We recently wrote about the disappointing results and less-than-inspiring strategy to turn the ship around at Butterfly Network (BFLY). The medical device company has developed a game-changing handheld ultrasound probe powered by artificial intelligence, but is struggling mightily to hit high-growth revenue targets while bleeding money like a high-growth tech stock. In our last article, we officially put Butterfly Network stock on double-secret probation and will switch it from “like” to “avoid” if it doesn’t hit certain milestones at the next check-in. iRhythm stock (IRTC) is another medical device stock on the bubble. Is it another bust or ready to finally boom?
iRhythm Stock Today
It’s been a couple of years since we last checked in with iRhythm stock when we discussed whether it was finally time to buy. It wasn’t. The total addressable market (TAM) seemed too small ($1.8 billion) and niche, focused on monitoring cardiac patients using a mobile heart monitor and AI algorithms. In addition, the company was fighting an uphill battle to raise reimbursement rates from Medicare, which is what passes for national medical insurance in the United States for its mostly older, retired population. A significant chunk of revenue was at stake. Also, that article came out in April 2020 at the start of the Rona rollercoaster and there was just too much uncertainty around firms like iRhythm Technologies. Finally, our Nanalyze Disruptive Tech Portfolio had no room for yet another life sciences medical device company, so it got shuffled into our Nanalyze Disruptive Tech Catalog as a “like” and forgotten.
Today, iRhythm stock sports a market cap of nearly $4 billion with reported 2022 revenues of more than $410 million, a 27% increase over the year before. The company has maintained a compound annual growth rate (CAGR) of about 30% over a five-year period, so the growth story remains live and well (unlike with Butterfly Network). Over the last two years, shares of iRhythm stock are up 55% compared to the tech gold-standard Invesco QQQ Trust (QQQ), which basically flatlined over the same period.
Of course, such performance comparisons are generally meaningless. If we move the goalposts back just about a month to when we published our last article, iRhythm stock is down 15% since April 2020. Shares dropped nearly 9% after the company released its Q1-2023 results on May 5, despite revenue growth of more than 20%. It reminds us that timing is everything – but you can’t time the market. What we can control is whether an investment thesis is still sound based on our confidence in the company. Let’s revisit the issues that caused us to balk the last time around.
Total Addressable Market
One of our biggest complaints a couple of years ago was that iRhythm’s total addressable market is too small at $1.8 billion to allow for long-term revenue growth. Indeed, the company estimates it has already captured about 25% of the current U.S. ambulatory cardiac monitoring market. At $410 million in 2022 revenue, that’s about a $1.6 billion market, so the numbers pretty much jive. However, the company believes its Zio System can expand well beyond its current use by cardiologists to monitor patients and diagnose arrhythmias or irregular heartbeats. The plan is to push into other departments such as neurology, emergency rooms, and especially primary care offices. The latter alone represents an annual 14 million U.S. patients who visit a primary care physician annually with palpitations due to suspected cardiac disease. Other adjacent markets could help increase iRhythm’s TAM significantly.
Let’s do some back-of-the-napkin math here. Revenue of $410 million based on about 1.5 million patients in 2022 works out to about $273 per case. That’s probably a pretty good benchmark based on the latest Medicare reimbursement rates (more on that shortly). The above graphic suggests a total adjacent market population of about 13.7 million patients for a TAM of $3.7 billion. Then basically double that based on the primary care market for a total U.S. TAM of more than $9 billion ($1.6 billion current market + $3.7 billion adjacent market + $3.8 billion primary care market). And we haven’t even gotten to the international market:
Just 2% of revenues come from outside the United States – and all of that from the UK. iRhythm claims it can grow the percentage to 8% by 2027. That’s also when the company is targeting $1 billion in total revenue, which would require 20% CAGR – so doable based on historic performance at least. Management also claims it can eventually reach $1 billion in overseas revenue, with international business representing 25% of total revenue in time – implying $4 billion in total annual revenue at some distant point in the glass-is-half-full future.
Medicare Reimbursement Rates
Keep in mind that a lot of these numbers are predicated on the all-important Medicare reimbursement, which accounted for 25% of revenues in 2022 after dropping to just 14% the prior year. As we noted in 2021, iRhythm was engaged in a tug-of-war over Medicare reimbursement with Novitas, a private contractor that is involved with administering the program. Specifically, Novitas slashed reimbursement costs associated with iRhythms’s Zio Patch from about $300 to less than $50, before upping the rate back up to more than $100 – still far from what the company considered a fair price.
Prices have stabilized since 2021, with rates ranging from about $230 to more than $330 based on a variety of factors that only someone well versed in the byzantine world of medical billing could possibly understand. One thing we do understand is that iRhythm still believes the reimbursement rates don’t “adequately reflect the value and expense of this technology and related monitoring services.” In addition, the company is still nervous that Medicare could recalculate rates again, causing further financial stress. In other words, there’s quite a bit of regulatory risk associated with iRhythm stock.
Should You Buy iRhythm Stock?
All of this begs the question: Is iRhythm stock worth an investment? The company has a commanding market share and is growing revenues with a gross margin of 68.5%. It has amassed more than one billion hours of heartbeat data, which represents a pretty valuable asset as it continues to build its portfolio of biosensors. Its newest product, set to be released this year, is a heart-monitoring watch developed in collaboration with Verily Life Sciences, a digital healthcare subsidiary of Alphabet.
iRhythm has more than $200 million in cash, with a burn rate that suggests it has a couple of more years of runway before something gives. However, the company does expect to spend between $15 million and $20 million in 2023 on “business transformation and restructuring costs related to the ongoing globalization efforts to drive efficiency, improve scalability and provide continued high-quality customer and patient experience.” That’s after spending more than $30 million on similar activities in 2022. It also anticipates another $8 million to $10 million in capital expenditures this year related to standing up new facilities, including a global business services center in Manila, Philippines. So the warchest might run out sooner than later, though the company hopes it can gain some efficiencies through automation and other technologies over the next few years.
We’re MBAs, not omniscient seers with a crystal ball, but we still see the best value in iRhythm stock as an attractive acquisition target similar to Butterfly Network. Indeed, a number of large medical device players have shown strong interest in the ambulatory ECG monitoring space. For example, Boston Scientific Corporation acquired Minneapolis-based Preventice Solutions for $925 million, with another $300 million on the table if it hits certain milestones. A medical tech company called Hillrom bought Seattle-based Bardy Diagnostics for $375 million. Both of those deals went down within a week of each other in early January 2021.
And just prior to those exits, in December 2020, Royal Philips shelled out $2.8 billion for BioTelemetry, yet another remote cardiac diagnostics and monitoring. About a year later, Philips acquired Cardiologs, a French AI startup that also uses AI and cloud technology for cardiac diagnostics. Philips is certainly one possible suitor. Another could be Alphabet, considering the Verily collaboration. The tech giant paid $2.1 billion for Fibit just a couple of years ago. And that brings up another point retail investors should note: Wearables like Fitbit and Apple Watch can already monitor irregular heartbeats associated with arrhythmias. The disruptor can quickly become the disrupted.
Conclusion
Retail investors who got in on the ground floor with iRhythm stock when the company IPO’d back in October 2016 have enjoyed a more than 380% return on their investment – more than double the performance of QQQ over the same timeframe. There is still certainly lots to like about the company, with strong revenue growth projected to continue into the near term. The upsized TAM makes for a good story, but we don’t invest in stories. Ditto on the plans to expand internationally. Right now, the TAM ceiling is too low to support the projected growth through 2027 without significant expansion into these other markets. In addition, the regulatory risk around Medicare is an annual heart-stopping event.
While the 2020-21 M&A frenzy for ambulatory ECG monitoring has apparently died down, iRhythm is still valued at a reasonable price for deep-pocketed companies like Philips or Alphabet that are looking to add a big chunk of market share and intellectual property with the stroke of a pen. A big exit may be the biggest reason for retail investors to buy and hold, but at the current share price, we don’t see the value of taking a position today.
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