Spine Surgery Devices - A Growing Market With Exciting Opportunities For Investors

| About: Exactech, Inc. (EXAC)

Summary

Spinal disease is a growing health problem and the corresponding market for spine surgery devices is growing rapidly.

I reviewed and ranked all American spine device companies using value/growth as a metric.

Overall market growth is being driven by an aging population and disruptive technologies, which has allowed new entrants to capture market share from the established players.

EXAC is an undervalued small-cap that should reward investors as it grows faster than the overall spine device market.

Spine surgery has changed significantly over the past 2 decades. I am told by the senior neurosurgeons with whom I work that operating on the spine was a high-risk fear-inducing topic in the 1990s. Now close to 881,000 spinal procedures are performed annually in the US and the worldwide market for spinal devices is $10 Billion. In this article I perform a comprehensive review of American spine device companies.

Background

Degenerative spine conditions are surprisingly common. According to the World Health Organization 80-90% of Americans will be afflicted at some point during their life and their symptoms can range from back pain to severe limitations in mobility. Only a fraction of these patients require surgery, yet these patients account for a robust market for spine devices. The baby-boomer phenomenon is at play here. With age comes degenerative spinal disease, which can be very debilitating if not treated surgically. The prevalence of degenerative spine disease is therefore expected to rise significantly as the median age of the population creeps upwards.

Figure 1 - The rate of spinal fusion operations including lumbar fusions has been rising dramatically since the 1990s. Key drivers of this growth have been safer operative techniques, an aging population, and disruptive technologies.

Traditional Spinal Surgery vs. Disruptive Technologies

Traditional fusion devices are the oldest and best-developed aspect of spine surgery. Despite disruptive technologies, traditional fusion devices still comprise the largest share of the spine device market at %58.

In 2004 the FDA approved the first artificial intervertebral disk, which allowed a new market for motion preserving spinal devices. Artificial intervertebral disks are surgically implanted between the vertebrae in a diseased section of the spine. Unlike traditional fusion, artificial intervertebral disks preserve the mobility of the affected area of the spine. Artificial intervertebral disks have faced some resistance from insurers due to controversy about their efficacy over traditional fusion. Artificial intervertebral disks have resultantly grown to currently occupy %8 of the market.

The newest trend in the spinal devices market is minimally invasive surgery (MIS). The advantages of MIS over traditional surgery are shorter hospital stays, lower infection risk, reduced bleeding, shorter scars, and earlier return to work. MIS is currently in its early stages and is not uniformly covered by insurance providers. There is a significant learning-curve associated with the technology and surgeons wishing to offer MIS generally require additional specialized training. Currently less than %10 of providers can perform MIS operations. Nonetheless, MIS is expected to be offered by 70% of providers by 2025. MIS is expected to contribute to the overall growth of the spinal devices market. Although some of the growth in MIS will come at the expense of traditional fusion techniques, the reduced risk associated with MIS is expected to broaden indications for spinal procedures.

Click to enlargeFigure 2 - Breakdown of global spinal devices market place. While traditional fusion devices occupy the majority of the market, newer technologies such as motion preserving implants, and minimally invasive devices are driving overall market growth.

Ranking American Spinal Devices Companies

I identified all American companies significantly involved in the development, manufacture, and commercialization of spinal devices. For the subsequent analysis I used the Portfolio123 platform, which uses CapitalIQ data feeds. I used a simple ranking algorithm to stratify the companies. This ranking algorithm valued EPS growth, upward EPS estimate revisions and devalued excessive short interest, low 52-week momentum, and excessive debt.

Table 1 - Ranking of American spinal devices companies.

Ticker Name Price Rank SICM MktCap EPS%ChgPQ NextFYEPSMean ROE%Q Forward PE
EXAC Exactech Inc 18.42 91.01 0.31 259.3 -23.08 1.18 5.15 17.75
MDT Medtronic PLC 75.92 79.97 11.17 106755.36 -36.84 4.86 3.93 17.34
JNJ Johnson & Johnson 96.75 78.7 28.57 267734.44 -25.47 6.4 18.69 15.63
RTIX RTI Surgical Inc 3.4 78.2 1.73 195.69 0 0.23 7.89 17.44
OFIX Orthofix International NV 38.84 77.26 0.38 733.42 -119.05 1.06 -1.05 51.79
ZBH Zimmer Biomet Holdings Inc 99.15 74.06 5.76 20196.86 111 7.81 0.88 14.47
CNMD CONMED Corp 39.09 71.75 1.27 1082.83 18.52 1.86 6.1 23.48
GMED Globus Medical Inc 25.32 67.08 8.57 2411.12 12 1.21 15.96 23.34
SYK Stryker Corp 93.91 63.12 4.49 35265.27 -23.3 5.58 14.07 18.38
NUVA NuVasive Inc 46.77 61.73 2.61 2295.66 20 1.48 7.61 37.1
KTWO K2M Group Holdings Inc 14.15 61.49 0.77 583.32 -56.25 -0.55 -14.19 N/A
ATEC Alphatec Holdings Inc 0.29 52.78 2.31 29.2 -3925 -0.1 -1184.5 N/A
AMDA Amedica Corp 0.11 39.51 2.14 8.34 -36.36 -0.16 -1248.58 N/A
CFMS ConforMIS Inc 11.55 31.93 2.99 470.19 -58.33 -1.34 -74.36 N/A
WMGI Wright Medical Group NV 21.85 25.26 7.32 1158.02 -67.12 -1.08 -152.99 N/A
OTCQB:IMSC Implant Sciences Corp 0.47 15.13 N/A 36.51 83.33 N/A N/A N/A
Click to enlarge

Established Players in the Spine Device Market

The established players in the spinal devices market are Medtronic , Johnston and Johnston , and Stryker , which collectively have 54% of the market share of spine devices. In my ranking these companies ranked 2, 3, and 9 respectively. The ranking system has a strong preference for EPS growth.

Newer Entrants are Gaining Market Share

Smaller players such as Globus Medical and NuVasive ranking 8 and 10 respectively have received much attention in the past few years as they have grown their market share. These companies have been able to grow faster than the established players by offering niche products for specific indications. GMED has made use of strategic acquisitions, such as the acquisition of Transplant Technologies of Texas to expand their regenerative biologics product offerings. Both GMED and NUVA have benefited from aggressive sales strategies allowing for continued growth at a pace at least twice that of the market average. Both GMED and NUVA management have set a goal of >$1 billion in annual sales by 2020.

Exactech

The number 1 ranked stock, Exactech , turns out to be quite interesting. I believe EXAC represents an attractive small-cap that will continue to grow faster than the overall spinal devices industry.

Click to enlarge

Figure 3 - The share price of EXAC (top) compared to the quarterly EPS estimates (bottom). EXAC has enjoyed upwards revisions of its EPS estimates. The company, however, continues to trade at a forward P/E that is discounted relative to its peers.

EXAC is an orthopedic devices manufacturer that entered the spine market in 2008 and now offers products in all of the domains discussed above - traditional fusion with the Proliant® system, motion-preserving with the Octane® system, and MIS with the Silverbold® system. A strength of EXAC is its diverse sales force that has grown since the company's founding in 1985. Management is emphasizing that the sales force, which was initially developed for extremity implants, is now effectively transitioned into marketing the company's spine portfolio.

EXAC turns out to be a nice value play. The forward P/E ratio is 17.75. This means an investor in EXAC is paying $17.75 for each dollar of expected earnings in the upcoming fiscal year. Compare this to the medical devices industry average forward P/E of 27.95 or the spine device industry average forward P/E of 23.67. This indicates that EXAC is undervalued relative to other spine device companies.

Management has recently initiated a buyback of $1million in shares over 2016. CEO David Petty has said, "Based on historical prices for Exactech stock, it is presently trading at a level which presents an attractive investment opportunity for the company itself." It is always nice when management speaks with their money along with their mouth.

The ranking employed here valued upward revisions of EPS estimates. EXAC has enjoyed favorable EPS estimate revisions. Of the analysts covering EXAC over 2015 one has revised their EPS estimate upwards, and none have revised their EPS estimate downward. As a result the yearly EPS for EXAC rose from $1.03 per share to $1.05 at the conclusion of 2015.

The next catalyst for EXAC are upcoming 2015 Q4 results in February. There is no reason to believe Q4 earnings will be surprising in either direction. However, I am inclined to wait until after Q4 results before purchasing shares. The value argument here is strong and if Q4 results are positive we should have some time before the effects are fully priced into the share price.

Investors can benefit from the growing spine device market. I am most excited by EXAC, but I am interested to hear from those of you with thoughts on the other spine device companies featured in this article.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EXAC over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.