Concentrate on what’s actually happening

“Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard.” Warren Buffett.

Inflation might be the flavour of the month however this does not alter the way we invest. As the legendary Peter Lynch puts it, “Nobody can predict interest rates, the future direction of the economy or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.”

Other than being opportunistic and adding to our positions in firms which were unfairly hit by sentiment, we are agnostic about short-term price movements which are driven by human behaviours and emotion.

We focus on what is actually going on in the underlying business. As Warren Buffett argues “Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard.”

One such example of a company which has come forward in leaps and bounds is Masimo. It is the leading provider in pulse oximetry since developing signal extraction oximetry in the late 1990s - a technology that offered superior accuracy and reliability. The firm is founder-led by Joe Kiani, a visionary outsider, who has consistently outmanoeuvred the incumbents.

Pulse oximetry is a test used to measure the oxygen level (oxygen saturation) of the blood. It is an easy, painless measure of how well oxygen is being sent to parts of your body furthest from your heart, such as the arms and legs.

In 2010, Masimo had a 26% market share in the pulse oximetry market. From 2010 to 2019, the company won circa 2% market share per annum and in 2020, Masimo won a whopping 6.8% of market share and ended 2020 with just under 50% market share. During the last decade, the installed base of the Pulse oximetry market grew by 32% which amounted to 972,964 units yet Masimo’s installed base increased by 1,186,700 units or approximately 250%.

The technology boards used to perform the tests have a lifetime value of 10 to 12 years. So, the product cycle is relative slow and therefore stable. Furthermore, new monitor integration is a relative long process taking another 1-2 years from start to finish. Within this context, the company’s market share gains are far more impressive than first meets the eye.

The company capitalises on its ever-expanding installed base by operating a lucrative razor and blade model (a model often attributed to Gillette: “Give them the razor; sell them the blades”). Masimo sells its high margin disposable sensors at a 30% -40% premium over primary competitor Nellcor with a 5-to-7-year contract. The majority of its sensors are single patient use and last a week.

In order to maintain its market leadership position, Masimo spends approximately 9% of revenue on R&D, higher than that of its medical technology peers. Clearly the high R&D spend is adding value. According to a recent study, Masimo SET had 3% missed true alarms and 5% false alarms, these compare favourably to Nellcor’s N-600 sensors which had 43% missed true alarms and 28% false alarms.

For healthcare providers, pulse oximeters that produce inaccurate results take up valuable clinician time and lead to poor health outcomes. Missed true alarms could be the difference between life and death whilst false alarms could result in true positive alerts being ignored. Because of the high stakes, healthcare providers are strongly motivated to use the best-in-class product and this leads Masimo to a 98% customer renewal rate.

Furthermore, Masimo cites substantial cost savings, claiming that an average-size 250-bed hospital can save over $3 million per year by using Masimo SET pulse oximetry.

Due to these market dynamics, Masimo has carved out an economic moat. Returns on invested capital have consistently far exceeded cost of capital, averaging 30% over the past decade.

What do we mean by moat? A moat is a deep, wide ditch surrounding a castle, typically filled with water. It is intended as a defence against an attack. A crucial part of our investment philosophy is to focus on those companies which have an economic moat; some sort of competitive advantage over others in their field. As these companies tend to dominate the market, it is extremely difficult for their competitors to take market share away from them.

Crucially for our investment philosophy, these are the businesses that, thanks to their competitive advantages, have high sustainable profitability margins and the ability to create long-term shareholder value by compounding high returns on capital employed over time.

Core pulse oximetry accounts for 85% of Masimo’s sales today, yet the valuable intangible assets, company culture which strives for excellence and innovative led growth leads to significant opportunities ahead. From a total addressable market of $3 billion today, management estimates that the company will have an addressable market of $15 billion by 2025.

In the US, continuous monitoring is standard practice in intensive care. Further revenue and market share growth is expected to come from winning business from Nellcor as hospitals seek to upgrade. On the other hand, the penetration rate in general wards is a low 10%, so Masimo has strong runaway growth ahead, particularly with its strong case of improved patient care and reduced hospital costs.

The hospital gets real time, non-invasive and continuous patient monitoring solutions on the general care floors in a manner that is far more comprehensive, efficient and safer.

Far fewer nurses are required to monitor patient vitals on a screen instead of physically taking their vitals one by one. For hospitals this not only saves on staff costs but the continuous monitoring also reduces litigation risk. There is far less contact between the patients and nurses. Since there is no contact between nurses and patients, the risk of viral transmission is also contained. As the pandemic stretched hospital resources to the limits, the possibilities of attending to far more patients with fewer staff in a safe environment, accelerated the adoption of this program

The hospital automation program, which involves integrating central monitoring with bedside vital-sign aggregation systems is a potential growth driver for the business. The program is being established as a software-as-a-service business, with a per-bed cost for hospitals of $1,000 to $5,000, depending on services offered.

Masimo’s Opioid SafetyNet is another pipeline product that could have a material impact on the business over the coming decade. This product, a modified version of the company’s remote monitoring Patient SafetyNet system, is designed to monitor for Opioid overdose risk and alert emergency contacts if needed. The take-home, direct to customer monitoring system connects to a smartphone and alerts medical staff in case of respiratory depression. At a cost of $150 for 8 days of continuous monitoring, compared to hospital stays, the cost savings are massive. Masimo estimates that the total addressable market in Opioid SafetyNet is $4 billion.

Masimo was initially bought for the Garraway Global Equity Fund in February 2019 at a price of $131 per share. At time of writing, shares are trading at $287, up 119%. We believe that the market is underestimating the opportunities which lay ahead and have strategically added to the holding when the market presented opportunities.

Masimo is just one of many healthcare companies owned by the Garraway Global Equity Fund. All are market leaders within their respective fields with sustainable competitive advantages. All are run by strong management teams, operate capital light business models, generate high returns on capital employed and are positioned for secular growth.

Malcolm Schembri
Fund Manager, Garraway Global Equity Fund