Billionaire Steve Cohen Bought Medical Device Stock ArthroCare

SAC CAPITAL ADVISORSSAC Capital Advisors isn’t going to let the current speculation and investigation into insider trading by past employees of the fund interfere with its investing activities. A recent 13G filed with the SEC shows that the fund, which is managed by billionaire Steven Cohen, owns 1.6 million shares of medical device company ArthroCare Corporation (NASDAQ:ARTC). This gives it 5.6% of the shares outstanding. ArthroCare is best known for products which help treat orthopedic and soft tissue conditions. SAC had owned about 400,000 shares of the company at the beginning of October, and that had been an increase of 250% from the size of its position at the end of June (check out more of Cohen’s stock picks and read our latest report on the insider trading probe). As such this seems to have been a fairly recent buy by Cohen and his team, and with the stock about flat since the end of September investors have the opportunity to buy in at a similar price.

ArthroCare Corporation has a market capitalization of a little over $900 million; it averages about 140,000 shares traded daily, and has a current market price of about $33 per share, giving it close to $5 million in average daily dollar volume. The company’s most recent 10-Q showed a small increase in product sales compared to the third quarter of 2011. Because ArthroCare did not report as much in exit, investigation, and restatement costs, earnings were up substantially from a year ago. However, for the fuller year, income seems to be more steady and it looks to us like the company merely had a number of one-time charges in Q3 2011- there hasn’t been much actual growth. A little over two-thirds of the company’s business comes from the United States. At the current stock price, ArthroCare trades at 22 times forward earnings estimates. This is a valuation at which we’d expect to see substantial growth in the company’s business.

Healthcor Management, a healthcare-focused hedge fund managed by two former SAC employees (Arthur Cohen and Joseph Healey), reported owning nearly 2 million shares of ArthroCare Corporation at the end of September, making the stock one of the fund’s ten largest holdings by market value (see what other healthcare stocks they thought were good investments). Healthcor had been increasing its stake in the company earlier this year. Renaissance Technologies, whose founder Jim Simons is now a multi-billionaire thanks to the fund’s success, had reported owning about 400,000 shares though this had been a 15% decrease from three months earlier (find more stocks that Renaissance was trading).

A number of medical device companies tend to have lower P/E multiples than where ArthroCare is trading. Medtronic, Inc. (NYSE:MDT) and Stryker Corporation (NYSE:SYK), for example, have trailing earnings multiples in the teens. These companies are also expected to grow their earnings in 2013. As our reading of ArthroCare is that its recent growth in net income is the result of more or less one-time events a year ago, we don’t expect its growth rate to be sustainable (particularly since revenue growth has been limited). As a result these two larger companies look like better values. Intuitive Surgical, Inc. (NASDAQ:IRSG) is priced higher- it carries trailing and forward P/E multiples of 34 and 30, respectively- but that company has been more of a growth player in the industry with revenue and earnings rising at least 20% in the third quarter versus a year earlier.

Of course, these three companies are much larger in terms of market cap than ArthroCare, so it’s also useful to consider orthopedic medical device company Wright Medical Group, Inc. (NASDAQ:WMGI). Wright’s profits are low, both on a trailing basis and in terms of consensus for 2013, and its sales have actually been slipping. Despite this, the stock is up 41% in the last year. At first glance it doesn’t seem like a good stock to buy, and there’s considerable short interest in the company as well.

It’s interesting that SAC is buying ArthroCare. However, we think that larger medical device companies such as Medtronic and Stryker are not only larger and safer businesses to invest in, they also trade at a considerable discount to ArthroCare’s pricing on a forward earnings basis. With little growth advantage at the smaller company, we’d avoid following Cohen and his team here.