Intuitive Surgical (ISRG) is a Serenity level position in the Freedom Portfolio (one of the many). It’s a leading provider of robotic surgical systems, which help to increase the number of minimally invasive surgeries, which in turn “results in fewer complications, shorter length of hospital stay, a trend toward lower mortality and a trend toward more effective removal of cancer when compared with open surgery”.

It’s also a pretty good example of a “razor and blades” business model.

What is a “razor and blades” business model? Even though we’re talking about a robotic surgery company, razor and blades has nothing to do with cutting people open. Wikipedia has a great description, but for those who clicking is too much effort, here’s my best shot at defining it:

The razor and blades model involves selling one item (the “razor”) for a low price with the hope to make more money by selling a higher margin complementary product (the “blades”). The eponymous example is how razor companies ironically don’t often make most of their money selling razors, but instead , but the replacement blades are expensive. Perhaps a more well-known example is how printer companies don’t make too much money off selling printers, but do make a lot of money off the ink cartridges. Video game consoles are another example of a low margin device which is sold in the hopes that money would be made off game sales.

As an aside, the term “margin” can mean a few different things when it comes to investing. In this case I am referring to the profit margin that businesses earn on certain products they produce. For example, when it comes to things like hamburgers, fast food restaurants might only make a tiny amount of money (or just break even), but beverages are often highly profitable, only costing a few cents to make but being sold to the customer for a few dollars.

Intuitive Surgical is an example of a razor and blades business model. Their da Vinci robotic surgery systems are expensive, but that’s not where the company makes most of their money. They actually make most of their money off of instruments and accessories that need to be replaced as the systems are used for surgeries. In other words, they make their money off of the “blades”.

Intuitive Surgical is a relatively new addition to the Freedom Portfolio, having just been bought late in 2018. As a result, its performance so far is fairly uninteresting, having lost around 1%. Still, with the S&P 500 down close to 8% during that same period, Intuitive Surgical is still an outperformer.

Intuitive Surgical announced earnings last week. Here are the key takeaways for their fourth quarter:

• Revenue increased 17% from $892 million to $1.047 billion
• Earnings per share increased 14% from $2.60 to $2.96
• Shipments of their da Vinci systems increased 34%

In my mind, the most important metric there is the increase of shipments of the da Vinci system, since it’s what everything else is based off of. More da Vinci systems sold means more operations done using the system, which leads to more instruments and accessories sold. Those systems sold this quarter are going to make the company a lot of recurring revenue over the coming years.

P.A.U.L. Score

Protected: 4

Da Vinci systems are expensive, and while the concept of sunk cost is a fallacy, humans are very prone to falling for fallacies. If a hospital has put down a lot of money to purchase a da Vinci system, that’s a powerful incentive to stick with Intuitive Surgical and not switch to a competitor (and have to buy another expensive system) in the future.

It’s not perfect protection, because competitors could easily offer a better overall value proposition by offering systems in the future where the accessories are cheaper. Also, there are plenty of other types of surgeries that the da Vinci system doesn’t handle right now which leaves opportunities for competitors to sneak in that way. Still, I like the dominant position that Intuitive Surgical has right now and don’t see them losing it anytime soon.

Alternatives: 3

It’s a little hard to judge what counts as optionality for Intuitive Surgical. Right now, the number of operations that the da Vinci system can be used for is limited, but that means there are plenty of other operations they can expand into. There’s even talk of remote surgeries being enabled in the future. Are these alternate areas that the company can move into? Or just part of their long runway? I tend to think the latter, which explains the average score here.

Understanding: 4

Intuitive Surgical is fairly easy to understand. They sell advanced robotics devices to which improve outcomes for surgical procedures. They make money selling the devices, but also make money training people how to use the devices and on accessories for those devices. They can expand their business by selling more devices, or increasing the number of procedures done per device. Honestly, the only thing knocking their score down a bit here is my lack of knowledge of which kinds of medical procedures could, or could not be improved by these machines.

Long Runway: 4

There’s a nice long runway ahead of Intuitive Surgical due to a couple of different trends working in their favor. In the United States, an aging population means more medical procedures, which means a larger addressable market for the company. There’s also plenty of room to expand the types of procedures that their machines are approved for, which can help provide more sales of the high margin accessories. Lastly, as with many US based companies, there is plenty of room for international expansion as well.

Total Score: 15

A very solid score. I like Intuitive Surgical because despite being fairly cutting edge (no pun intended) with a lot of growth ahead of it, it also feels like a pretty safe stock thanks to its moat and leadership position. Obviously things can always change, and I need to keep an eye on them to make sure the competition doesn’t overtake them, but things are shaping up for Intuitive Surgical to be a great performer for the next 5+ years.