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Medtronic, Inc. (MDT), Boston Scientific (BSX): Prem Watsa Is Buying Into This Small-Cap Stock, Should You Follow?

Recently, Prem Watsa, who is well known as “Canada’s Warren Buffett”, increased his stake significantly in the Canadian medical imaging and therapeutic device company, Novadaq Technologies Inc. (NASDAQ:NVDQ). He first initiated a long position in the company in the fourth quarter of 2012, and then he added more in the middle of February, to own nearly 2.84 million shares in the company. Should we follow Prem Watsa into this Canadian company? Let’s take a closer look.

A small business with good partnerships

Medtronic Inc. (NYSE:MDT)Novadaq, founded in 2000 in Canada, is a developer and manufacturer of fluorescence imaging products that are used by surgeons in the operating room. The company reported that it owned 47 patent families, representing 117 granted and 89 applications in different reviewing processes. The majority of its revenue, $16.17 million, or 70.3% of total revenue in 2012, was generated from the sales of SPY imaging technology products, while the TMR Laser System contributed only $2.87 million in 2012 revenue.

It has two big customers, LifeCell and Intuitive Surgical, Inc. (NASDAQ:ISRG). LifeCell brought nearly $12 million in revenue to Novadaq, while the sales to Intuitive Surgical was more than $5.3 million in 2012. Since September 2010, the company has had a 5-year, exclusive agreement with LifeCell for its SPY Imaging products, and LifeCell began to market Novadaq’s latest generation of SPY system, the SPY Elite in the beginning of 2011.

The company reported that SPY Elite was installed in 90% of the top 50 U.S. Cancer Hospitals. Novadaq also had an agreement with Intuitive Surgical to integrate a SPY Imaging System into the “da Vinci Surgical Robotic System” under the name FIREFLY.

Huge top line growth

What makes me interested is a huge growth in the business. Since the third quarter of 2011, Novadaq experienced a 72% annual growth in the Patient Kits (SPY Elite + FIREFLY) shipped. Since 2006, revenue has grown from $2 million to $30 million.

However, the company has consistently generated losses. The 2012 net loss was $12 million, or $0.32 per share. Interestingly, Novadaq had a quite conservative capital structure. As of December 2012, it had $31 million in total stockholders’ equity, $39 million in cash, and only $5 million in long-term debt.

But extremely high valuation

At around $11 per share, Novadaq is worth around $460 million on the market. The market values Novadaq quite expensively, at more than 18 times sales. As Novadaq generated little EBITDA, the EV multiple is not a right valuation for the company.

Compared to its bigger peers, including Medtronic, Inc. (NYSE:MDT) and Boston Scientific Corporation (NYSE:BSX), Novadaq seems to be the most expensively valued company. Medtronic, at around $46 per share, has a total market cap of around $46.6 billion. The market values Medtronic, Inc. (NYSE:MDT) at only 2.8 times sales and 10.1 times EV/EBITDA. Boston Scientific is trading at around $7 per share, with a total market cap of around $10 billion. It has the cheapest valuation of only 1.4 times sales and 8.6 times EV/EBITDA.

Among the three, while Boston Scientific Corporation (NYSE:BSX) and Novadaq do not pay any dividends to their existing shareholders, Medtronic pays investors a dividend yielding around 2.3%. Medtronic, Inc. (NYSE:MDT) is also the most profitable company among the three, with the highest operating margin of more than 28.2%. Boston Scientific Corporation (NYSE:BSX) has an operating margin of 13.2% while the operating margin of Novadaq is a negative 13.33%.

My Foolish take

Among the three, long-term investors could consider Medtronic with its decent dividend yield, the highest profitability, and a reasonable valuation. I personally think that Novadaq is not a value position, but rather a speculative position for tremendous potential growth in its surgery imaging products.

The article Prem Watsa Is Buying Into This Small-Cap Stock, Should You Follow? originally appeared on Fool.com and is written by Anh HOANG.

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