The outlook for the global spine surgery devices market has improved significantly over the last few months. In 2012 and the first half of 2013, spine surgical device makers had experienced a temporary pricing pressure and reimbursement challenges. Although the reimbursement challenges still remain, technological advancements coupled with an ageing population are causing a tremendous turnaround of this market, which was previously expected to grow at a CAGR of 5.1% over the next four years and reach $14.8 billion by 2017.
Alphatec Spine, a wholly-owned subsidiary of Alphatec Holdings (ATEC), is a small but growing player in spine surgery market with a market cap of just $212 million. I believe that Alphatec Spine could be a great investment idea for 2014, when the overall stock market has rallied a lot and it's hard to find compelling growth opportunities. For investing in this growth story, you've to buy the shares of Alphatec Holdings (hereinafter referred to as Alphatec, ATEC, or the company), the parent company of Alphatec Spine.
Alphatec witnessed a small bull market of its own in 2009-10 when the stock crossed $7. Since the second half of 2010, the stock has been consolidating in a narrow range and I think this year it could see a sharp up move with a meaningful upside.
Alphatec develops and markets surgical instruments for spine disorders in the United States and abroad. The company has a robust portfolio consisting of products for the cervical, thoracolumbar, and inter-vertebral regions of the spine. It has numerous products in its existing portfolio, amongst which the following products generate most of its revenues:
- ATEC's new Pegasus anchored cervical interbody system, which features a single step delivery of a spacer with an integrated anchoring mechanism, provides a simplified approach to traditional ACDF (anterior cervical discectomy and fusion).
- In its thoracolumbar fixation product-line, the Zodiac spinal fixation system offers comprehensive spinal fusion solution towards the treatment of degenerative disc disease, spine trauma and deformity. Zodiac can be connected with the company's Solanas cervico-thoracic posterior fixation system, which offers a comprehensive array of implants and instrumentation.
- In the minimally invasive spine surgery marketplace, Alphatec's ILLICO MIS posterior fixation system offers a broad selection of screw/rod delivery instruments and implants designed to treat disorders in the thoracic and lumbar spine. It is specifically designed to deliver Zodiac cannulated polyaxial screws and pre-cut, pre-bent rods through the ILLICO Retractor.
- ATEC also offers innovative interbody solutions, such as Solus that provides an industry leading product on spinal column stability for internal fixation ALIF (anterior lumbar interbody fusion) devices.
- In biologics, Alphatec's NEXoss nanostructure bioactive matrix is an innovative bioactive scaffold for bone grafting.
Can Alphatec Become the Market Leader in Spine Surgery?
The company seeks to become the market leader in spine surgery. It aims to provide solutions for various spine disorders by the development of new products and the enhancement of existing products. In this article I will try to gauge ATEC's revenue growth potential in the spine surgery market.
There are four major categories of spine disorders: degenerative conditions, deformities, trauma-based disorders and tumors. Although ATEC's product offering addresses all the four categories, the majority of the company's business is concentrated on products used in the treatment of degenerative and deformity conditions, which can create pressure on the nerve roots causing back pain and pain in the arms or legs.
According to Millennium Research Group ("MRG"), the global authority on medical technology market intelligence, despite some significant downward pressures, the United States market for minimally invasive ("MI") spine technologies will grow strongly, reaching nearly $2 billion by 2017. Most of this growth will come from expansion of the largest segment, the minimally invasive spinal fusion market, but the less mature facet fixation segment will also experience significant revenue growth.
I believe that Alphatec's two new minimally invasive FDA-approved products - Pegasus (spinal fusion) and ILLICO FS Facet Fixation System (facet fixation) - have the potential to help it gain significant market share and stand apart from competitors.
Pegasus: As I said above, Pegasus is an anchored, anterior cervical interbody device used in ACDF, which offers single-step deployment of the anchoring blades without the need for impaction. Anterior cervical discectomy and fusion or ACDF is a type of cervical spine surgery from the front (anterior) of the neck (cervical) for treating degenerative disc diseases like spondylosis and cervical trauma including flexion-distraction injuries. The neck, or cervical spine, consists of seven vertebrae (C1-C7). ACDF removes the damaged disc and then grows bone between the vertebrae above and below. To prevent the vertebrae from collapsing and to increase stability, the open space is often filled with bone graft. The slow process of the bone graft joining the vertebrae together is called fusion.
Image Courtesy: Wikipedia
ACDF is generally performed using an anterior cervical plate, such as the NuVasive's (NUVA) Helix and Gradient Plus Anterior Cervical Plate systems or Globus Medical's (GMED) COALITION integrated plate and spacer system. However, to avoid potential issues associated with dissection and traditional instrumentation, ACDF is increasingly performed using standalone cervical interbody fixation devices, such as Alphatec's Pegasus, Stryker's (SYK) AVS Anchor-C, NuVasive's CoRoent Small Interlock, Globus' COLONIAL, or Medtronic's (MDT) PEEK Prevail devices.
The anchored spacers of Pegasus or AVS Anchor-C provide a similar biomechanical stability to that of the traditional anterior fusion technique using an anterior plate plus cage, such as COALITION or Helix and Gradient Plus Anterior Cervical Plate systems, but have a potentially lower perioperative and postoperative morbidity. Moreover, Alphatec's Pegasus helps surgeons providing a simplified single-step delivery of a spacer, compared to other interbody fixation devices. I think this competitive edge of Pegasus would make it the most widely used interbody fixation device in near future.
ACDF being an anterior approach leads to less muscle stripping from the spine compared to a posterior approach and helps surgeons perform a clear and uncomplicated operative procedure. Since ACDF allows good access to the discs at the front of the spine, patients tend to have less pain from incision. However, there are some risks associated with using interbody devices in ACDF, such as disassembly, bending, and/or breakage of any or all of the components of the device. Moreover, pressure on the skin from the device often causes skin penetration, irritation, and/or pain, tissue or nerve damage and scar formation. These risks can cause less than expected adoption of Alphatec's Pegasus and other interbody devices.
ILLICO FS Facet Fixation System: Facet fixation systems help spine surgeons achieve rigid fixation and compression of facet joints with or without bone graft, the joints that link vertebrae together and give the spine its flexibility. The ILLICO FS facet fixation system is a new MIS system that enables spine surgeons to immobilize and stabilize spinal segments without the need for pedicle screw and rod constructs. Although biomechanical testing showed no significant differences in fixation or stability between facet fixation systems and conventional pedicle screws when used to augment lateral interbody fusion, I believe that since facet fixation is a minimally invasive technique, its application is bound to grow over time.
ILLICO FS primarily competes with VIPER F2 by DePuy Spine, a unit of Johnson & Johnson (JNJ), and ANCHOR FS by Medtronic. VIPER F2 consists of large diameter lag screws that are inserted bilaterally through the superior side of the facet, across the facet joint and into the inferior pedicle. Polyaxial rings are available to increase the load bearing area of the screw that is in contact with the bone. The ANCHOR FS, which employs a similar technology, is a minimally invasive posterior screw system used in the lumbar region of the spine. Amedica, a company that sells a broad range of medical devices, has also developed a facet fixation system that works with a smaller incision than traditional interbody fusion procedures. The company plans to raise $35 million by an initial public offering of 3.2 million shares at a price range of $10 to $12. A few days ago Amedica announced the terms for its IPO.
ILLICO FS is one of the fastest facet screws to implant, compared to most of its competitors. Its dual lead thread doubles translation for each 360º rotation making it two times faster to implant, saving clinician time and patient exposure. I believe that ILLICO FS has the potential to grab a significant market share from its peers.
Currently ATEC is hovering around $2.20. Since the company hasn't yet posted a profit, it's not possible to value the company based on trailing 12-month P/E. However, in terms of Price to Sales the company is trading at 1x, a dirt-cheap valuation relative to its peers and the industry average of 2.9x.
In terms of Price to Book, Alphatec is trading below 1x, and at a significant discount compared to peers. Since the company is not profitable yet and has a net long-term debt of $30 million, it's available at such a discount. However, I don't believe that the discount will prevail for a long time because it's a matter of time ATEC will turn profitable. Moreover, the debt level is not very alarming.
I expect that the company's revenue will grow at least at a CAGR of 25% for the next three to five years and reach close to $390 million from today's $200 million by the end of 2016, three years from now, because the company has developed some extraordinary products in the filed of spine surgery. Moreover, market outlook for spine surgery has also improved considerably driven by an aging population and technological advancement. The company achieved a four-fold revenue growth between 2009 and 2012, which was even more impressive. However, during that time the company failed to register profit and the stock nosedived from above $7 to below $2.
A rough estimate of ATEC's share price: If a gross margin of 60% (the company's five-year historical average) is applied on ATEC's $390 million estimated revenue figure for 2016, I get its gross profit of $234 million. I believe that the company's operating expenses won't rise more than 20% from the current level around $150 million, which leads to an operating expense of approximately $180 million and an operating income of approximately $54 million. Operating income already has the impact of depreciation and amortization expense factored into it. For simplicity's sake, I assume that the sum of depreciation and amortization is nil. Since EBITDA is basically operating income plus depreciation and amortization, I get ATEC's 2016 EBITDA of $54 million. Applying a conservative EV/EBITDA of 15x (NUVA trades at an EV/EBITDA of ~25x, GMED and SYK at ~18x) I get ATEC's EV of $810 million. Subtracting an assumed debt of $60 million (double from today's level) I get the company's market cap of $750 million or share price of $7.70 (with 97.45 million shares outstanding). At $7.70, ATEC will trade at a Price to Sales of 3.6x and at a Price to Book of 3.3x, which I think is quite reasonable given its growth prospects and the improved market outlook in which it operates.
According to the American Academy of Orthopedic Surgeons ("AAOS"), about 300,000 Americans have spinal fusion surgery each year. This implies that the chance of ATEC to grow is enormous. Apart from the United States, Japan continues to represent the company's largest international business driven by its ILLICO minimally invasive product and other novel interbody devices. In the third quarter of 2013 Japan grew 21% on a constant currency basis year-over-year. The stock is certainly a "buy" at the current price.