The Health Care Short Sales That Never Fit

As an aside, Celgene's repeated missteps over the past few months -- which I think will trigger involvement by activist investors -- have been magnified by company's unexciting post-Revlimid pipeline. Now, even some of the company's most bullish investors struggle to justify long-term investment case.

The Cult: Intuitive Surgical (ISRG)

No discussion of valuation shorts would be complete without a mention of Intuitive Surgical. Virtually every long-short equity portfolio manager in healthcare has lost money shorting this stock at some point. I am no exception.

Intuitive's da Vinci surgical robot has become nearly ubiquitous in US hospitals and the company's valuation has for years floated far above the earnings growth rate. Bulls have long argued that the da Vinci will become a surgical standard, in procedures ranging from prostatectomies -- a market the company has already fully penetrated -- to gynecologic and general surgery applications.

The clinical data are mixed, and no prospective, randomized trials have been conducted. Some historical studies show advantages for the da Vinci -- reduced blood loss or a modestly shorter hospital stay -- while others show equivocal results. Importantly, the clinical data all share one characteristic: da Vinci surgeries cost considerably more than traditional alternatives, minimally invasive or not.

Despite this lack of compelling cost effectiveness data, institutions large and small want the marketing benefit of offering robotic surgery. Intuitive has triggered a capital equipment arms race among hospitals. This is especially true in the U.S., where patients demand drugs or technology based on ad campaigns. Ex-U.S., da Vinci growth has been slower due to increased price sensitivity. Bulls contend this too will change over time.

The company's sales growth opportunities -- new procedures, increased disposable utilization, limited competition, and ex-U.S. markets -- enable bulls to remain fixated on a long-term vision of global surgery dominance. Unless reality shatters that vision, the persistent disconnect between Intuitive's EPS growth and earnings multiple won't matter.

The lesson: If the investor base believes the market for the product is infinite, only extreme disruption to the business will trigger a negative re-rating of the stock.

Now let's examine a short idea recently pitched to me that seems to rely solely on valuation: Pharmacyclics (PCYC).

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