Most Americans suffer back pain at some point in their life. Luckily, the majority of cases need little more than rest or physical therapy. For the minority, however, chronic back pain requires surgery. And, NuVasive (NUVA), a fast growing provider of products to the spine fusion industry, is betting its minimally invasive approach will garner a greater share of sales over the coming years.
NuVasive is a little company with its fair share of risks. It operates against some tough competitors including Medtronic (MDT), a goliath in the spine fusion business. In fact, in 2008, Medtronic filed a patent infringement lawsuit against NuVasive, which in turn counter-sued. The lawsuit has kept potential acquirers at bay, creating an overhang, which has weighed on the stock price. The legal battle comes to a head this August, when the first patent case is heard.
Alongside the legal wrangling, the insurance industry dealt NuVasive two blows in 2009 when it chose to label its lateral spine surgery approach as experimental and tightened spine fusion surgery requirements in a push-back against steep costs. To top it off, a weakening economy did its fair share to slowdown demand as patients opted to live with pain rather than part with money amid a tough job market. Investors suffered significantly as the stock fell from a peak of $58 in 2008 to a low of $22 in 2010.
Despite the risks, however, there's a lot to like about NuVasive. Its products are innovative and gaining share in a lucrative and growing industry. The economy is rebounding, which is good for utilization, and insurers have reversed course and are reimbursing lateral procedures.
From 2002 through 2008, spine fusion surgeries doubled to 413,000, according to the federal Healthcare Cost and Utilization Project. And in 2011, there may be as many as 453,000 such procedures, according to the Millennium Research Group. While spinal fusion is far from a sure fire remedy, some 41% of patients still benefit by experiencing less pain following the procedure, according to a 2007 study in Spine.
There's also a lot of running room for NuVasive, which has been steadily chipping away at Medtronic's market share. The introduction of NuVasive's XLIF instruments and equipment, including a nerve-monitoring device, alongside aggressive marketing, has won over many surgeons.
The company now boasts 7% share in a $4.9 billion market expected to grow to $12 billion by 2020. And the market for minimally invasive spine surgeries - NuVasive's sweet spot - is expected to rise to $7.9 billion from $1.7 billion this year, according to the company.
Two trends are driving industry growth: Obesity and an ever-growing population. A bigger waistline is putting more pressure on the spine, causing more cases of degenerative disc disease and prompting more people to seek out surgical solutions. And that means sales and profit upside for related instrument suppliers like NuVasive.
In the past, surgeons operated on the spine from the front or rear of the body, muscle-laden areas which make for longer recovery periods. NuVasive products, however, are designed for lateral procedures. By targeting the side of the body, surgeons are able to reduce recovery times using minimally invasive techniques. This not only speeds recovery but also helps reduce complications. Surgeons like the quick turnaround, hospitals like the drop in complications and NuVasive benefits from higher sales.
Where NuVasive makes the lion's share of its revenue is from selling disposables and implants used in procedures. They loan the costly equipment for free to surgeons, who in turn buy necessary instruments.
This revenue model has proven effective. In 2010, NuVasive's sales rose 30% to $478 million, ahead of $470-$475 million guidance. And this year, the company is targeting sales of $530-$540 million. Last quarter, NuVasive's sales rose 14% while operating margins rose to 13.3%. And, the company expects operating margins to move even higher this year, reaching 17.5% (non-GAAP). Of the company's $124.4 million in revenue last quarter, $101.9 million came from spine surgery products and another $22.5 million came from biologics, which speed bone healing and development in fusion procedures.
Additionally, the company is expanding up and down the spine, hoping to capture even greater opportunities. It has launched cervical products and continues to invest in biologics. The company also has upside opportunity abroad, where it expects revenue to double to 8% of total sales this year.
NuVasive has a solid cash position, with $4.86 per share on its books. It has also beaten analyst forecasts in each of the past four quarters, prompting the Street to increase its 2012 estimate to $1.43 per share from $1.35 60 days ago. Short sellers remain overly pessimistic, worried over Medtronic's patent suit and future cost pushback from insurers. Currently, there are 7.6 days to cover short in the stock.
Given the industry is heavily tied into the surgical community, spinal fusion isn't going away anytime soon, particularly given the amount of money on the line. This suggests NuVasive investors can benefit from picking up a stock trading well off its multi-year highs with double-digit revenue and earnings growth. Any clarity into a settlement with Medtronic adds upside and will likely force shorts to cover positions.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NUVA, MDT over the next 72 hours.