Wednesday, August 13, 1997

Arterial Vascular Engineering
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Phone:707-525-0111
Price (8/13/97): $36 1/8

HOW DID IT DOUBLE?

Arterial Vascular Engineering was nearly $50 per share in early 1996 before plummeting to $9 in mid-December. The stock fell as a result of extreme overvaluation and a slowing of orders. This slowdown in orders created a backlog of inventory, and lower earnings growth was expected.

The shares drifted a bit higher until late April when third quarter results came in ahead of expectations. The good news kept on coming with the announcement of approval of the company's stents for the Japanese market, the earning of the European CE seal for quality, and the commencement of trials of a new stent for the U.S. market. The company recently submitted data for approval of its first stent in the U.S. market and the FDA has the data under review. Improving earnings and the prospects for entering the U.S. market fired up investors, and the stock price has quadrupled over the past nine months.

BUSINESS DESCRIPTION

Arterial Vascular Engineering is a cardiovascular products company with a very limited product line. It makes arterial stents and balloon angioplasty catheters. At present, none of its products are available in the U.S.

Stents are used to keep blood vessels open after balloon angioplasty procedures. The use of stents has exploded over the past couple of years, and the market is expected to reach $2 billion by the year 2000. In Europe, Arterial Vascular Engineering is #2 in market share to JOHNSON & JOHNSON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JNJ)") else Response.Write("(NYSE: JNJ)") end if %>, and its stents have received good reviews.

Here in the U.S., Johnson & Johnson has a dominant market position as competitors seek approval for their stents. One of the factors behind the rally in Arterial Vascular Engineering is the prospect of cutting into Johnson & Johnson's market share. Other stent makers include MEDTRONIC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MDT)") else Response.Write("(NYSE: MDT)") end if %>, PFIZER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PFE)") else Response.Write("(NYSE: PFE)") end if %>, and BOSTON SCIENTIFIC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BSX)") else Response.Write("(NYSE: BSX)") end if %>.

FINANCIAL FACTS

Income Statement

      12-month sales:  $79.4 million
      12-month income: $21.7 million
      12-month EPS:    $0.69
      Profit Margin:    27.4%
      Market Cap:      $1147.6 million

      Balance Sheet
      Cash:                $25 million
      Current Assets:      $124.3 million
      Current Liabilities: $9.8 million
      Long-term Debt:      N/A

      Ratios
      Price-to-earnings: 52.4
      Price-to-sales:    14.5

HOW COULD YOU HAVE FOUND THIS DOUBLE?

Arterial Vascular Engineering was a darling in early 1996 but quickly fell from grace. Although the stock may have been overvalued at $50 per share, last December when it hit $9 a stub might have been a bit of an overreaction. At that time, the company was selling for around 4 times sales. While this may not seem cheap to investors used to looking for companies with price/sales ratios of 1.5 or below, for a development stage company in the medical products business this is pretty low. Remember that it sometimes pays look at how an industry is valued and not just rely on arbitrary rules for valuing all companies.

In early February, with the stock at $14 a share, the YPEG valuation was $23 according to estimates available from Zacks. Although the upcoming positive news could not have been anticipated, there was certainly reason to believe that the stock could move up in price significantly. The success of the stent in the European market was also known at that time.

WHERE TO FROM HERE?

The FDA is reviewing data on the Arterial Vascular Engineering stent. Given that the stent has been in use in Europe and has been approved by the very stringent Japanese regulators, U.S. approval appears likely. But, as has been seen in the Daily Trouble column on numerous occasions, nothing is certain with the FDA.

Analysts have factored FDA approval into their earnings estimates, which have recently been revised upward. Using these estimates, the PEG ratio is 1.19 -- not necessarily cheap if those estimates prove to be accurate. However, if the company can consistently grow earnings 50% or better annually over the next five years (a big assumption) and hits the current 1999 consensus estimate of $1.31 EPS (another assumption), there is still room for the shares to rise.

In this Fool's opinion, waiting for the FDA to grant approval would be prudent. After that time, these shares might be worth a look.

-Mark Weaver, MD ([email protected])

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