Article Date: 3/1/2005

Wall Street Analysts Dig Deep to Cover Eyecare Stocks
Full-disclosure rules make for tight-lipped companies.
JERRY HELZNER, SENIOR EDITOR

Just a decade ago, an investor interested in participating in the anticipated growth of ophthalmology-related companies was essentially limited to 2 investment-grade stocks, Allergan and Bausch & Lomb.

But that's all changed during the past few years. Today, an investor in eyecare stocks can now also choose among such industry stalwarts as Alcon and Advanced Medical Optics (AMO), niche companies such as Eyetech Pharmaceuticals, IntraLase, and QLT, Inc., laser vision correction providers, including LCA-Vision and TLC Vision, and major pharmaceutical firms like Novartis, Pfizer, and Genentech that have recognized the extent of the potential opportunity in developing effective treatments for the wet form of age-related macular degeneration (AMD) and positioned themselves to participate in that area of eye care.

Helping investors to sort through the increasing variety of choices in eyecare investments is a group of more than a dozen securities analysts working for firms ranging from mammoth Merrill Lynch to small "boutiques" catering to high net-worth investors. These analysts are called "sell side" because their research is "sold" to institutional investors, usually in return for the commissions generated by institutional trading. Institutions that purchase large amounts of stock for mutual funds, pension funds and exchange-traded equity funds may also employ their own analysts. These analysts are called "buy side" and tend to have much lower profiles than the analysts who work for the major brokerage firms.

For this article, Retinal Physician asked several sell-side analysts to discuss the methods and criteria they use to evaluate eyecare stocks. We also asked investor relations officers of 3 major eyecare companies to describe how they deal with securities analysts in the new era of full and public disclosure of all material company information that's now required by law.

 

 
"We can help direct investor funds to companies that provide the best services to physicians "
Steve Hamill, Healthcare analyst, Piper Jaffray and Co.

CREATING THE "MOSAIC"

When a security analyst recommends a stock, the stakes are high. Not only are large sums of clients' money at stake, the analyst is putting his or her professional reputation on the line. That's why analysts must carefully study, and then take into account, a large number of often complex factors before putting their seal of approval on a company's shares.

For example, when evaluating an eyecare company, an analyst must assess such key factors as the outlook for the overall marketplace that the company serves, the track record of the management team, the company's relationships with its customers, the company's reputation for innovation, the potential of the product pipeline, and the company's financial health. To obtain this information, analysts talk to a variety of sources, including company management, physicians who use the company's products, industry consultants, and competitors.

"Most analysts follow what's called the 'mosaic theory' in analyzing specific industries and companies," says Anthony Vendetti, a senior vice president of Maxim Group who covers eyecare companies. "We gather information from various sources and put it all together into an investment thesis. First, I look at the macro-trends that affect the industry, things such as demographics. Then, I try to identify the companies that are going to be the winners within that industry. It's a top-down approach."

Some of the ways Vendetti obtains information about a specific eyecare company are by speaking with management, reading all the public filings that the company makes, going to as many industry conferences as possible, and talking to practicing ophthalmologists to get their opinions on new products the company has launched, and their general feedback about how they view the company.

Vendetti says he judges each eyecare company he covers against its competitors.

"Before I can recommend a company, I must believe that management has the forward-thinking capability to achieve rapid growth," he notes.

Theodore Huber, an equity analyst who follows eyecare stocks for Wachovia Securities, also considers a company's capacity for growth a critical factor in his analysis.

"In addition to evaluating the product pipeline and the quality of management, I have to be satisfied that the company can grow the top line and expand its profit margins," he says.

Steve Hamill, CFA, vice president, senior analyst, Healthcare, for Piper Jaffray & Co., says he may put less emphasis on the product pipeline than some other analysts.

"The developmental pipeline is always important in the short-term, but it's less of a long-term indicator given the ability of a large company to acquire technology, particularly for companies that are more device-oriented than pharma-oriented," says Hamill.

Analysts also look for 'red flags," early signs that a company may not be a worthwhile investment.

"A management team that has a poor track record with not much history of success is a bad sign," says Vendetti. "New products that are launched but not adopted by physicians is another. And sometimes there are clues in the company's financial statements that something is potentially amiss."

Hamill says an overly promotional management team raises doubts with him.

"Many executives feel that they must manage Wall Street," says Hamill. "They tend to 'spin' investors by glossing over the warts and overemphasizing the positives."

"FIELDWORK" PROVIDES ANSWERS

Every analyst interviewed for this article placed a high priority on attending the major ophthalmology meetings, such as the annual meetings of the American Academy of Ophthalmology (AAO) and the American Society of Cataract and Refractive Surgery (ASCRS).

"These meetings are an opportunity to visit with multiple management teams in a short period of time, learn the latest clinical data, and talk to many physicians in one place," says Joanne Wuensch, who covers the eyecare industry for Harris Nesbitt.

"AAO and ASCRS provide great value to analysts," adds Hamill. "There's no better way to see how a company is positioning itself to its customers than to see what they are doing at the booth," he says. "We also try to see if any new scientific data is presented that may make or break a product . . . particularly if it's a new product. Finally, there's no better opportunity to speak with numerous thought-leaders in a short period of time."

"The meetings are invaluable as a way to judge the competitive landscape and get physician feedback on products and companies," notes Vendetti.

The analysts we interviewed say they have always spent a great deal of time in doing what they call "fieldwork." That means talking to physicians about specific products and companies, observing procedures and even talking to raw-materials suppliers to determine if they have productive relationships with the eyecare companies that are their customers.

Fieldwork has become even more important since 2000, when a new regulation, Reg FD, mandated companies to provide full and public disclosure of all information that could materially affect the company. The spur for Reg FD was the disclosure of chummy relationships between some high-profile analysts and the companies they covered.

"The regulatory changes have, in my opinion, forced a lot of poor research analysts out of the business," asserts Hamill. "No longer is it sufficient to work at a big-name firm, call up company management, and find out how the quarter looks. This has made predicting the short-term even tougher than it was. Today, we are forced, to a much greater degree, to develop independent sources of information and think months, if not years, ahead."

"Analysts are doing more fieldwork now because of Reg FD," says Vendetti. "Today, analysts must be skilled in the finance and accounting aspects of businesses, but they also must be almost like investigative reporters in doing their fieldwork."

 

 
"We're the gatekeepers who control the information that flows from the company"

Daniel L. Ritz, director of Investor Relations, Bausch & Lomb

THE INFORMATION "GATEKEEPERS"

The investor relations (IR) specialists at major eyecare companies, including Alcon, Advanced Medical Optics, and Bausch & Lomb, recently told Retinal Physician that Reg FD has created a level playing field in terms of allowing all shareholders to obtain the same information at the same time.

"We will allow analysts to talk one-on-one with senior management, but only with an investor relations person in attendance," says Doug MacHatton, vice president of investor relations and strategic communications at Alcon. "These talks are never for the purpose of giving out new information. They're held so that an analyst can gain a better understanding of information that's already been publicly announced."

Clearly, one area of concern is data being compiled from ongoing clinical trials.

"All of our clinical investigators are governed by confidentiality agreements, which they are obligated to abide by when dealing with the public," says MacHatton.

Proof that Alcon's controls on information are working became apparent late last year when important study results from a trial of Retaane, the company's investigational therapy for wet AMD, were released. The data was disappointing, and Alcon shares immediately dropped more than $10 when trading opened.

"The fact that the stock dropped only after the public announcement showed that the information hadn't leaked out," says MacHatton. "The limited number of people who had the information took their pledge of confidentiality very seriously."

At Advanced Medical Optics, Sheree Aronson, vice president of corporate communications and investor relations, says the company's goal is to "ensure full access to everyone at the same time and to the same degree."

The company ensures equal access by issuing news releases, holding conference calls and making presentations at major meetings that are also Web cast. Like other major eyecare companies, AMO allows analysts to speak one-on-one with managers, but only with an IR specialist sitting in, and all of the company's clinical investigators are bound by confidentiality agreements.

"When we announced that we were purchasing VISX, it completely surprised the investment community," says Aronson. "That's a good thing, because it shows that the information was tightly held and didn't leak out."

Though Alcon and AMO weren't publicly owned companies before the advent of Reg FD, Bausch & Lomb has a long history of dealing with the analyst community.

"Before Reg FD, analysts could ask the company to review their models and comment on them, and we did," says Daniel Ritz, director of investor relations at Bausch & Lomb. "If someone was off base with their numbers, we would walk through their assumptions to help them get to numbers that were more consistent with our guidance. Subsequent to Reg FD, it's our practice not to review or comment on analyst models."

Ritz says he looks at the IR group at Bausch & Lomb as "gatekeepers" who control the information that flows from the company to the investment community.

"We'll allow analysts one-on-one contact with top management, but if there's an inadvertent slip and something material comes out of the conversation, we'll immediately disseminate that information through a press release."

ARE ANALYSTS MISUNDERSTOOD?

Though their relationships with analysts are largely governed by the restrictions imposed by Reg FD, company IR specialists say today's analysts are intelligent, hard-working, and ethical. Most of them have backgrounds in accounting and finance, and many, like Vendetti and Huber, have years of experience inside the healthcare industry. The perception among many novice investors that Wall Street runs on so-called "inside information" couldn't be more wrong, say analysts and company officials alike.

"People think that analysts are trying to get an edge with inside information," says MacHatton. "Their real objective is simply to understand the industry and our business better so that they can make an accurate evaluation."

"As we call on physicians in the industry to tap their knowledge and vision, I hope they will recognize that stock analysts do provide a valuable service in return," Hamill concludes. "Hopefully, through our work we can help direct investor funds to companies that provide the best service to physicians, and/or products that meet large, unmet needs in patient care. Such companies typically provide the greatest financial rewards in the long run."

 

AN ANALYST'S REPORT

Theodore Huber, the equity analyst who follows ophthalmology-related stocks for Wachovia Securities, puts out a weekly e-mailed newsletter called Eye on Ophthalmology reporting on news with the ophthalmic community. As a sample of the product of analysts' research, below is a short excerpt from a January newsletter on his overall outlook for 2005:

2005 - A Stronger New Product Year

ZyLet (Bausch & Lomb) and Macugen (Eyetech) are FDA approved and expected to launch shortly. We expect Retisert for treatment of uveitis (Bausch & Lomb) by midyear. Several filed new drug applications (NDAs) represent possible but lower probability product launches, including Alcon's Retaane for treatment of wet AMD, a ciprofloxacin/dexamethasone combination drug from Alcon, and combination prostaglandin/timolol drugs for treatment of glaucoma from Alcon, Allergan, and Pfizer. Though Alcon's once-daily ocular antiallergy formulation,

Patanol QD, was FDA approved on December 22, 2004, Alcon is not committed to a 2005 launch given its weaker label relative to the original formulation.

Product Cycles Drive Growth - In Time

Given the time it takes for new products to gain traction, we expect this 2005 crop of products to drive more growth in 2006. With difficult comps in glaucoma treatment categories, declining domestic trends in the anti-infective categories, and no 2004 launches, we expect global ophthalmic revenue growth to drop a few points in 2005. Longer term, we expect sustainable double-digit growth in ophthalmic pharma, given major unmet developed-world clinical needs in dry eye and AMD, and untreated glaucoma in the developing world, all propelled by the positive tide of an aging population. 

 


Retinal Physician, Issue: March 2005