Seeking Alpha
Long only, deep value, special situations
Profile| Send Message|
( followers)  

Introduction

After the incredible 14 year run where investors saw the price of Intuitive Surgical, Inc. (ISRG) appreciate by nearly 1900% and the recent acquisition of MAKO Surgical Corp. (MAKO) by Stryker Corporation (SYK), investors may be looking for the next big thing in robotic assisted surgery. Mazor Robotics Ltd. (MZOR) may be the company investors are looking for.

Company Profile

Mazor Robotics is an Israel based company, with subsidiaries in the U.S. and Germany, operating in the advanced medical technology sector. It is engaged in the development of robotic, bone-mounted positioning systems for orthopedic procedures. The company's flagship Renaissance system is transforming spine surgery from freehand procedures to highly-accurate, state-of-the-art procedures that raise the standard of care with better clinical outcomes. In addition, the system allows the surgeon to create a virtual, 3D pre-operative blueprint of the procedure. Mazor's goal is to establish Renaissance spine surgery as the standard of care in the eyes of surgeons, patients and medical facilities around the world.

The company initially started its sales efforts overseas and has just started to market and grow its presence in the U.S. As of the first quarter of 2010, Mazor had 10 systems installed internationally and 2 installed in the U.S. As of the second quarter of 2013, there were 29 systems installed in the U.S. and 25 installed internationally. To put this into perspective, in 2012 the company had 5 sales team members and 7 clinical sales representatives in the U.S. and in 2013 these numbers jumped to 11 and 20 respectively with the addition of 3 marketing specialists. Mazor already has systems installed in key Asian countries such as India, Singapore, Vietnam, China, Japan, Korea and Australia.

Clinical studies by The Spine Journal of 3,271 implants in 14 medical centers have shown that the Renaissance system has improved placement accuracy from 90% to 98.3%. Additionally, the robotics guided surgery reduced X-ray dosage, complication rates, number of re-operations and average length of stay in the hospital.

With a system costing over $800,000, a hospital needs to analyze the costs and benefits of owning a Renaissance system. According to Mazor's Investor Presentation, pedicle screws inserted free-hand are misplaced in 10% of cases and major medical complications were reported in 5.2% of fusion procedures. Dr. Roger Smith, Chief Technology Officer of the Florida Nicholson Center, noted that a revisit for a minor complication eliminates all profit from the original surgery. A revisit for a major complication costs three times the profit of the original surgery.

Currently there are no studies validating and quantifying the cost-effectiveness of robotic spine surgery, however a study conducted by Robert Watkins IV, MD, Akash Gupta, MD, and Robert Watkins III, MD, showed an image guided procedure reduced the revision rate to 0% from 3%. Given the average cost of revision surgery was $23,762; this resulted in a cost savings of $71,286 to the institution in the first 100 cases.

The company has a 3-tiered business model. First, the Renaissance robotic system sells for approximately $830,000. One year after the system is deployed Mazor services the system and charges the client a fee of 10% of the purchase price of the system or roughly $83,000 per year. Lastly, the company charges $1,500 for the consumable and disposable items that the system uses during surgery.

Large Addressable Market

With only 56 systems deployed globally and only 4,000 surgeries performed thus far, Mazor owns a very small fraction of the market for robotic surgical systems. The U.S. market for annual surgical robotics is $1.9 billion and is currently dominated by Intuitive Surgical with a 91% market share.

Back pain is one of the most common health issues in the U.S. affecting 80% of the population over their lifetime. According to the National Institute of Neurological Disorders and Stroke it is estimated that Americans spend at least $50 billion on the treatment of lower back pain each year in the U.S. alone. There are over 600,000 back operations a year in the U.S. with approximately 300,000 to 350,000 being spinal fixation surgeries, the primary procedure for the Renaissance system. Given the number of procedures done annually, the market for devices and consumables related to spinal fusion surgeries stands at approximately $4.5 billion.

Competition

There are two different ways to look at Mazor's competition. The company's Renaissance system is currently the only spine assisted surgical system that is FDA approved in the U.S. giving it no direct competition for the exact procedure it assists in. For example, Intuitive Surgical's Da Vinci can assist in a Hysterectomy or prostatectomy among other procedures, MAKO's RIO system assists in knee and hip replacement, Accuray Incorporated's (ARAY) CyberKnife system assists in stereotactic radiosurgery and stereotactic body radiation therapy in cancer patients, and Hansen Medical's (HNSN) systems specialize in catheters and catheter-based technologies. While these companies do not compete in the same area of medicine or procedure, they will compete in the same marketplace and in many instances they will compete directly for a share of a hospital's or medical center's budget. As previously noted, the $1.9 billion U.S. annual robotics market is dominated by Intuitive surgical with a 91% market share. In addition to the competitors previously discussed, Mazor also has to compete with Medtronic (MDT) and Stryker which have positions in the market of image-guided surgical operations. Stryker is also moving into the surgical assisting robotics with its recent acquisition of MAKO.

Although the company has the only system that assists in back surgery, it still has an uphill battle against large players in the medical device industry and the much larger, established and proven Intuitive Surgical. It has also been rumored that both ISRG and MAKO have been developing robotic applications for spinal procedures to compete directly with Mazor's Renaissance system.

Nine Month Financial Review

Mazor announced a review of its financial results for the first nine months of 2013 on November 18, 2013. The company sold 16 Renaissance systems in the first 9 months of 2013 a 33% increase when compared with 12 systems sold in the same period of the prior year. Revenue for the first nine months was $14.3 million a 51% increase from $9.4 million in the first nine months of 2012. Gross margin expanded slightly to 78.6% from 77.2% in the prior year period. Mazor's net loss expanded from $1.9 million in the prior year period to $4.1 million or $0.13 per share in the first nine months of 2013.

Recent Developments

After the company announced its third quarter 2013 results, it announced the sale of three additional Renaissance systems in the fourth quarter. The first sale was to the company's distribution partner Transmedic in Southeast Asia. Transmedic operates primarily in Singapore and Vietnam. The second and third orders came from North America. The second order came from a hospital known for its technological excellence within the Southeast and the third came from the Baptists Medical Center Jacksonville. The Baptist Medical Center order is significant because it is the second Renaissance system they have purchased. This demonstrates that customers are having success with the system in terms of procedures and the cost benefit it provides.

Financial Strength & Current Valuation

The company is currently trading at a market capitalization of approximately $340.0 million and an enterprise value of $280.6 million. The company has current assets of $27.6 million, of which $23.0 million is in cash and cash equivalents, $2.3 million in accounts receivables and $2.3 million in inventory. However, it is important to note that the company's cash position is the result of a recent offering of ADS shares which resulted in gross proceeds of $46.9 million. The main purpose of the equity offering was to provide the company the financial resources necessary to expand sales and marketing initiatives with respect to the company's flagship Renaissance system. With current liabilities at $5.7 million, all of which is accounts payable, the company has a strong current ratio of 5.1. Mazor currently has no long-term debt adding financial flexibility to the company to invest in and fuel future growth. Shareholders' equity as of the last reporting date was $23.1 million equating to a book value of $1.31 per share. At 14.5x, MZOR is trading at the highest price-to-book ratio of all its competitors except MAKO at 14.6x.

While Mazor grew its revenue at over a compound annual growth rate of 110% from 2008 to 2012, at a price-to-sales ratio of 19.7, a lot of future growth may already be priced into the stock. To put this ratio into perspective, ISRG currently trades at a P/S of 6, MAKO was purchased at a P/S ratio of 13.5, ARAY has a P/S ratio of 1.9, and HNSN has a P/S ratio of 10.0.

As is the case with many small capitalization stocks, analyst coverage on the stock is minimal. There are three analysts covering the stock with a mean price target of $21.92 representing an upside of approximately 15.4% from its currently price of $19.00. The highest price target is $23.00 by Barclays.

Future Valuation

While the company currently sports a rich valuation that doesn't mean the stock lacks the potential to reward investors over the long term. For the purpose of estimating Mazor's potential valuation upside, the 10-year revenue growth rate used was from a larger but comparable company, in this case Intuitive Surgical. ISRG's 10-year revenue growth rate stands at 37.5%. The price-to-book ratio of Mazor was also scaled down over the five year period from the current of approximately 20x to 6x, the current P/B of ISRG. Full year 2012 revenues of $12.2 million were used as the starting point to project full year 2013 through 2018 revenues. Using this approach we get a 5-year price forecast of $28.10 representing upside of 47.9% from the current price. While a 9.6% annual return may not seem like a great return for a company in the infant stage in a high growth industry, please note conservative estimates were used in this case. ISRG grew revenues much more quickly in its infancy than 37.5%, and as noted above MZOR is as well. The company grew FY revenues 133.4% in 2009, 191.5% in 2010, 48.6% in 2011, and 106.2% in 2012. In addition, high growth companies such as Mazor, tend to trade at higher multiple for a much longer period of time than many think possible. For example, Intuitive Surgical is down over 26% year-to-date. At its peak early this year, and also being a more mature company, traded at a P/B of approximately 10.

(click to enlarge)

Summary

Positive Catalysts

  1. Other players in the medical robotics field have paved the way and made hospitals more open to robotic assisted surgery which may lead to a faster adoption rate of the Renaissance system
  2. Expected launch of brain surgery robotic system in the first half of 2014
  3. Large addressable market
  4. Huge switching costs and barriers to competitors' entry once established
  5. Future technology may address cost reduction in spine surgery and generate better clinical results.
  6. Presence in emerging markets
  7. As a specialized player Mazor can easily become an acquisition target
  8. Grow from a net loss to positive net income

Risks

  1. Short term growth already priced into stock at current valuation
  2. Revenue may be inconsistent
  3. Being so new there is a lack of evidence for this technology supporting the case of better clinical outcomes or cost-effectiveness
  4. There are becoming more players in medical robotics market

Conclusion

If you are looking for a medical robotics company to invest in after MAKO's acquisition and Intuitive Surgical's recent weakness, Mazor Robotics deserves serious consideration. Significant risks and challenges remain in gaining widespread adoption of its Renaissance system and will lead to a volatile ride in this stock. After a recent run-up in the company's stock over the past couple of days it may be worthwhile to wait for a correction to initiate a position, however, if management can continue to grow sales as quickly as they have, the stock will prove extremely profitable to investors in the long term regardless.

Source: Mazor Robotics: The Medical Renaissance Is Underway