⚠️ Please note this research report was first released on June 6th, 2018. This report will be updated in late 2022 / early 2023.
“Time is The Friend of A Wonderful Business”
Charlie Munger taught Warren Buffett to buy shares in wonderful businesses. Before that, Buffett spent much of his time buying ‘cheap stocks’.
To me, a wonderful business is one that compounds shareholder wealth again and again and again.
While the company’s share price might bounce around from one year to the next, it’s the long-term return from the business that counts.
When I think of a ‘wonderful business’ I think of a few things:
- A business model which has proven itself
- Generates lots of profit for every dollar of sales
- Has loyal customers
- Can grow for many years without buying other companies
Who is Pro Medicus?
Unless you’re an active Australian investor in small companies, chances are, Pro Medicus is not a name many people would be familiar with. It was founded in the 80’s by management who are still involved in running the business.
What does it do?
Primarily, Pro Medicus does two things:
- Provides an ‘all-in-one’ software used in radiology clinics throughout Australia.
From bookings and billing, to patient management. The product is called Radiology Information System (RIS). It’s the smaller part of Pro Medicus’ revenue (around 22% in FY17) but provides a recurring stream of cash.
Medical clinics are a competitive market for software providers and Pro Medicus’ RIS is somewhat limited in the pace at which it can grow overseas. For example, a RIS in Australia would be slightly different to a system rolled out in Europe because of things like payment. Think Medicare, TAC, private health, bulk-billing, DVA… the list goes on.
Nonetheless, RIS is a great product which has been sold to reliable clients for many years. This part of the business has won some sizeable projects in recent years as it redeveloped the RIS suite. It recently struck deals with Primary Health Care Limited (ASX: PRY) and I-MED.
- Visage 7 PACS Software
Each of Pro Medicus’ products are sold under the banner of “Visage”. The Visage library of software is a great tool for radiologists and other doctors to send and receive medical images to a variety of devices.
Ok, that might sound a little ‘out there’, so let’s use an example…
Jill needs an X-ray to determine what’s wrong with her back. She steps into a hospital’s X-ray device which produces an extremely clear picture. In fact, the picture is so large that it takes up enough space for 1,000 copies of Johnny Cash’s Burning Ring of Fire.
Traditional “Picture Archiving Systems” or PACS would store the images locally in the hospital (or be printed out) and the images would take seemingly forever to send from one place to the next.
With Visage 7 and Visage Ease, a doctor taking Jill’s X-Ray could send the file to the iPhone of a specialist radiologist who is, say, watching their daughter’s basketball game. It could be sent in seconds and Jill could be diagnosed there and then.
Obviously, the software is great for patients like Jill. But it could be even better for the doctors. Hospitals have reported spending less on IT overheads, increased radiologist productivity, increased accuracy and the benefit of being able to scale their services.
In one of the best acquisitions I’ve heard of, Pro Medicus bought Visage 7 software in 2009 for $5 million before selling some unwanted pieces for $15 million — a 300% gain. But if that wasn’t good enough the remaining stake is now worth hundreds of millions of dollars.
Pro Medicus pushed the Visage product into the United States in 2012, where it has begun to take market share from heavyweights in the industry. It has signed some of the largest clinics and most renowned hospitals in the United States market, which is estimated to be worth $US 2 billion per year. Pro Medicus estimates it controls less than 5% of the market, based on the number of examinations undertaken.
Competition
Philips, General Electric (NYSE: GE) and other large multinational companies control much of the healthcare industry’s technology. They have their own PACS technologies.
However, Pro Medicus has grown in the presence of competition.
Pro Medicus CEO Sam Hupert said the renowned Mayo Clinic completed two months of due diligence on Visage 7 before agreeing to sign a long-term deal. Mayo Clinic was a landmark deal for Pro Medicus, providing a platform for other sales and confirmed that even the best doctors choose Pro Medicus software over competitors.
In a recent interview, Dr Hupert said they believe their technology is at least 18 months ahead of the competition, based on feedback from potential customers. At the RSNA trade show, Pro Medicus had 8 demo stations available. All were booked out.
The Art of The Deal
What’s interesting — and promising — about Visage 7 is how it contracts with hospitals and clinics. Much of Pro Medicus’ margin-thick software is recurring. In fact, less than 10% of its revenue comes from research, training and installing software at the hospital. The rest comes from a ‘pay per use’ contractual relationship. Think of it as if the customers are billed on a ‘pay per image’ basis — with guaranteed minimums.
Based on its expectations in early 2018, Pro Medicus said it had $125 million of contracted revenue over the next five years. That doesn’t take into account future growth, new add-on services to its software or geographical expansion.
Leadership
Pro Medicus is run from Richmond, just outside Melbourne, Victoria. That’s the location for many of its leaders, including its co-founder and CEO, Sam Hupert. The office also provides a base for its RIS practice management software development team, which is headed up by co-founder Anthony Hall.
Both Hall and Hupert own more than $200 million of Pro Medicus shares — more than half the company. That’s despite a recent sell-down of 1 million shares by each co-founder. While a sell-down would normally concern me, each of them still own more than 28% of the shares available.
In-line with its US expansion over the past five years Pro Medicus has built a US-based sales and marketing force, which has been very successful.
Berlin (Europe) is where Pro Medicus’ research and software development team work on Visage’s visualisation capabilities. This is headed up by Malte Westerhoff, the company’s chief technology officer and head of global research and development.
Combined, the directors and senior leadership of Pro Medicus held 61 million shares at the end of 2017 (note: the founders have sold two million since then). Few things incentivise a business person more than a major financial interest in a $700 million company!
If Hupert, Hall or Westerhoff were to leave Pro Medicus, I would revisit my investment thesis.
What’s Your Edge?
Pro Medicus doesn’t look cheap, especially if investors use conventional metrics like the price-earnings ratio.
While I’ll admit it may not be a steal at today’s prices, I think better times could lay ahead of Pro Medicus over the next 10 years. Indeed, I think this is a growth investment with a twist.
Its software is sticky, its customers sign multi-year contracts with guaranteed minimums and it is consistently developing new technologies. For example, it has expanded Visage into other imaging formats and adjacent services (neurology, ophthalmology, etc.). The Visage suite of products has also positioned itself for the growth in machine learning and artificial intelligence.
As Dr Westerhoff recently said in an ASX statement:
“Historically, imaging platforms for research and diagnostic purposes have been totally separate. Visage’s GPU-based architecture is ideal for AI and, combined with our open APIs, will enable us to unify research and diagnostic imaging in ways not available before. This will enable AI breakthroughs to advance patient care by giving radiologists faster access to new tools that help increase productivity and improve clinical accuracy.”
While revenue from AI is still a way off, being a platform leader in medical imaging and data could provide Pro Medicus shareholders with a significant growth lever.
In the meantime, there is also the potential for organic growth via geographical expansion, plus rising dividends and an ongoing share buyback.
Risks
As I noted above, Pro Medicus is not alone. There are some fierce and well-resourced competitors who will be doing what they can to get ahead of Pro Medicus’ technologies.
So while I really like Pro Medicus’ wide profit margins, intense competition could stymie further margin expansion or — worse — cut the margin and weigh on growth. There is also a risk of a selloff given the company’s seemingly high profit multiple.
As most investors know, good sharemarket investments:
- pay dividends
- trade on low multiples (e.g. P/E ratios), and
- can grow their profits (i.e. the ‘E’ in P/E).
Over time, the best share investments pay more dividends, increase their P/E ratios and grow profits.
Currently, Pro Medicus shares have a P/E ratio over 80 while the market average is 16, according to Morningstar.
What am I talking about?
It follows that for me to buy shares at these levels I’m betting on some pretty impressive profit growth (‘E’) over many years and more dividends.
In my mind, some other noteworthy risks to a Pro Medicus investment include changes to regulation, changes in the management team, poor execution of research and development, and bad or costly acquisitions.
Financials
Pro Medicus has a great piece of software which should attract wide profit margins over time. Indeed, once a Visage system is installed on-site, revenue from customers tends to drip straight to the bottom line (profit). In fact, almost one-third of every dollar in sales turns into profit — after tax.
To the balance sheet and Pro Medicus ended 2017 with no debt and almost $23 million in cash.
Summary
I think Pro Medicus is high-risk growth company with a great piece of software and a few years’ head start on the competition. I’m anticipating plenty of ups and downs in its share price but expect Pro Medicus to compound my investment over many years.
Please note: in January 2019 I instructed Rask Invest members to sell half of Pro Medicus. As of August 2022 it has a HOLD rating inside Rask Invest.
– Owen
Rask Invest provides general financial advice only. That means, the advice does not take into account your objectives, financial situation or needs. Because of that, you should consider if the advice is appropriate to you and your needs, before acting on the information. Investing in shares involves a high level of risk and past performance is not a guarantee of future returns.
