Seeing Beyond Visx, Part 1

Many thanks for the feedback to last month's column on Visx (VISX). (OK -- it wasn't all positive!) There were so many questions, in fact, that I'm following up with further analysis of the vision-correction industry, the players competing with Visx and a look at some of the technological advances driving developments in this field. And the timing couldn't be better, now that Visx has launched an industry price war and a new competitor has joined the fray.

First, a little background on how I think about investing. I'm a proud member of a fast-dying breed: the long-term, buy-and-hold investor. Consequently, the primary factor I look for when evaluating a company is sustainable competitive advantage. Powerful competitive advantages create a moat around a company that can keep competitors at bay and allow the business to reap extraordinary growth and profit. Like Warren Buffett, I seek companies with wide, deep moats that will expand over time.

This is a rare phenomenon, as big moats seldom endure for many reasons: High profit can lead to complacency and are almost certain to attract competitors, while new technologies, customer preferences and ways of doing business emerge, etc. Yet when a company is able to achieve a significant moat -- and, most importantly, maintain and even expand it -- the company and its shareholders can be rewarded for decades. The big pharmaceutical companies are great examples of this.

Industry Overview

When I first took a look at the corrective eye-surgery industry last September, I didn't like what I found. Numerous companies were competing fiercely in an emerging industry characterized by rapid technological change. Identifying the long-term market leaders in this type of situation is difficult, and there is no guarantee that any company will be able to earn high returns on capital in such a competitive environment.

Yes, there was rapid growth, but this had fueled valuations rooted in lofty dreams for the future of many companies. I worry about my odds as an investor in such situations, since it's mathematically impossible for five companies to each have 30% market share, and it's unlikely that multiple companies will be able to earn high returns -- yet this is what was implied in the valuations.

Visx

If any company qualified for my investment, it would most likely be Visx. As I noted in my previous column, Visx has mouthwatering economic characteristics, and appeared to have a strong competitive position (including 140 existing and 70 pending U.S. and foreign patents). However, it was priced for perfection last September at 94 a share, or 86 times trailing EPS.

At that price, there was absolutely no margin for error. Given the ferociously competitive nature of our capitalist system, where any company earning excess profit invariably attracts multiple rivals, I'm not willing to bet on perfection very often. In the case of Visx, my analysis led me to believe that there was plenty of room for error -- mainly in the form of competitive threats from other companies (which, in fact, materialized) -- so I fortunately did not invest.

Competition Heats Up

In the meantime, Summit Technologies(BEAM) has emerged as a significant challenger to Visx. While Visx's laser was the first to receive FDA approval for the correction of hyperopia, or farsightedness, in October the FDA approved Summit' Apex Plus Excimer Laser Workstation for hyperopia as well.

In addition, Summit's laser was the first to receive any FDA-approved Lasik (a type of laser eye surgery) indication for high myopia (nearsightedness) with or without astigmatism, which is an irregularity in the shape of the cornea. Both Visx's and Summit's machines were approved for an older procedure called photorefractive keratectomy, or PRK, but once a machine is approved for one use, doctors can, if they choose, use it for other procedures such as the more popular Lasik.

The latest developments at Summit are from its wholly owned subsidiary, Autonomous Technologies. It has introduced the LadarVision System, which according to a press release:

is the only small-spot scanning laser with an [active] eye-tracking device approved by the FDA. The system tracks the position of the eye during the laser vision-correction procedure at a rate of 4,000 times per second, essentially removing voluntary and involuntary eye movement as a factor during the procedure and greatly increasing the comfort level for both the patient and the surgeon. Other laser systems typically rely on the patient focusing on a point of light to ensure the eye remains still during surgery.

This is important: When I had the surgery, I remember how intently I stared at the red dot because any eye movement could have disrupted the surgery. But it's impossible to keep your eye completely still, so I can appreciate what an advance the active eye-tracking feature is. Some readers (who, not surprisingly, have long positions in Summit) said that the LadarVision System is getting rave reviews.

Summit and others are also developing a related technology called wavefront, which provides a much more detailed refractive map of the eye -- and its aberrations -- than is presently available. Combined with an eye-tracking laser, these two advances offer the prospect of even better patient outcomes. Summit expects that its wavefront system, CustomCornea, which is in feasibility clinical trials, to be commercially available within the coming months.

I will continue with a discussion of other companies in this sector, and some conclusions. In the meantime, I highly recommend reading the excerpts of comments from Ed Gold, an expert on tracking systems similar to the one used in Summit's LadarVision System. Thank you, Ed.

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