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Raj Denhoy
[email protected]

Accuray’s first full-quarter post the Tomotherapy acquisition was largely a success when viewed through the lens of its initial targets for revenue growth, a profitable service business, and return to profitability. The company’s non-GAAP revenue of $95.4 million (+16.8 percent year over year) was well ahead of our $84.5 million (+3.5 percent year over year) forecast as well as Street consensus of $83.8 million (+2.8 percent year over year).

Overall revenues surged on beats in both product sales ($56.5 million versus our $50.6 million estimate) and service revenues ($38.3 million versus our $32.2 million estimate). Loss per share of ($0.17) was ahead of our ($0.25) estimate and Street consensus of ($0.28) on the revenue beat, an unexpected surge in the overall service margin, and lower relative operating expenses (46.7 percent of revenue versus our 48.4 percent estimate).

ARAY achieved an aggregate service margin of 12 percent which although in-line with our admittedly aggressive 12.3 percent estimate is sure to be viewed favorably considering the significance of improving the Tomotherapy service business to the overall success of the integration process. The higher service margin was achieved from a combination of higher than expected service revenues from a growing Cyberknife install base and the initial phases of retrofitting the Tomotherapy install units with newer components.

While the company’s F1Q showed significant strides … we continue to view shares as an attractive opportunity and maintain our Buy rating.

Karen Andersen, CFA
[email protected]

The long patent life of Roche’s portfolio puts it among the biotechs least exposed to generic competition. Patents don’t begin to expire until 2013 – when Rituxan loses protection in Europe – and management is implementing strategies to counteract future competitive pressures that we think will enable the firm to achieve 5 percent five-year earnings growth. Subcutaneous versions of Roche’s blockbuster antibodies are in the works, which could reduce hospital costs and add to convenience. Novel drugs are in development that could improve on the efficacy of its current products or represent new, personalized treatments for cancer patients.

Roche also has a solid pipeline beyond oncology, including drugs to treat schizophrenia and hepatitis C. With the Genentech integration starting to yield synergies, we think Roche’s drug portfolio and industry-leading diagnostics conspire to create sustainable competitive advantages.

We expect pharmaceutical and diagnostic synergies to increase in the wake of the Genentech acquisition. A late-stage pipeline including drug candidates in schizophrenia and hepatitis C could expand Roche’s reach beyond oncology.

Tycho W. Peterson
JP Morgan
[email protected]

During the past year, the debate over Varian Medical Systems (VAR) has been about upside from the TrueBeam product cycle, continued execution, capital deployment and secular industry tailwinds vs. fears over U.S. reimbursement and potential macroeconomic effects on capital expenditure, particularly in Europe. While many of these issues will remain in 2012, an important and underappreciated recent development – the selective exit of Siemens from the radiation oncology market – dramatically improves the risk/reward, as VAR (and others) should benefit from a global industry that is moving from four to three competitors. With that in mind, we upgrade VAR to Overweight and increase our December 2012 price target to $75.

In a growth-challenged MedTech environment, VAR increasingly stands out as a well-managed franchise with a strong competitive position in a market with secular growth tailwinds and the near-term benefit from the Siemens exit. Over the 2010-2015E period, we model an 8.4-percent revenue CAGR (compound annual growth rate) and +12 percent EPS CAGR, although this includes conservative assumptions in 2013 and beyond and also includes the effect of adding the PPACA MedTech tax beginning in 2013. These numbers put VAR among the higher-growth companies in our coverage, particularly on the top line, and the market has demonstrated a willingness to pay for the few growth stories remaining.

We are increasing our December 2012 price target from $66 to $75 on the back of increased estimates. Our $75 is derived from DCF with CAPM-derived WACC (capital asset pricing model-derived weighted average cost of capital) of 10.1 percent and terminal growth of +2 percent. The stock currently trades at a 10 times EV/EBITDA multiple on our 2011 estimate, whereas our December 2012 price target of $75 equates to 11.3 times EV/EBITDA multiple on our 2012 estimate, which essentially assumes minimal margin expansion.

Raj Denhoy
[email protected]

Varian Medical Systems CEO Tim Guertin kicked off the annual year-end review by reiterating its target of reaching $4 billion in total revenue by F14 (fiscal year 2014) and established a new target of $4.5 billion by 2016. However, he also inconspicuously added that these targets could be achieved exclusively through organic growth, a shift from the previous position where the company committed to this target through both organic and inorganic means.

Based on our current F11 outlook ($2.6 billion), the company’s target translates to three-year revenue CAGR of over 15 percent through F14.

The company supports its growth strategy by pointing to its own replacement cycle and share gains from competing aging systems now that it has what it views as the leading linac (premium-priced TrueBeam), treatment planning package (Eclipse), and now motion management capabilities (Calypso). Further, the company stated that replacement cycles for aging imaging equipment bodes well for its X-ray business, and recent proton wins make its goal of reaching $200 million in annual revenue for this division achievable.

The year-end review offered more evidence that there is still plenty of runway for the VAR growth story. Internationally, oncology orders are accelerating despite pressures in the EU, and it is in the very early innings of key markets such as China. This growth should continue in part from additional competitive wins in development markets, along with TrueBeam and eventually Unique system adoption in China.

David Risinger
Morgan Stanley
[email protected]

Watson Pharmaceutical’s (WPI) core business is generic drugs, and we continue to have confidence in management’s ability to drive shareholder value. We believe WPI will rebuild investor confidence in the outlook as it delivers on new generics.

Growth catalysts could be crystallized in 2012-2013 as product approvals occur and Watson Pharmaceuticals overcomes litigation hurdles. Strong generics execution should drive a rebound in investor confidence in the outlook. There are several big opportunities, including potential generic launches of Mucinex ($500 million branded), Lidoderm ($1.2 billion), Pulmicort ($1 billion), Lovenox ($1.2 billion at retail), OxyContin ($2.9 billion) and Adderall XR ($1.9 billion).

We think some investors are missing WPI’s relatively unlevered balance sheet and $3.3 billion debt capacity (before incremental EBITDA from M&A). Our $65 price target is 7 times our 2013E (estimated) EBITDA of $1.35 billion, which is 11 times our 2013E EPS of $5.97.


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