Small Caps Could Gain On Medtronic's Pain

by: Ian Cassel

Medtronic’s (NYSE:MDT) issues with INFUSE has been well documented in most financial publications. INFUSE contains recombinant human bone morphogenetic protein (rhBMP-2), which is basically a modified/engineered version of a natural occurring protein we all have in our bodies that initiates bone growth. Medtronic’s INFUSE was approved in 2002 by the FDA for spinal fusions and quickly turned into a blockbuster for the company. In just 4 years (2006), BMP-2 was used in over 25% of all spinal fusions. Today, INFUSE is estimated to contribute ~$750 million in annual revenue to Medtronic.

Problems surrounding INFUSE started a few years ago. The issues weren’t that the product didn’t work, it was actually quite the opposite. The product worked so well for spine fusions that surgeons started using it off-label, such as for neck procedures etc. It is said that the ratio of off-label to on-label use of INFUSE is somewhere between 3:1 and 4:1. Medtronic was also blamed for aggressive marketing techniques to promote off-label use. You can understand that this type of thing must drive the FDA bonkers.

It doesn’t take a rocket scientist to figure out that a product that regrows about anything it touches being used off-label is a PR nightmare. The negative buzz hit a new high this summer when the Spine Journal outlined several problems with peer-reviewed articles by company-backed doctors. It found that as many as 13 studies downplayed or left out safety risks of using INFUSE. Recently, Becker’s Orthopedic: Spine & Pain Management Review, interviewed 10 spine surgeons to see if their opinions/use of INFUSE have changed.

It isn’t too farfetched to think that INFUSE sales/market share might start to decline as surgeons look at comparable alternatives. As a micro-small cap investor, I’m interested in looking at “smaller” companies that could gain significant traction due to Medtronic’s INFUSE woes. Many of these companies could also be takeout targets by Medtronic or one of their large competitors.

Bacterin International (BONE), $90m Market Cap, Current PPS $2.30: Bacterin International uses proprietary methods in human allografts to create stem cell scaffolds to promote bone growth, subchondral repair, and dermal growth. The Company also develops and manufactures antimicrobial coatings to prevent infection from implanted devices. Bacterin’s core product, OsteoSponge (1/3 the price of INFUSE), has shown to be equivalent to INFUSE in 12-month data, and 24-month data is set to be released over the coming weeks. Bacterin has grown revenue from $7m in 2009, $15m 2010, Guidance of $30m+ 2011, and $52m+ for 2012. Bacterin is the fastest growing micro-small cap on this list. Two Analysts cover BONE with an average price target of $4.75. [Company Presentation]

BioMimetic Therapeutics (NASDAQ:BMTI), $85m Market Cap, Current PPS $3.00: BioMimetic specializes in the development and commercialization of clinically proven products to promote the healing of musculoskeletal injuries and diseases, including therapies for orthopedic and sports medicine applications. All Augment branded products are based upon recombinant human platelet-derived growth factor (rhPDGF-BB), which is an engineered form of PDGF, one of the body's principal agents to stimulate and direct healing and regeneration. Augment looks to be the first new pure rh protein therapeutic to come to market in nearly a decade. Recently, BioMimetic Therapeutics officials said they haven't yet heard back from the Food and Drug Administration about the hurdles they'll have to clear to bring the anticipated Augement Bone Graft product to the U.S. market. BMTI is a “pre-revenue” company but does have $68 million in cash and short-term investments to wait out product approval. Four Analysts cover BMTI with an average price target of $10.75. [Company Presentation]

Exactech (NASDAQ:EXAC), $185m Market Cap, Current PPS $14.00: Exactech develops and markets orthopaedic implant devices, related surgical instruments and biologic materials and services to hospitals and physicians. The company manufactures many of its orthopaedic devices at its facility in Gainesville. Exactech’s orthopaedic products are used in the restoration of bones and joints that have deteriorated as a result of injury or diseases such as arthritis. Exactech is profitable and expected to grow FY2011 sales by ~7-10% ($203m-208m) over FY 2010 ($190m). Analysts expect the company to earn $1.11 for FY 2011, and $1.21 FY 2012. Four Analysts cover EXAC with an average price target of $23.20. [Company Presentation]

Wright Medical Group (NASDAQ:WMGI), $675m Market Cap, Current PPS $17.50: Wright has been in business for more than 50 years and has approximately 1,000 employees. WMGI is a global orthopaedic medical device company specializing in the design, manufacture, and marketing of reconstructive joint devices and biologics. Wright's product offerings include large joint implants for the hip and knee; extremity implants for the hand, elbow, shoulder, foot and ankle; and both synthetic and tissue-based bone graft substitute materials. Wright Medical recently reiterated FY2011 guidance of $517-535m in revenue (up 0-3% from FY2010), and adjusted earnings per share of $0.89-0.97 (up 0-8% from FY 2010). Thirteen Analysts cover WMGI with an average price target of $17.60. [Company Presentation]

RTI Biologics (NASDAQ:RTIX), $200m Market Cap, Current PPS $3.60: RTIX provides tissue-based innovations that repair and support the natural healing of human bone and tissues. RTIX prepares human donated tissue and bovine tissue for transplantation through extensive testing and screening and using proprietary processes. These allograft and xenograft implants are used in orthopedic, dental and other specialty surgeries. The company expects FY2011 revenue of $164 million to $166 million (Flat from FY 2010), and expected to earn 0.12 – 0.14 EPS for FY 2011 (up from 0.10 EPS FY 2010). Seven Analysts cover RTIX with an average price target of $4.63. [Company Presentation - pdf]

Synovis Life Technologies (NASDAQ:SYNO), $200m Market Cap, Current PPS $17.20: Synovis develops, manufactures and markets biological and mechanical products used by several surgical specialties to facilitate the repair and reconstruction of soft tissue damaged or destroyed by disease or injury. The company’s products include implantable biomaterials for soft tissue repair, devices for microsurgery and surgical tools. Analysts expect the company to have revenue of $81m for FY 2011 (up 19% from $68m FY 2010), and earnings of $0.67 (up from $0.43 EPS for FY 2010). The company also has almost $60 million in cash and short-term investments on the balance sheet. SYNO has been a serial “performer” growing ~20% per year for several years. Five Analysts cover SYNO with an average price target of $23.17. [Company Presentation]

Alphatech Holdings (NASDAQ:ATEC), $180m Market Cap, Current PPS $2.10: Alphatec Spine is a medical device company that designs, develops, manufactures and markets a full line of spinal implants and surgical instruments. The company has given FY2011 revenue guidance of $195-205m (up ~20% from $171m FY 2010), and adjusted EBITDA of $22 – 25m for FY 2011. Six Analysts cover ATEC with an average price target of $3.72. [Company Presentation - pdf ]

Medtronic (MDT), Shire (SHPGY), Johnson & Johnson (NYSE:JNJ), Merck (NYSE:MRK), Baxter (NYSE:BAX), and NuVasive (NASDAQ:NUVA) have all been active via M&A in the space. Prices paid on average were around 4-5x TTM Sales (low 2/High 9x Sales) for small-cap growth companies. Potential acquirers are looking to fill potential voids in their product pipelines while also acquiring “growth” for their underlying businesses.

Disclosure: I am long BONE, SYNO.