Why Passport Capital Likes Thoratec

PASSPORT CAPITALAccording to John Burbank, “2012 will be a seminal one for Thoratec.” This medical device manufacturer’s main product is HeartMate II (HM II), a left-ventricular assist device (LVAD). HM II has received its FDA approval for both bridge-to-transplant (BTT) and destination therapy (DT) indications. Thoratec Corp (NASDAQ: THOR) also distributes other short-term circulatory support systems (PVAD, IVAD, and BVAD) and has an extracorporeal short-term circulatory support system called CentriMag. Burbank is not the only hedge fund manager to like THOR, Jacob Gottilieb, Eric Bannasch, Lee Hobson are also buyers.

THOR’s only significant competitor in the artificial mechanical heart space is Heartware (NASDAQ: HTWR). In the first half of this year, HTWR will come before the FDA for approval of their technology. Passport Global believes that “certain bioengineering aspects of the HTWR device as evidenced in its high blood-clotting rate create a real and significant risk to them of either delay or denial of approval that is not yet appropriately appreciated by the market.” Note that most sell-side analysts expect that the panel and the FDA will be in favor of approval. Assuming a three to six month timeline for approval after panel, which is set for April 25th, the approval could occur between late July and late October.

Furthermore, Passport Global indicates that “independent of an approval if and when that were to happen, we note that the approval is only for the limited indication of ‘Bridge to Heart Transplantation,’ not the more rigorous and faster-growing ‘Destination’ or definitive mechanical circulatory-support market in which we believe Thoratec will be the market leader until at least 2015.” Though the potential for HTWR’s product approval has been reflected in increased volatility in THOR’s shares, Passport feels that this would be “largely immaterial to its future prospects.” From this perspective, it is true that THOR remains a leader in the cardiovascular space, specifically circulator support and artificial heart technology. Many analysts are expecting a record implant figure for Q1 2012 of HM II, which is likely push revenue above consensus estimates. Physicians have indicated strong referral volume and expect the LVAD market to grow as more doctors become comfortable with LVAD as an option for their patients. HM II has proved itself in areas of safety and efficacy in thousands of patients and should continue to be leader in the market “even in the face of a HTWR approval in temporary bridge to heart transplantation.”

There are a number of catalysts in THOR’s own pipeline that if successful, will serve to drive performance in their own right. Later this year, THOR is expected to begin the first in-man testing of Heart Mate III (HM III), which is an artificial mechanical heart technology. Passport Global points out that “[THOR ]also expects to start the first in-man trials of its Percutaneous Heart Pump, which is a nonsurgical, groin-based catheter micro pump designed for rapid, minimally invasive use in acute settings in which heart support is required, such as in acute heart attack patients. These innovations should provide a significant competitive advantage for Thoratec independent of any other market entry.”

From a financial standpoint, THOR looks solid as well with no debt and cash and short-term investments of ~$193 million. The Company generated fourth quarter free cash flow of ~$24.5 million, representing a 119% y-o-y increase. THOR also repurchased 3.5 million shares for approximately $100 million. Currently, high growth medical technology peers are trading at multiples in the 30.0x range. Given the long-term growth potential of the LVAD market, THOR could also trade at a P/E multiple similar to companies that are trading at the upper end of the range.

Passport’s final note indicates that there may be a potential sale. “Tangentially, another significant and activist shareholder has recommended that Thoratec put itself up for sale given its unique, high barrier to entry technology, high growth rates, and large addressable markets.” Passport does not affirm or deny the speculation and remains invested “because of the aforementioned fundamentals and appreciate that unique high-technology companies like Thoratec are often the target of acquisition.” We believe that a sale to strategic medical technology interested in entering the LVAD market is a real possibility, which will add to multiple expansion.

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