Citing multi-billion-dollar market opportunities, a "tried and true" patent portfolio and a strong platform technology, BMO Capital Markets (New York) initiated coverage Tuesday of Masimo (Irvine, California) with a $44 price target.

Masimo makes devices for the non-invasive measurement of pulse rate, arterial oxygen saturation and other blood constituents such as carbon monoxide levels and total hemoglobin. The company went public last August.

BMO med-tech analyst Joanne Wuensch told investors during a conference call yesterday that Masimo is one of the more unique companies that BMO has run across in medical technology.

"If anyone has been in the hospital, or knows somebody who has been in the hospital lately, you will notice that the patient will have on a sensor usually on the finger, sometimes on a toe or a ear lobe to help monitor blood oxygenation level ... . it is fairly dominating in the hospital," Wuensch said.

"What Masimo did," she said, was to create "a better mousetrap. They created filtering algorithms, which allowed for a more direct and clean, if you will, read of the pulse oximetry signal so that the patient could be read continuously, non-invasively if the patient happens to be being moved, if the patient happens to have a cold and be shaking, so it is clearly a better mouse trap.

"What's also interesting is the technology can be applied to multiple applications. So while the first application was pulse oximetry, it has added since then other measurements, such as carbon monoxide or carboxyhemoglobin or methemoglobin."

Wuensch cited Masimo's "huge" market opportunities as another decider in BMO's decision to initiate coverage of Masimo. She said that the company's Signal Extraction Technology (SET), introduced in 1995, addresses many of the limitations of conventional pulse oximetry devices, tapping the $1 billion worldwide pulse oximetry market, which BMO said is growing 6% to 8% a year.

Masimo's technology began to expand in 2005, BMO noted, with the introduction of the measurement carboxyhemoglobin, methemoglobin in 2006, pleth variability index last year, and with total hemoglobin in March.

Frost & Sullivan has estimated that Masimo shipped 38% of the pulse oximetry systems into the U.S. market in 2006. Based on the company's growth rates, BMO estimates its share of annual U.S. shipments is now well into the 40% range and increasing.

"This is a tried and true patent portfolio," Wuensch said.

Masimo holds more than 444 patents in that portfolio, which has been extensively tested against Nellcor/Tyco (now Covidien [Hamilton, Bermuda]), Wuensch said.

She noted the companies' settlement of patent litigation in January 2006 that resulted in Covidien paying $263 million and royalties to Masimo through March 2011. Covidien agreed to pay Masimo a royalty equal to 20% of its U.S. pulse oximetry sales in 2006 ($69.2 million) and 15% in 2007 ($56.6 million), and that it will continue to pay about 13% at least through March 14, 2011, according to BMO.

Wuensch said Masimo is using the money from Covidien to ramp up its direct sales effort.

The market opportunity for Masimo's products is expected to increase over the fairly near term from about $1 billion in 2007 to about $4 billion in 2010, Wuensch estimated.

In 3Q09, Masimo is expected to launch another measurement, BMO said, this time for acoustic respiration monitoring (ARM).

"The ARM technology measures patient respiration, an important feature for the general floor of the hospital, an area that is estimated to have 450,000 beds, creating an incremental $1-billion opportunity to Masimo, assuming it taps only a quarter of the beds in the U.S. alone," Wuensch said in a research report.

"[Masimo] is a unique franchise within our medical technology universe, with a platform technology, a tried and proven patent portfolio, and new market opportunities knocking on its door," Wuensch said in the note. "As such, we would argue that it should receive a premium multiple, and it has."

Applying a forward P/E multiple of 50x leads to a price target of $40, she said. In a similar vein, using an EV/revenue multiple of 7x on 2009 revenue leads to a price target of $43, she noted. Finally, BMO conducted a DCF analysis, resulting in a price target of $47.

Triangulating these methodologies and their results, "we arrive at a $44 price target, or 21.6% upside," Wuensch said.