These have not been the easiest of times for small-cap orthopedics company NuVasive (NUVA). Not only has the company gotten caught up in the generalize spine market malaise, but the company's litigation with Medtronic (MDT) has been a significant overhand for some time. With solid share in minimally invasive procedures and meaningful new products on the horizon, NuVasive looks like an interesting rebound play at today's prices.
Relatively Speaking, A Good Quarter
Although analysts have been trimming numbers on NuVasive, the company still delivered pretty solid results for its fiscal fourth quarter. Revenue rose about 16% on a reported basis, with underlying organic growth in the range of 8-9%. Overseas sales grew at a torrid 53% clip, albeit off a low base, while biologics sales were unimpressive (down 1%).
NuVasive's margins have never been great, but they took a step back this quarter. Gross margin slid about seven points, with royalty expenses taking a toll but also mix and obsolescence issues as well. Operating income declined 26% on a reported basis, and operating margin pulled back about three points.
And Now The Relative Part
NuVasive is long past the days of 50% revenue growth, but the company's performance this quarter was still quite strong. Assuming that Alphatec (ATEC) does as expected, these two companies and Synthes will be the only companies to show growth in spine this quarter. That's not bad when major players like Johnson & Johnson (JNJ) and Stryker (SYK) are seeing mid-single digit declines and market-leader Medtronic is faring even worse.
While NuVasive's share of the overall spine care and lumbar markets is relatively modest (high single digits), it does have more than 40% share of the minimally invasive segment. Although spine care in general is under the same broad negative factors as the larger orthopedics market (tougher reimbursement, lower procedure counts, tough pricing), there is an ongoing move from open surgery to minimally invasive.
The Medtronic Cloud
Medtronic recently won long-fought patent litigation against NuVasive. While Medtronic seems unlikely to succeed in getting an injunction prohibiting the sale of the offending protects (which includes an implant responsible for about 20% of sales) and lost a preliminary injunction to that effect, there's still plenty of uncertainty about the ultimate outcomes.
NuVasive has already recognized over $100 million in damages and has been accruing royalties with the assumption of 10% royalties on at least one of the patents. While a final verdict obligating 10% royalties would be steep by the standards of the industry, it wouldn't cripple the company and a total injunction would be a very rare move.
Still Opportunities For Growth
While NuVasive does not compete in all facets of the spine market, there are still multiple opportunities for the company to expand its share and its scope of business. While Medtronic, Johnson & Johnson/Synthes, and Stryker all want a bigger piece of the minimally invasive market, NuVasive has built a good business here and should stand to benefit from a gradual increase in not only the number of patients needing spinal fusion, but those demanding the less invasive approach.
In the near term, NuVasive also has some product lunches that can support growth. The company is looking to launch a new biologic called AttraX, as well as a motion-preserving cervical disc in 2012. Management is also looking to expand into Japan, the second-largest spine care market in the world.
A Tough Market Getting Tougher
Certainly NuVasive is competing in a rough neighborhood. Medtronic has over one-third of the global spine market and happens to be an aggressive competitor. Soon too there will be the combination of Johnson & Johnson and Synthes - a deal that not only doubles JNJ's share to roughly one-quarter of the market, but gives the company a growing presence in more innovative (and competitive) devices.
All the while, orthopedics companies continue to operate in a more severe environment. The DOJ has taken a much firmer hard with marketing practices and reimbursement has been moving against the spinal fusion market - making it increasingly difficult to get reimbursement authorization in the absence of degenerative disc disease.
NuVasive has also suffered from all of the negative press around Medtronic's biologics product InFuse. While it may seem that this would be an opportunity for NuVasive to supplant Medtronic and grow this business, it seems that the market is cooling on biologics altogether as it tries to sort out and digest the information.
Making matters worse, NuVasive is a small company trying to market against much larger entities. If investors are wondering why NuVasive's margins aren't better, this is the reason. Orthopedics and spine is a relatively "high touch" market and it takes a lot of sales and marketing to maintain and grow a business alongside Medtronic, JNJ, and Stryker.
The Bottom Line
It would not surprise me to see NuVasive eventually get bought. Med-tech companies that do basically one thing and do it well seldom stay independent. On first blush, it would seem as though Stryker or Zimmer (ZMH) could easily buy NuVasive, integrate its leading MIS business, and reap synergies by doing away with redundant sales, research, and administrative expenses. Moreover, with a larger sales force and a fuller suite of products to sell, such a buyer could arguably drive more share growth than NuVasive alone.
I am not currently expecting that much will change between now and the final verdict in the Medtronic case. To that end, I see several years of potential low double-digit sales growth as the spine market slowly recovers and NuVasive builds share. What I don't see, though, is dramatic free cash flow conversion improvement. Nevertheless, I think investors can buy NuVasive today with an eye toward a low $20s fair value.