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Sitting In A Circle Shooting at Each Other


I'm watching you...


Yesterday I dangled before the Minyanship whether Boston Scientific (BSX) is an angel fallen on Hoofy's lap, or a Trojan horse hell-bent on suckering value oriented players. To justify my long--but hedged--position, I am going to lay out my thinking, partly to make sense of this play, but mostly to seek out hyena-like laughter from anyone in need of a good chuckle.

I have long been mighty skeptical of medical technology companies. In my simpleton mind they comprise a universe very similar to that of today's hedge funds': a bunch of companies sitting in a circle taking turns at shooting at each other (why am I sitting in that circle is beside the point). Look at the charts of Medtronic (MDT), St. Jude Medical (STJ), Guidant (GDT) and BSX, and it's no wonder they are in the heart disease / difibrillation business. Each have had spells of 5, 7, sometimes 10 years during which they did absolutely nothing but send investors for psychiatric referrals.

So why go any further in this exercise? Before the "little" incident of not being able to get pieces of its stent gadget out of an artery without killing the patient, BSX was, by all accounts, way ahead of the competition. Surgeons loved its products. Alas, when the shoe hit the fan, BSX mis-management turned a technical problem into a credibility disaster. I still recall Jeffmacke's © ripping the company apart in true . . .well Jeffmackean © style. But that was more than a year ago, and in terms of performance BSX has been taught a 35% lesson for its sins.

Today BSX is still in the penalty box, but if the boom and bust pattern of med-tech companies still applies, the stock may be low enough for basic financial measures to start lending it support. Here is what I am looking at:

generated $1.87/sh in FCF for the trailing twelve months; for 2005, '06, and '07, FCF estimates are about $1.17, $2.55 and $2.43. By the end of '06 BSX will have "net cash" of about $1.8b or $2.12/sh. That means that on a cash adjusted price of $21.40 (today's price of $23.50 less the net cash), one can buy BSX for 8.4x '06 FCF, or a FCF yield of 12%.

Remember the Graham "earnings yield" rule of thumb?. At these prices BSX looks to be fitting right in.

But wait . . . there is more - and I am not talking about a set of Ginzu knives. The Iron Horse scenario of LBO's, mergers and buy-outs is playing out just as he describes it. That much is not open to debate. MDT is trading at a 29 P/E, STJ at 34, GDT at 31, JNJ at 18; BSX is . . . at 12. Can you say "accretive acquisition?" I know, I know: JNJ is buying GDT in order to get into the class-action lawsuit business, so those two players are out of the picture; MDT is sniffing around JNJ/GDT's possible divestiture of the stent business, and if it succeeds, MDT will "crush" BSX - yep, heard that too; but STJ does not have a date; and what about Abbot Labs (ABT)? they are a techie-druggie outfit.

Let me be clear - I don't know, nor have I heard anything about a possible buy-out. But if BSX management can unplug its head from the dark recess it's been hiding in for the last 18 months, the cash flow and the possibilities for financial engineering are there.

There are many good reasons for having beaten up BSX, but cash, generated or in the bank, is not one of them. Can it completely unravel under the weight of its own incompetence? Absolutely, and that's why I splurged a couple of bucks for 2 years of protection. But if it does not unravel, Boo better beware.

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Position in BSX
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