Shares in ResMed Inc. (CHESS) (ASX: RMD) have been knocked down 15% since it announced the failed trial using its adaptive servo-ventilation (ASV) system. But is this really a $1.5 billion problem, as ResMed's share price fall suggests?
What went wrong?
Unlike ResMed's regular Continuous Positive Airway Pressure (CPAP) breathing devices, the ASV devices use special algorithms to monitor and respond to a person's breathing.
The aborted trial was testing if these devices would reduce the risk of death for a special niche of patients who have both severe central sleep apnoea and symptomatic chronic heart failure. The treatment was not productive and the trial was abandoned.
There are no issues with the actual devices, but the result means customers with moderate to severe central sleep apnoea and symptomatic chronic heart failure are being asked to swap devices, which is a recall of sorts.
The cost to ResMed
How much the recall to revise labels and usage instructions will cost is unclear, but it is likely to be relatively small. The impact on sales can also be expected to be small given affected customers can switch to alternative, non ASV, ResMed products.
It is important to note that the results ripple beyond ResMed. Competitor Phillips also produces algorithmic breathing devices and has announced it is following ResMed's caution against use of ASV devices for the same affected group until it has investigated further.
Breathing devices made up 54% of ResMed's net revenues to 30 June 2014 (US$846.7 million), while masks and other accessories made up the rest. Although sales of the specific units may fall, it is likely they will be replaced instead with different ResMed devices.
What about brand damage?
If there is any avoiding ResMed's brand, it won't be for long. As noted above; the trial results seemed to indicate an issue with the specific type of therapy being used. There was no fault with the devices themselves.
This differentiates ResMed's situation from Cochlear Limited's (ASX: COH) 2011 voluntary recall of hearing devices after some devices failed, which saw a sharp sell down in shares. Since then shares in Cochlear have bounced back to record highs.
Ok, so should we buy?
If there is only a small impact on revenue and no long-term brand damage, it could be an opportunity.
In my view ResMed's shares were priced for perfection before the announcement and the negative trial outcome came as a sharp reminder to investors that the company is not bulletproof.
Now priced at around 25x earnings, ResMed looks more attractive than competitor Fisher & Paykel Healthcare Corp Ltd (ASX: FPH) at 33x earnings, even if it does have a slightly lower growth outlook.
Both companies still have significant long-term tail winds of aging populations and a growing global healthcare spend, which Deloitte forecasts will rise by an average 5.3% between 2013 and 2017. Overall, ResMed would be my preference at current prices.
