Natus Medical: Baby Got Back

On April 7, The Wall Street Transcript interviewed Joshua Zable, an analyst covering the medical devices and equipment sector for Natixis Bleichroeder Inc. Key excerpts, including his smallcap sector pick, follow:

TWST: Let's start with Natus Medical (BABY).

Mr. Zable: This is a smallcap stock, but it's a leader in infant hearing screening and is about to embark on a brand new product launch for the first time in a number of years. We talk about that from a bottom-up standpoint. That would be the key catalyst here but it also is integrating an acquisition and growing that product base along with a relaunch of a Cool-Cap device, which is a product to treat birth asphyxia in newborns, a rare condition but an important one nonetheless as far as treatment. When I look at that stock, there are a lot of good things going on in terms of bottom-up catalysts.

TWST: Let's back up and start with their main product, which is infant hearing testing. How big is this market? What are the prospects there?

Mr. Zable: The market is anywhere from $150 million to $250 million. It's not a tremendous market and in terms of growth opportunities, you're really talking about outside the US. Inside the US, 95% plus of infants are screened for hearing, so your growth is driven from new babies being born and that grows an estimated 3% to 5%. Then obviously, as a leading player, they often get pricing, so maybe that's a little gravy on top of that. But the real growth comes from expanding internationally, getting into countries that don't have infant hearing screening programs or ones that do have some level of screening but not one similar to ours.

TWST: Are they doing that at this point?

Mr. Zable: Yes. They've done it in the past and will continue to do their best to expand the market. I point out that this isn't the sexiest market in the world, but it is a very stable one. It's a market that they have a significant leadership position in with an 80% plus market share and one that isn't really adversely affected by the economy or by hospital spending, simply because the devices aren't that expensive and the disposables are literally anywhere from $2 to $10. The third component is the management. They have an excellent track record of making acquisitions, accretive ones, and then integrating them. Usually the company gets some operating leverage from integrating these acquisitions because you effectively acquire new products to sell through your channel and you get to boost sales growth by putting it into a stronger selling organization. If you layer that on top of the new product cycle in their base business, you have a lot of positive things going on from the bottom up.

TWST: You mentioned that they had made an acquisition and are integrating it. What was it and where does this stand?

Mr. Zable: The acquisition was called Excel-Tech. It was a Canadian-based neurology company. The company should begin to get operating leverage starting in the first quarter. They decided to work on improving manufacturing and quality control, and they did that, for this newly acquired company. I believe they are poised to benefit from now running an integrated machine, like I said, with a new product cycle. The reason why I highlight this stock here is because, like I said, this ties back to the macro scene that we talked about. I'd alluded to a competitor's downgrade for what I believe is misinformation on the company. When you look at the stock and you see a stock that is poised for growth, poised to deliver stronger than expected results, yet misinformation hurts the stock. For me that presents an excellent entry point because the market is mispricing the stock.

I had a mentor once tell me that the market is always telling you things; it's your job to listen to it. However, there are opportunities that the market gets things wrong, and when they do get things wrong, that's when you have an opportunity to make a lot of money. I think this is an example of the market believing that the information out there on the company related to sleep diagnostic testing is correct. The theory is that sleep diagnostic testing, as it moves toward home testing — and we can talk about that some more when we go to ResMed (RMD) — will adversely affect the company. Sleep diagnostic equipment is an immaterial part of their revenues and we don't believe that home diagnostic testing should adversely affect them in any way, shape or form. Again, that's why we take this opportunity to highlight the name as an excellent entry point for the stock.

TWST: You mentioned the new product cycle. What's on the horizon?

Mr. Zable: The new product cycle that I keep referring to is the infant screening device. It's basically the new iteration of their older product launch, but, again, they haven't launched a device in a number of years. You are looking at an excuse to come back to all the NICUs and nurseries out there that have these devices and basically present them an opportunity to upgrade their device. It has been long enough since they have done that; it's obviously a name they know and they trust, and it's a good device from the market leader.

TWST: When does this start and when does the company begin to benefit?

Mr. Zable: The company begins to sell the product at the end of the first quarter, so it should be selling as we speak. We think the company will benefit over the course of this year.

TWST: What's it going to take to get investors to pay attention again?

Mr. Zable: I think once we hear the first quarter results, investors will pay attention. I wouldn't be surprised to see the stock move that day. That's why we want to be in front of that and obviously we are pointing it out as a good idea.

Comments

[DanielJacome]

BABY: Easiest takeout candidate on the block: holds all the properties of a takeout target (niche leader, reasonable valuation, consolidation-frenzied sector), like LIFC did when we found it in early 2006 - LIFC acquired today for 10x sales or a 70% premium to our initiation date price......

[JasonR]

Does the trend toward in-home births (with a midwife) have any effect on Natus' business?

[NJgolfer]

This article was spot on. Congrats on research well done. I was watching BABY from a technical standpoint only and with Q1 earnings out today, it is looking really good.