Robots have already found their way onto the factory floor. Now they’re finding their way into the operating room.

We’re seeing a prominent rise in the adoption of surgical robots, and it’s driving a wave of acquisitions from larger medical device companies. Smaller, independent robotics companies are being bought-up at a significant premium to their current market capitalizations. And that spells opportunity for investors.

But how can we find these smaller acquisition targets? And if they stay independent, will they be able to hold their own against much larger competitors in this space?

To help us answers these questions, we’ve brought in a few experts. Brian Gahsman is the Chief Investment Officer of the Contego Capital Groups and the Portfolio Manager of the AlphaCentric Robotics and Automation Fund (GNXIX). He has first-hand experience with medical robotics (literally!) and is on the hunt for small and micro-cap robotics companies.

In this exclusive interview, Brian and his analyst Jin Kwon are joined by 7investing CEO Simon Erickson and lead advisor Steve Symington. The group talk about how COVID has positivity impacted the robotics industry this past year and how 5G could be a sneaky way to play the robotics trend. They also discuss several smaller robotics companies such as Stereotaxis and Accuray, and what makes them so appealing as acquisition targets for larger players. Finally, they discuss the competitive position of Intuitive Surgical (Nasdaq: ISRG) and what factors are driving the adoption of medical robotics.

Publicly-traded companies mentioned in this interview include Accuray, Intuitive Surgical, Medtronic, and Stereotaxis. 7investing’s advisors or its guests may have positions in the companies mentioned.

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Timestamps

00:56 –  How was COVID Impacted the Robotics Market?

06:44 – Lesser Known Companies on Brian’s Radar

10:02 – Jin’s Thoughts on Accuray

15:07 – Acquisitions in the Robotics Industry

18:36 – What is Driving the Market at the Highest Level for Robotic Surgery?

24:56 – The Use of Surgical Robots Without Human Intervention

Transcript

Simon Erickson  0:01

Good afternoon and welcome everyone to our 7investing podcast. I’m 7investing founder and CEO Simon Erickson, joined by my colleague 7investing Lead Advisor Steve Symington. We’re going to be talking about robotics on today’s show, which is a topic that’s really interesting – really innovating quickly out there. And so we brought on some experts to share their opinions of this space. Brian Gahsman is the Chief Investment Officer of the Contego Capital Group. He is also the portfolio manager of the AlphaCentric Robotics and Automation Fund. Ticker on that is GNXIX. He’s also got his analysts from the Contego Group. Jin Kwon joining us on the call this afternoon, gentlemen, thanks for being here with 7investing. Brian, you and I have chatted for years about robotics. I’ve always enjoyed these conversations. But the last time I think that we spoke was before COVID entered the picture. How do you think that this last year has impacted the robotics market at the 10,000 foot level?

Brian Gahsman  0:56

I think it’s been a you know, I hate to say anything positive about COVID. But I mean, as far as robotics are concerned with the social distancing, and, you know, we still have to have manufacturing, there’s products that still need to be made. But at, you know, normal manufacturing line, when you have to have six feet separation between two people, well, then you’re going to have product loss, right? You’re going to have capacity issues. So there’s been over 36.7% increase in orders for robots year over year since COVID started. Because if you don’t have that one person in the middle, in the manufacturing line, you have a robot in the middle. And so that has kind of happened throughout this whole past year, this whole period, so that companies can continue to manufacture as many products.

And I don’t see it going backwards, by any means. I mean, the global adoption has already been increased exponentially over the years, but then with COVID now it’s just increased significantly. If not for the semiconductor shortage right now, I wouldn’t surprised if that 36.7 was more like 60%. COVID has greatly, greatly escalated the adoption all around the world, and orders are up. So I think that we’re just in a new work environment, a new workplace, whether it’s manufacturing or anything else. I mean, we’re obviously doing this call over zoom. A lot of people are working from home now. But as far as automation, I think a lot of companies that were kind of on the fence about automating, or using robotics, they’ve kind of just been pushed over the cliff. Because there’s really has been no other option to survive over the past year. And so we’re seeing that in the, you know, the sales numbers, the revenue numbers, from the robotics companies all around the world.

Steve Symington  3:13

Beautiful. So that kind of, I guess you can look back and see how things have been accelerated. And I agree, it’s been kind of fantastic to watch. Maybe one of the few silver linings for investors amid the COVID pandemic. But taking a more maybe present and forward looking stance investors have been kind of bombarded with “here’s a way to play 5g! 5g is such a massive opportunity!” Lots of different ways it can take advantage. But one sneaky way to play 5g’s through the robotics industry. Can you talk a little bit about how 5g is impacting and potentially fueling robotics?

Brian Gahsman  3:52

Sure. So there’s a couple of things. So prior to 5g, you know, a lot of robots had to be tethered to something, right? So how do you implement robotics and automation in agriculture? And frankly, with other robots, right, that doesn’t really work out too well. With 5g, the amount of data that’s able to be transferred wirelessly. The latency issues that have been cleaned up. Now we have the ability to cut the cord on the robots. And that’s significant in almost every industry group as far as robots are concerned. Now, going beyond that, if you look at more precision things, like surgical robotics, I recently did an interview and I got to play with the Stereotaxis Genesis system from up here in Minnesota, and the robot in St. Louis. And I’m here with my mouse controlling the machine on my monitor, moving a catheter around electromagnetically in St. Louis. It was a fake heart, by the way, but wow.

Simon Erickson  5:08

Yeah, that’s awesome.

Brian Gahsman  5:10

But the thing is, while scrolling in and out with my mouse, I’m moving the catheter back and forth inside of this heart from here. No latency. Just, you know, in milliseconds, my movement moving over there, before 5g that was going to be difficult. I mean, there’s been a lot of companies – Intuitive Surgical, it’s been working on telerobotics for quite some time. And I believe Corindus had the capabilities when they were acquired. But now with 5g, the precision, zero latency zero margin of error, from a surgeon anywhere in the world, operating on a patient anywhere in the world. So those are the fundamental aspects of how 5g is revolutionizing every aspect of robotics.

Simon Erickson  6:13

Yeah, let’s double click on that surgical robots topic there, Brian. And I mean, that pun intended that you actually probably weren’t double clicking when you actually got to control the robot itself. I mean, as investors we know, Intuitive Surgical, right. This is probably the most well named, publicly traded company that’s in surgical robotics right now. But you mentioned a couple other others. Stereotaxis? You mentioned Accuray, you mentioned as well. I mean, are there lesser known companies that are that are on your radar in this space that you think could be investment opportunities for us?

Brian Gahsman  6:44

Well, I mean, I think all the companies that are on my radar are lesser known. Back in 2013, when I started, you know, building my universe of robotics companies, we had a period of surgical robotics that, over the past few years, became a group of almost 16 to 20 different names. Everywhere from laparoscopic surgery, cardiovascular surgery, dental surgery, there’s Restoration Robotics that was acquired, I mean, they’re doing hair transplants with robotics. I mean, just across the spectrum, that space has grown significantly just over the past few years. Now, there’s also a lot of consolidation in the space, because we all know that there are a few large players in the medical device arena.

And the days of Intuitive Surgical trading under 100 bucks going up to over $1000, doing a reverse three way split and being back up to $800. Now they’re too expensive. They’re the main player, their market cap is reaching, you know, significant, like Stryker and other companies. The medical device companies have learned over the past few years that you better not let any of these guys go that far, or get that that large. When Mazor Robotics was purchased by Medtronic, you know, it was a strategic partnership. And I mean, I think there were capacity issues, if I remember correctly, and then that partnership turned into an acquisition. I don’t know, I think we bought it at $8. and it was acquired for around $50 or so. But, since then one of these companies gets to about $10, or $15. And it’s gobbled up by, you know, one of these large players, whether it’s Medtronic or Siemens or Stryker, which is kind of unfortunate, from the investment standpoint, because you want these guys to run, you know, I wanted it to be a $100 stock, but you know, it’s just the learning curve. The new way that we’re doing medicine is robotics and tele-robotics, it just makes sense. Because you don’t always have a doctor or a specialist in the same location as you have a patient with a critical issue that has to happen right now, with telerobotics, I mean, it’s saving lives. There’s a doctor everywhere in the world now. As long as there’s a device in one location, and there’s a doctor with a computer in another location. The impact of human life in general, it’s extreme. So the medical space has kind of been revolutionized over the past couple of years. And I don’t know how much focus is even being paid to that. But it’s changing significantly.

Simon Erickson  9:57

How about Accuray, Jin, can you talk a little bit about Accuray? I think that was another company you guys mentioned just a minute ago.

Jin Kwon  10:02

Yeah, I would love to.  We’re kind of going back to like what Brian was saying, robotics has changed the entire field of healthcare. When Brian and I are doing analytics on these companies, we really look at – go for data – that like any of us had something that went wrong. So Accuray focuses on cancer. But if something were to go wrong, we want us, for our friends or family to be treated by the best doctor and the best robotic system possible now. And that’s how we kind of like gauge our analytics. Going back to Accuray, so one in two women in this world are going to have cancer and one in three men in this world are going to have cancer. That’s the statistic. And the biggest complication that involves radiotherapy is called intrafraction tumor motion. And what that means is when a tumor or cancer is in somebody’s body, they have to get radiotherapy. And when they’re laying on that device, let’s say it’s a lung cancer process, (but) any type of cancer in the body, your bodily fluids are moving consistently, you’re breathing. And when the doctors try to accurately precision the cancer treatments, no abnormal systems, what they do is they create a bigger margin and treat the whole radiation area so they don’t miss the goal and not have to cut you open. Yeah, and then kill you.

But with Accuray, and with this new device, CyberKnife 7 system, it’s going to be revolutionary technology. What it does is, it has now incorporated synchrony. And what that means is it uses AI systems to be able to track the tumor precisely and to be able to send radiation to that tumor in a sub millimeter manner. And the reason why I’m so excited about this new device, is the old version you’d have to allocate an hour to treat the patient. But now with the new CyberKnife 7, that hour has been decreased to 15 minutes. Accuray is a pioneer of radiation therapy starting out with hypo fractionated achievements. What that means is traditionally when you have radiotherapy, patients go to the hospital for six to eight weeks. And they’re given the radiation dose, in a very consistent manner. But with Accuray, its accuracy and precision and with all the technology that’s going on incorporating toggle products as well, they’re able to give higher doses to the tumor, and the patient can just walk out of there receiving four or five treatments versus having the radiation be given over eight weeks. To unpackage all that a little bit. So here’s the visualization. If you have a brain tumor, and you go in and the surgeons has to cut you open and they say here’s your chances you know, you got a maybe 70 or 80% chance that this is going to work, 30% chance that you’re screwed. Now they bumped something in your brain. Accuray is a robotic laser that you go, you lay down with all of your clothes on. Nobody cuts you open, laying on the table it accurately shoots the laser directly at the tumor in your head for 15 minutes and you get up and you leave. So just the impact of that but in addition they have FDA approval for cancers anywhere in the body to be able to just directly, in micro millimeters, shoot out that cancer is game changing. And their 7 system incorporates an additional amount of AI and with that it’s just I mean it’s game changing. And so they have their CE mark. They’re showing systems and it’s really one to follow and keep an eye on.

Simon Erickson  14:54

Duly noted. Brian. Let’s change gears as I think about my mortality here. I like the robot though, if that increases my chances. But let’s see, what else do we have? Steve, is there any other questions we wanted to ask Brian and Jin about robotics?

Steve Symington  15:07

Yeah. So, I mean, we’ve mentioned acquisitions a little bit. And, you know, for perspective, you know, just taking a look at it Accuray and Stereotaxis? I mean, these are both very small companies – 400 million to 500 million market caps. What kind of chance, you know, do you give them to kind of continue to blaze their own trails without being acquired? And if they, you know by some maybe miracle they aren’t, you know, chased as acquisition candidates, you know, how big do you think they become in their respective spaces? Like, what’s the potential here?

Brian Gahsman  15:46

Well, and that’s difficult. So when I was interviewing David Fischel, the CEO of Stereotaxis, I kind of asked that same question. Is there anybody sniffing around? He kind of eloquently explained that there’s a board, they diligently have to entertain any offers for their shareholders. So there’s not always a choice. You know, when you run a company, you have to entertain these offers. But you know, I tell you, as far as Stereotaxis goes, talking to Fischel, that is a textbook balance sheet, like you see in college in an accounting class ideally how a balance sheet should look, that is how that company’s balance sheet looks. He came in, he cleaned up the whole company, cleaned up the debt. And their plan has been conservative, I would say, their growth, because it’s very financially conservative the same way. So a company like Stereotaxis, I mean, the longevity, right? They could go forever. I mean, that’s a multibillion dollar business; the heart ablation treatments alone. Regardless, the Genesis system can do more than that.

But I mean, that area of focus, right, there is multibillion dollar marketplace right now. And they’re the only ones that are using electromagnetic fields to pull a catheter from wherever it goes into your body, maybe in your leg and pull it into your heart, manipulate it remotely through electromagnetic fields, and pull it back out. As opposed to how we normally do catheters. You know, I put it in you, and it’s connected, and we just shove it up and through into your heart and try to, you know, manipulate that from way back on the end of the hose. Yeah, like three feet away. With these electromagnetic systems, it pulls, it’s more accurate, it’s game changing. It’s just completely more precise. It’s safer to patients. When we talk about accuracy, it’s just safer. Humans have a certain amount of manual dexterity, hey, the best surgeon in the world is limited and does not go to the decreased margin of error that these robotic systems can perform.

Steve Symington  18:32

Got me squirming a little bit here.

Simon Erickson  18:36

The question I wanted to ask though, Brian is exactly what I think you’re touching on right there, which is what – I’m not sure how to ask this correctly, but you know, what is driving the adoption for these robots? Right, you’ve got institutional knowledge in the medical community, you’ve got doctors that are used to being laparoscopic surgeons rather than using robotic surgery. I know you come from a medical family yourself.

I mean, is it the data that is driving this? And the hospitals are adopting it? Or is it regulatory groups, or the government like we saw with electronic health records, just kind of shoving it down people’s throats and saying “this is what you need to do now.” What is driving the market at the highest level for robotic surgery higher?

Brian Gahsman  19:19

So any of these companies, whether it’s Accuray, or Stereotaxis, or any of the others, there are years and years of clinical data built up for each of these procedures. So just talking about like, the heart ablation they’re doing, the decade of preclinical data and research and study that has gone in to that and at the same time, they’ve also created these, what are called fellowship programs for doctors. So if a doctor is interested in trying this or at least, you know, touching or learning how to use it before you spend 2 million bucks on a new device for your hospital, a lot of these companies have these fellowship programs where doctors can go in and touch the device, manipulate the device, read the preclinical data, and really learn hands on and then decide, you know, then let the doctor go to the hospital, the administration and say we really have to buy this thing. We have to do this.

But it’s a hands on approach rather than just marketing and trying to sell to the hospitals and doctors they’re marketing by teaching an open forum and teaching these doctors, “hey, would you like to come and take this course and use this instrument?” Well, of course, your doctor, I mean, I’m not a doctor, but I’m nerdy enough I’d sign up for one of those fellowships. But once you know, I think once these doctors go through those programs, they’re hooked. You know, they see and they read the preclinical data, they’ve seen the results and the precision and they’re excited, and they understand how to use these systems. And that’s it. So anyway, that’s kind of the marketing direction that a lot of these companies are using to sell their devices.

Steve Symington  21:26

It’s really interesting. I’ve just kind of been thinking in the background here. Talking about this kind of large company versus small company, you know, this battle, you almost wonder what hope do these up and comers have in challenging sort of the established leaders in their niche? You know, you talk about Intuitive Surgical, you wonder how defensible is. They’ve got this razor and blades model that’s massively profitable. where, like, in a case, like Stereotaxis, I think I was reading that interview you did with their CEO, where you’re talking about how they kind of cleaned up their balance sheet, and they paid off, I think it was 20 million in debt and they only had 2 million in cash on hand, and they’re burning 8 million in cash a year, which isn’t a good position for a company like that. So great from terms of capital allocation and balance sheet, but then you look at a company like Intuitive Surgical that I think last year generated over 1.1 billion in free cash flow and they’ve got over 5 billion in cash on hand.

So how disruptible are the leaders in the space? And how do you kind of determine, like, who in which companies have the potential to potentially, I guess, disrupt them and move around? What is what do you look for there?

Brian Gahsman  22:46

Well, you want to look at R&D spending, you want to look at organic growth. Intuitive Surgical just merged with…I forgot the name of the company right now. But they purchased that healthcare database, you know, the cloud technology system. Which I didn’t really get the synergy there. But regardless, the Da Vinci X has come out, I’ve not heard a whole lot more since. Is there another system that’s going to be coming out? I mean where’s the product development? Where’s the R&D? Or they just have gotten so big that they’re just going to grow through acquisition? I don’t like that. I like organic growth, personally. Not to mention, there are other companies out there just for laparoscopic robotic surgery in general. So the Da Vinci system is expensive. It’s very expensive. And so, you know, there’s other countries besides the US. They have hospitals that can’t necessarily spend 20 million bucks on a surgical robot. And not to mention, like the service contract that goes along with that.

So then you have companies like TransEnterix, right? They also have a laparoscopic surgical robot. They’re not the size of Intuitive. I don’t know that they ever will be. But it doesn’t really matter, because they offer a similar product at a lower cost that’s already being adopted by places that can’t afford Intuitive’ s system. So there’s a marketplace right there. And as this technology advances, and as we talked about 5g earlier, there’s going to be more and more competition. Because it’s just easier to do and the FDA’s learning curve has increased so much on robotics over the past few years, that it doesn’t even take a quarter of the time for them to get approval. So I don’t know. For the big leaders, I would say watch out.

Simon Erickson  24:56

Yeah, and I’ve got to ask one more question since we do have Steve Symington, an AI expert on this call is, are you seeing any role of machine learning in this field? Where today you can actually go and control the surgical robot with a human being? Are those robots now identifying tumors themselves and actually autonomously knowing exactly how to cut within a patient, knowing exactly what to do without human intervention? Are we there yet? Or is that something that’s still years on the horizon, Brian?

Brian Gahsman  25:23

Oh, we’re there. We’re there. If you look at companies, companies like ClearPoint Neuro. I mean, Jin could probably talk to you for 15 minutes about the AI that Accuray is using with their new Cyberknife 7. But, you know, beyond that, even if you look at pharmaceuticals, or biotech drug development, you’ve got companies like BioXcel out there. They’re using AI for multiple pipelines. So we’re talking multi pipeline, like three or four or five or six or ten different products out there in phase two, FDA approval, because their AI systems just allow them to exponentially increase the amount of products that they can literally put out there that they feel are ready. The AI that’s been used in biotech is just as impressive as the AI that’s been used in surgical robotics.

But yeah, I mean, it’s been implemented aggressively by a lot of these companies. So yeah, I would look at you know, look at companies like Accuray and ClearPoint Neuro and BioXcel if you’re interested in researching where AI is becoming involved in this stuff.

Simon Erickson  26:52

Steve, I got some homework for you on those with some of the names that Brian just threw out there AI and robotics. Sounds like a really great combination and definitely an interesting market for investors to be keeping an eye on again. Today, thanks very much to Brian Gahsman, Chief Investment Officer, the Contego Capital Group, but also Portfolio Manager, the Alpha Centric Robotics and Automation Fund. Also thanks to Jin Kwon, an analyst with that team as well. Gentlemen, had a lot of fun. I enjoyed learning about this market from you. Thanks for joining us.

Brian Gahsman  27:18

Thanks. My pleasure.

Simon Erickson  27:21

And on behalf of my colleague, Steve Symington, my name is Simon Erickson. We are here to empower you to invest in your future. We are 7investing!