During our fourth quarter portfolio update, we profiled portfolio holding, Masimo (MASI). Below is a replay of our live commentary on the company from our quarterly portfolio update WEBINAR and an excerpt from our QUARTERLY LETTER.

Masimo

2022 was a wild year for Masimo – and that’s saying something given the concurrent volatility in the market at large. In February, Masimo announced it was acquiring a consumer audio holding company called Sound United, which owns higher-end audio brands like Polk, Denon, and Bowers & Wilkins. The deal price was for $1.025 billion, but the stock dropped 37%, representing nearly $5 billion in market value, on the day after the announcement. The amplitude of the drop relative to the deal value suggested investor revulsion that went far beyond the acquisition itself.

At first glance, we were also puzzled by the company’s decision to acquire Sound United. In particular, we were disappointed by the way the deal – by far the largest in Masimo history and a departure from its stated M&A strategy – was communicated to shareholders. For example, Masimo did not hold a separate conference call with investors to specifically discuss the deal and instead combined it with its routine fourth quarter earnings conference call, which greatly limited the time that analysts had to ask questions and diminished what was otherwise a strong quarter for the core healthcare business. Compounding the problem, Masimo’s founder/CEO Joe Kiani told investors he was an “audiophile,” which raised concerns about this being a pet project, and management declined to answer certain questions due to stated worries about potentially tipping off competitors.

We spoke directly with management after the conference call, where we communicated our concerns and shared our feedback about poor investor communications.

 

Having owned Masimo for three years prior to the deal being announced, we had conviction in our fair value estimate for the legacy healthcare business and thought the post-acquisition share price significantly discounted that valuable franchise. While the plunging stock price was hard to take and it would have been emotionally easier for us to exit the stock, the discounted price was already the new reality, and it was our job to freshly evaluate the opportunity as it was now presented. The discounted share price provided us time to learn more about Masimo’s strategy and give them time to develop products with Sound United, some of which we were able to see at Masimo’s much-awaited investor day in December at company headquarters.

In August, an activist investor, Politan Capital, acquired a nearly 9% stake in Masimo, and though we have no comment on the merits of Politan’s strategy, we do believe their interest in Masimo aligns with our own take that the current market price dramatically undervalues Masimo’s core health franchise.

Looking back at a blog post we wrote in November 2019, we wrote that “Masimo is a technology company pursuing better solutions in the healthcare industry, rather than a healthcare company using technology as an avenue for higher-priced solutions.” We continue to believe this is the correct way to view Masimo rather than as a “healthcare” company. It’s an engineering-first culture that happened to solve difficult problems in the healthcare industry and developed expertise in the field, including regulatory and R&D know-how.

Masimo’s motivation for the Sound United deal is clearer when viewed through this lens, as there are a number of markets where highly accurate non-invasive sensors can be used to improve lives. One of the ways in which Masimo might achieve this is through remote patient monitoring using its W1 Watch. In March 2020, when hospitals were overrun and struggling to triage COVID patients, Masimo came up with a solution to remotely monitor patients with medical-grade sensors that within weeks received emergency FDA approval. By February 2021, Masimo SafetyNet technology was deployed to 200 hospitals to keep track of patients at home who were not critical enough to be admitted, while keeping hospital beds reserved for the most ill patients. In October 2020, Masimo shared that an additional 2,000 hospitals were evaluating the product. The stressful rush on hospitals was relatively short-lived, thankfully, but provided a high profile use-case for monitoring patients outside of the hospital setting.

Masimo’s W1 Watch is focused on medical-grade health monitoring and there are no apps or frills as found in competing “wellness” focused smartwatches. During the investor day, Masimo shared data showing its W1 Watch caught every adverse medical event tested during a patient’s sleep cycle while the Apple Watch only caught between 6% and 7%. If you wear a watch designed to alert you and your medical team to life-threatening episodes, your watch cannot miss true alarms, nor can it produce many false alarms. The former could be catastrophic, and the latter would make the device unusable as false alarms would cause undue stress and greatly reduce doctor-patient confidence in the product.

The opportunity for continuous and remote patient monitoring is massive. From the hospital point of view, many hospitals are losing money with each Medicare/Medicaid patient and need to find ways to reduce per patient costs. Being able to confidently send patients home and monitor their progress in that setting could help hospital systems save money and help patients recover more quickly. Additionally, hospitals are penalized by Medicare/Medicaid when patients are readmitted within 30 days of discharge with the same ailment. There’s clear monetary motivation for hospitals, in appropriate circumstances, to monitor patients at home rather than in the hospital setting.

From the patient point of view, recovering at home is generally preferable to recovering in the hospital and also reduces the risk of catching viruses and infections. Patients are also often nervous about being sent home, worried about adverse scenarios occurring away from medical care. Medical-grade monitoring can help reassure recently discharged patients and those with chronic conditions like COPD and congestive heart failure and reduce the impulse to rush to the emergency room.

Masimo has submitted 510k approval for the W1 Watch with the FDA. The W1 is available today and can currently be used to share live medical data with your doctor through printed reports or with loved ones concerned about your health.

We were pleased to see that Masimo is further leveraging its Sound United acquisition by enabling W1 Watch users to plug into Denon’s HEOS connectivity technology, which connects user data to Masimo’s HIPPA-compliant cloud. In other words, if you have a Denon speaker with HEOS in your home, it’s another way beyond your smartphone to get your health data to the cloud. Like a “Trojan horse” of sorts, Masimo announced at the investor day that they are turning on this functionality to 4 million households with Denon speakers in 2023 with more to come in 2024.

As more people “age in place” or spend their retirement years at home, the more they will rely on at-home health services. A benefit of the Sound United deal is that there’s a network of professional independent contractors who install home audio equipment made by Sound United’s brands. It does not seem a stretch to imagine that these contractors can also install remote medical monitoring in people’s homes.

While it remains to be seen if Masimo can properly commercialize the opportunities and profitably take share in the much larger total addressable markets it acquired with Sound United, we continue to have confidence that management remains authentically committed to improving patient outcomes and reducing costs through the use of superior non-invasive sensors and products.

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