This May Be the Next Great Growth Opportunity

Follow Jason on Twitter.

Pulse oximetry may sound like the headliner at the 9:30 Club last Saturday night, but in fact it's serious business. It's a non-invasive method allowing the continuous measurement of arterial oxygen in the blood and pulse rate. Low oxygen levels in the blood, better known as hypoxemia, can lead to brain damage and even death in a matter of minutes.

Now do I have your attention?

The company
Masimo (Nasdsaq: MASI) is setting the gold standard in noninvasive patient-monitoring technologies. And with a successful IPO back in 2007 now under the company's belt, the focus is on innovation and growth.

As an example, Masimo's products monitor a patient's blood before invasive procedures and check for things like oxygenation levels of the hemoglobin (the part of blood that carries oxygen to the body's cells) and even carbon monoxide levels when necessary. And as the company branches out with more innovative technology, it continues to grow its footprint around the globe.

Lemme tell you what I like
Setting standards: Masimo is blazing trails for the pulse oximetry market in signal processing and sensor technologies. Its noninvasive blood-monitoring solutions continue to be adopted as they overcome the many limitations of conventional pulse oximetry, including inaccurate measurements resulting from patient movement, interference from electrical surgical equipment, and low perfusion (arterial blood flow), to name a few. In fact, more than 100 independent studies show that it outperforms other pulse oximeters.

Still growing: Today, the pulse oximetry market is estimated at $1.2 billion globally, and Masimo's core razor-and-blade business model means that the more hospitals it gets its equipment (razors) into, the more consumables (blades) it will continue to sell. Pulse oximetry is becoming the standard in critical-care markets; however, management also sees a major opportunity in general care, which could potentially double the market (or more) for the company's proprietary technology.

Follow the leader: I love putting money behind leaders that make things happen, and founder and CEO Joe Kiani is making it happen. Here is a man who immigrated to the United States from Iran as a child and started Masimo in 1989 as a private "garage start-up" in his quest to "solve unsolvable problems." He owns a considerable chunk of the company (more than 7% of shares outstanding), and he's been taking on the health-care industry's group purchasing organizations for years now as an advocate of smaller device makers and winning. The bottom line is that Kiani is not only an innovator, but he's also a fighter -- qualities I love to see in leaders.

Why it could malfunction
Copycats: Although Masimo's consumables (sensors) are proprietary technology, they have been victim to knockoffs in the past that don't perform. So the ding to the bottom line from selling fewer consumables along with the reputational risk exists. But the X-Cal technology inside the company's reusable systems is now being incorporated into its consumables as well. With specific serial numbers and special encryption built in, this should help the company defend its technology.

Big bullies: Masimo's $1.3 billion market cap is quite small compared with competitor Covidien's (NYS: COV) $23 billion. The two are the major players in this market, but Covidien's size alone can give the company an advantage, particularly when dealing with the group purchasing organizations that Kiani has done battle with before.

Lackluster conditions: iData estimates that Masimo has about 32% of the total U.S. sensor market, but management noted on the most recent earnings call that concerns over health-care legislation, reimbursement rates, and overall economic conditions still present many challenges for the company's immediate future. Medicare and Medicaid are one issue, but Masimo also collects from big private insurers such as UnitedHealth Group (NYS: UNH) , so insurers certainly hold some of the cards here. I'll be keeping my eye on receivables and inventory turn to make sure they're making sales and getting paid.

Making cents of it
Coming up with realistic growth-rate assumptions for a young company like this is tough. Since 2006, Masimo has grown revenue at an annual rate of about 16%. Management believes that the company can still grow the top line at a 20% clip or better for the foreseeable future -- a bit optimistic for me in today's climate. However, the vertical integration initiatives that management is working on today should improve already double-digit net margins down the road, and today's price implies that we're getting the stock for about 16 times 2012 earnings estimates. I started looking at the stock back in April at around $34, which was too rich for my blood then. But the price has pulled back a bit, thanks in part to an FDA-related delay that led management to guide toward the low end of revenue expectations. The balance sheet, with $125 million in cash and no debt, tells me the company is in good financial shape, and I think the long-term growth opportunity here is too great to pass up.

The Foolish bottom line
In some ways this is a David-versus-Goliath story, with the small device maker going up against the big boys. But even though Masimo is smaller, its technology is packing a major punch. My impression of Kiani is that he intends on shaping the industry for years to come, so I'm allocating $750 in my Rising Stars portfolio and pulling up a seat to watch this story play out. Be sure to swing by my discussion board and let me know what you think.

At the time thisarticle was published Motley Fool Stock Advisor analyst Jason Moser owns no shares of any companies mentioned. The Motley Fool owns shares of UnitedHealth Group. Motley Fool newsletter services have recommended buying shares of Covidien and UnitedHealth Group and creating a diagonal call position in UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.