Varian Medical Systems (VAR)

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As of Q4 2007, Varian held about 60% of global market share in radiotherapy equipment.^[1] High switching costs protect Varian's market share since a brand-new system costs $2-3 million^[2], compared to upgrades like Varian's newest product RapidArc, which cuts treatment time and costs $400,000.^[3] On the other hand, Varian's "open systems" approach lets customers integrate its upgrades with old equipment from competitors, presenting an additional opportunity to steal market share. The reverse is not true of all its competitors. ^[4]

Despite its large market share, Varian is pressured to continually innovate as the US market (48% of revenue^[5]) for its existing products becomes saturated. To expand its product line, Varian acquired Accel Instruments, a manufacturer of proton therapy equipment and proton accelerators, for $40 million in January 2008.^[2] Proton therapy is the most advanced radiation treatment available, with fewer than ten treatment centers in the US.^[6] Varian plans to incur large R&D costs to commercialize Accel's technology but does not expect it to generate revenue until 2009.^[2]

Worldwide, larger number of cancer cases each year and the gradual acceptance of advanced technologies overseas lead Varian to expect increased growth in Europe and Asia. Domestically, an aging population sustains demand for radiotherapy. However, the 2007 credit crunch continues to limit US hospitals' ability to secure financing for new equipment and the ratio of treatment centers to patients in the US is already the highest in the world, which suggest slower growth in North America.

[edit] Company Overview

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Varian is the world's leading manufacturer of radiation therapy equipment, or oncology systems, although it also produces X-ray tubes and X-ray security scanners. The vast majority of its $1.78 billion revenue in 2007 (81%) came from sales of oncology systems to hospitals, clinics, and universities domestically and overseas. ^[9] Its more advanced equipment is used to perform intensity modulated radiation therapy (IMRT), image guided radiation therapy (IGRT), and stereotactic radiotherapy, and it has begun to make forays into proton therapy technology.

[edit] Business Financials

In the past three years, Varian has consistently earned a positive net income, and revenue has grown 11-16% annually. However, net income fell 2.3% to $239.5 million from 2006 to 2007.^[5] The first half of 2007 saw weak sales in the US market, and Varian's acquisition of Accel Instruments for $40 million also cut into net income and operating margins. The company reported higher than predicted expenses to commercialize Accel's proton technology and expects to spend more on R&D than it had in 2007. ^[10] In addition, proton therapy systems and proton accelerators are at least 50 times more expensive than Varian's conventional radiotherapy equipment, suggesting that orders will come mainly from publicly funded projects at irregular intervals.^[11] As a result, Varian expects the new acquisition to continue to decrease net income in 2008.

In January 2008, Varian introduced RapidArc, an improvement upon existing IMRT equipment that shortens the time needed for a full dose of radiation. In the third quarter of 2008, Varian reported 70 orders for RapidArc, which contributed to the 48% increase in net income from the third quarter of 2007. Varian expects net income to increase by 22% from 2007 to 2008. ^[12]

[edit] Business Segments

• Oncology Systems (81% of sales, 83% of gross margin): Radiation therapy equipment uses beams of radiation to kill cancerous tumors. More sophisticated equipment can generate more targeted and precise radiation, which lets doctors increase the intensity of the beam or cut down treatment time. Growth in the US market is due to sales of equipment used in IGRT, one of the most advanced therapies. However, overseas clinics and hospitals often lag behind the US technologically. Thus (IMRT) equipment, a product in high demand several years ago in the United States, drove a 24% and 13% change in revenue in 2007 in Europe and Asia respectively, well above the 9% revenue growth in North America.^[13]

• X-ray Products (15% of sales, 14% of gross margin): Varian’s X-ray components division manufactures X-ray tubes and flat panel digital image detectors for X-rays, which can be used in place of X-ray film. ^[14] The X-ray tubes market is more dependent on pricing and less dependent on technological innovation than the oncology systems market. As a result, Varian has less of a competitive advantage in this sector than in its main business. The 22% revenue growth in 3Q 2008 in this division comes mainly from the sales volume of flat panel detectors. ^[15]

• Other Products (4% of sales, 3% of gross margin): This division includes X-ray security scanners and revenues from Accel's backlog of proton systems. The X-ray security scanners produced by Varian are used to inspect cargo and to monitor border crossing areas. Growth in the division increased 135% from 2006 to 2007, since fears of terrorist attacks fuel greater demand for inspection and security systems. ^[16]

[edit] Key Trends and Forces

[edit] Rapidly changing cancer treatment technology forces continual innovation

State-of-the-art radiation therapies change quickly as new products are developed and reach the market, and treatments become obsolete just as quickly. From 1999 to 2003, IMRT sales bolstered revenue growth in the United States, but domestic IMRT sales have since slowed as the market became saturated.^[17] In contrast, one of Varian's newest technologies, RapidArc, has received over 70 orders as of July 2008 since its federal approval in January 2008. Furthermore, researchers have begun to explore alternative cancer treatments such as genetic therapy, although this technology is still in early developmental stages. To maintain its market share, Varian spent $117 million on research and development in 2007, a 17% increase from 2006. ^[18]

[edit] Growing number of cancer patients drives demand for radiotherapy

In 2007, the World Health Organization recorded 11.3 million new cases of cancer globally and predicted the annual number of new cancer patients to rise to 15.5 million by 2030.^[19] Approximately 50% of cancer patients in the United States receive radiation therapy ^[20], and some doctors believe that this percentage will increase since the most precise, targeted radiation therapy can replace surgery. ^[21] To prevent unreasonably long wait times for patients, more hospitals and clinics will need to install radiation treatment facilities. However, growing demand for radiotherapy equipment is also contingent on the availability (or lack thereof) of more effective technologies.

[edit] Hospitals and research institutions require large budgets and financing for products

Varian's product offerings range in cost from $2 million for conventional radiation therapy accelerators to upward of $60 million for accelerators used in proton therapy. Equipment used for particle physics research varies from customer to customer, since most is highly specialized, but has costs starting in the billions of dollars.^[2] During years of low interest rates, US hospitals used auction-rate securities to raise capital, but these markets dried up when the credit crunch hit in 2007. Interest rates have since reached 9 to 15%, making it more difficult for hospitals and clinics to invest in large-scale, long-term projects such as radiation therapy equipment. ^[22]

[edit] Viability of new technology depends on inclusion in insurance plans

Most insurance plans cover IMRT and IGRT therapy, including Medicare and Medicaid in the United States. Not all insurance providers cover proton therapy, and others only cover the treatment in case of a specific diagnosis. Proton therapy treatments can be up to twice as expensive as conventional radiation therapy, and physicians continue to question whether the treatment is worth the additional cost. As of March 2007, only five clinics in the United States have proton therapy facilities. Although demand has been growing and over 30 new facilities have been planned, demand depends in part on insurance companies' willingness to reimburse for proton radiation treatment.^[23]

[edit] Competition

Varian competes directly with large electronics companies such as Siemens and Philips, and with smaller, more specialized radiation therapy equipment companies including Accuray, Elekta, and TomoTherapy. Indirectly, Varian competes with all other cancer treatment equipment makers, since different cancer treatments are sometimes interchangeable or used in conjunction. As of 3Q 2008, Varian held a commanding 60% share of the world market share and an approximately 67% share of the US market. ^[1] Out of the major radiation therapy providers, Varian is best poised to capture sales from foreign markets - although over 57% of Elekta's sales came from outside North America compared to 51% of Varian's sales, Elekta's revenue from the underserved Asia market fell in 2007,^[24] whereas Varian's rose by 11%.^[25]

The most distinctive feature of Varian's products is their interconnectivity with other Varian products and competitors' products. However, Varian's systems are marketed as a package instead of by component, and thus Varian is not always price competitive if the customer does not want all elements of the package.^[26] Siemens and Philips also produce IMRT and IGRT equipment and are larger than Varian, giving them more financial clout. Elekta, TomoTherapy, and Accuray all manufacture more specialized high-precision equipment that lets doctors administer a single high-intensity dose of radiation to a tumor with minimal fear of damaging the surrounding tissue.

• Accuray: the CyberKnife is the only robotic radiation therapy system approved for use outside the brain and has been purchased by the most international customers out of the major radiation therapy companies. However, it is not yet covered by all insurance policies overseas, for instance in Taiwan.^[27]

• Elekta: produces versatile systems similar to Varian, but its best-known product is the Leksell Gamma Knife, used to perform radiosurgery on brain tumors and eliminating the need for open brain surgery. Orders grew 40% in 3Q 2008, partly due to Elekta's acquisition of CMS, which produces radiation treatment planning systems and proton therapy treatment planning systems. ^[28]

• TomoTherapy: Hi-Art Treatment System delivers continuous 360 degree IMRT to the patient.^[29] TomoTherapy received the highest user-satisfaction ranking from MD Buyline, a healthcare analysis organization, in the second and third quarters of 2008.^[30]

[edit] Market Share

Varian is the largest producer of radiation therapy equipment in the world. In terms of sales revenue, Varian occupied 59-60% of the world market and approximately 67% of the US market at the end of 2007. However, some of Varian's competitors only operate in the fastest-growing segments of the radiation therapy equipment market whereas Varian produces both innovative and mature technologies, meaning that market share fell slightly during 2007.

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[edit] References

1. ↑ ^{1.0 1.1 1.2} "Varian Medical Systems Q4 2007 Earnings Call Transcript," Seeking Alpha, 24 October 2007
2. ↑ ^{2.0 2.1 2.2 2.3} VAR 2007 10-k, Item 1 pg. 11
3. ↑ "Varian Medical Systems F3Q08 Earnings Call Transcript," Seeking Alpha, 23 July 2008
4. ↑ VAR 2007 10-k, Item 1 pg. 14
5. ↑ ^{5.0 5.1 5.2} VAR 2007 10-k, Item 7 pg. 59
6. ↑ The National Association for Proton Therapy, 2008
7. ↑ VAR 2007 10-k, Item 8 pg. 80
8. ↑ VAR 2007 10-k, Item 7 pg. 61
9. ↑ VAR 2007 10-k, Item 7 pg. 60
10. ↑ VAR 2007 10-k, Item 1A pg. 43
11. ↑ VAR 2007 10-k, Item 1A pg. 44
12. ↑ "Varian Medical expects higher 2008 profit," Forbes, 23 July 2008
13. ↑ VAR 2007 10-k, Item 7 pg. 61
14. ↑ VAR 2007 10-k, Item 7 pg. 53
15. ↑ "Varian Medical Systems Reports Strong Growth in Net Orders, Revenues, and Earnings for the Third Quarter of Fiscal Year 2008," iStockAnalyst, 23 July 2008
16. ↑ VAR 2007 10-k, Item 7 pg. 63
17. ↑ VAR 2007 10-k, Item 1A pg. 26
18. ↑ VAR 2007 10-k, Item 7 pg. 64
19. ↑ "Are the number of cases of cancer increasing or decreasing in the world?," WHO, 1 April 2008
20. ↑ "Radiation Therapy: Questions and Answers," National Cancer Institute
21. ↑ "State calls for more cancer facilities," The Boston Globe, 18 September 2006
22. ↑ "Credit Crunch Begins to Squeeze Hospital Industry," Yahoo Finance, 25 July 2008
23. ↑ "Proton Therapy Unlocks Closed Doors," Imaging Technology News, March 2007
24. ↑ Elekta Annual Report 2006/2007 pg. 32
25. ↑ VAR 2007 10-k, Item 7 pg. 59
26. ↑ VAR 2007 10-k, Item 1 pg. 15
27. ↑ "6 Medical Device Makers Poised For Growth," Seeking Alpha, 12 May 2008
28. ↑ "Lazard Capital Markets - VAR: Maintain Buy," PharmaLive, 1 July 2008
29. ↑ TomoTherapy Hi-Art Treatment System, TomoTherapy
30. ↑ "TomoTherapy Takes Top Honors," Business Wire, 2 July 2008