Leader: Ezequiel Silva, MD, FACR, Chair, American College of Radiology Commission on Economics
Imaging Technology News
Radiology (Journal of the Radiology Society of North America
As you can see, Nintai Investment’s research methodology is a robust process in trying to acquire knowledge that will best inform us about a potential investment. I should note that roughly 1 out 50 of these processes will lead to an actual investment. That doesn’t really bother us though. Acquiring knowledge on MRI imaging might help us when we look at a potential investment in a physician group in southern California or a patient outcomes informatics firm on the inner Beltway of Boston. Nearly no knowledge in these processes goes to waste. Much like Charlie Munger’s view of lattice work, research like this layers another piece on to our knowledge lattice work. A word of caution. Nearly every successful value investor I’ve met loves this process. They’d rather read the latest peer reviewed study on how demographic changes in Ithaca drove a cancer blossom in De Moines than attend the latest Avengers-franchise film. But if you have a strange passion like some of us – or want someone like that managing your funds – you might be hard pressed to find a better fit.
As always I look forward to your thoughts and comments.
DISCLOSURE: iRadimed (IRMD) is a holding in some of out personal and institutional accounts.