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Investors Are Heartless About Edwards Lifesciences

Stocks in this article: EWABTSTJISRGBSXMDT

NEW YORK (TheStreet) -- Given my recent love affair with medical device companies, I was recently asked for my opinion on, I was recently asked for my opinion on Edwards Lifesciences (EW), which has seen its stock plummet close to 10% since the company reported third-quarter earnings results that -- by the way -- beat Street estimates.

Since the stock peaked in October 2012 at around $109, shares have been on a steady decline,  losing close to 40%.

While I do believe these shares are fairly valued following this pullback, the question is how much of the recent decline was an overreaction to the company's guidance? Or are there real fundamental challenges investors would just rather not deal with?

Before we dive into Edwards' numbers, it's worth noting Edwards was at one point an obscure entrant in areas like tissue heart valves and critical care monitoring. These were markets that were dominated by giants like Abbott Labs (ABT), St. Jude Medical (STJ) and Intuitive Surgical (ISRG). But Edwards' management had bigger ambitions, and the Street was completely sold.

Following the footsteps of some of its rivals, namely St. Jude, Edwards' management seemingly got bored with the company's "old way" of doing things. Looking to generate higher margins and deliver more profits, management decided to move the company away from its legacy operations to focus instead on areas like transcatheter aortic valve implantation (TAVI), which (at the time) was considered a breakthrough in medical technology.

Given the level of success enjoyed by St. Jude, which was already in the transcatheter business, it was easy to see the business justification in Edwards' decision. Edwards' stock, meanwhile, immediately caught fire as investors began to see dollar signs. The problem, though, was the execution -- not to mention, management's regrettable decision to relinquish a very stable way of doing business, slow-growing as it was. These issues came home to roost in Edwards' third quarter.

First, the good news: The company posted revenue of $495.6 million, which represents year-over-year growth of 11%. Although U.S. revenue of the company's Sapien valve, which is used to repair a damaged aortic valve in the heart, underperformed, it was offset by stronger-than-expected gains abroad, which beat Street estimates.

Profits, meanwhile, rose to $76.9 million, or 68 cents a share, from $69.2 million, or 58 cents, in the year-ago quarter. Clearly, the company is doing well in these areas. But the Street was disappointed by the weak revenue performance for U.S. transcatheter heart valves. The Street had already priced in a beat as shares of Edwards had jumped 13% in the four weeks leading up to the report.

Complicating matters is the fact that Edwards' transcatheter business will soon face pressure from Boston Scientific (BSX), which recently received approval for its competing Lotus heart valve product. Plus, there is also Medtronic (MDT), which is looking to diversify its device business by entering the market with CoreValve. It's still too early to know what sort of impact these products will have on Edwards' market share and margins, but investors are not waiting to find out. But I wouldn't rush to dump this stock just yet.

In July Medtronic's CoreValve product was determined to have infringed upon Edwards' patents. To date, there has been no evidence to suggest that Edwards' patent victory has had a favorable impact from a revenue perspective. But, here again, this detail -- as important as it is -- doesn't seem to matter to this story. I have to wonder if investors have not given up too early on Edwards.

All told, I believe it was a decent quarter, one that was undeserving of the negative stock reaction. With shares having declined by roughly 40%, I believe not only is this stock fairly valued, but Edwards has now approached -- what I would call -- "acquisition-level valuation." What I mean here is, with a market cap of around $7 billion, I can see one of Edwards' rivals making a play for the company. Medtronic, which has $11 billion in cash, would be at the top of my list.

Although nothing is guaranteed to happen, it makes too much sense for it not to given the companies' mutual interests in the transcatheter heart-valve market.

To that end, while I do see these shares as fairly priced, there are other factors that can drive these shares higher, not the least of which is that the market may eventually comes to its senses. It just needs to have a heart.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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