It's not exactly Intuitive Surgical (ISRG) 2.0, but MAKO Surgical (MAKO) is a growing med-tech name that investors would do well to research. Today's valuation is too rich, but just as Intuitive has given investors some pullbacks so too will MAKO in the future.
Q4 Results Show Good Growth From A Small Base
MAKO did well by its investors for the fourth quarter. Revenue rose 122% and slightly exceeded sell-side expectations. The company sold 18 systems in the quarter (against 33 for all of 2010), and half of them were hip-enabled, bringing the total percentage of hip-enabled RIO systems in the field to 44%.
Implant volume was also strong. At a time when companies like Stryker (SYK), Johnson & Johnson (JNJ), and Zimmer (ZMH) are struggling to show any meaningful growth at all in their hip and knee businesses, MAKO saw implant volume grow almost 100% from last year and one-quarter from the third quarter.
Truth be told, profitability is a fairly trivial consideration for the stock today, but the company continues to make progress nonetheless. Gross margin improved nicely on an annual and sequential basis, and the operating loss continues to shrink despite significant ongoing spending increases in R&D.
Odds are that MAKO will look to raise money at some point in 2012, as the company ended the quarter with about $50 million in cash. The cash flow breakeven point for MAKO keeps getting pushed back, but this is nothing new. The sell-side almost always underestimates the cash burn of growing med-tech names.
MAKO's Market Isn't Chum
MAKO offers a new mousetrap for the orthopedics industry - the RIO robotic arm and the RESTORIS line of implants. MAKO got its start with knee procedures, where its robot and implants facilitate partial knee replacements in a much less invasive manner.
Partial knee replacement offers a few advantages to patients. Not only is there less trauma and recovery, but partial knee replacements typically leave the kneecap intact and allow the quadriceps to strengthen the joint. Unfortunately, partial knee procedures are tricky without special assistance (or a lot of experience), and they represent less than 10% of knee procedures today.
The latest, and perhaps greatest, offering of MAKO is its hip replacement capabilities. Hip MAKOplasty represents an alternative approach to total hip replacement and likewise gives patients a less traumatic option with an easier recovery pathway. While the U.S. knee market could be a $500 million to $750 million market for MAKO, the hip market could easily be $100 million to $200 million larger than that.
Still A Missionary Sale
Unfortunately, this is not a "build it and they will come" market for MAKO. Rivals like JNJ and Stryker sell their own image guidance systems, Zimmer is working on various "smart tools," and most of the major orthopedic companies have been rolling out their own cutting guides and so forth.
Are these direct replacements for MAKO and the RIO system? No, but these companies have enormous marketing budgets and are actively marketing against robot-assisted procedures - a problem Intuitive has never really had to contend with in its markets.
Making matters slightly more challenging, the RIO system doesn't necessarily offer as much to the experienced, high-volume surgeons who represent the "thought leaders" that get invited to speak at major industry conferences. MAKO can allow a good surgeon to get great results, but the improvements for already-great surgeons aren't as dramatic. That said, with the increasing attention being paid to the role of customization and alignment in getting better results in procedures, MAKO has a strong case to make.
A Market Worth Having
Right now the MAKO story is largely about partial knee replacement and hips. It will not be surprising, though, if MAKO launches additional total knee and total hip options in the relatively near future. Years down the road, applications in spine, shoulder, and other joints should add even more potential to MAKO's addressable market.
Certainly MAKO is not going to go unchallenged. As mentioned, the major orthopedic players already try to market against MAKO with their own tools and guides. A few small companies have also introduced their own robotic or robot-assisted systems (including Stanmore, Blue Belt, and Curexco). While some of these systems have been hampered by questionable risk/benefit data, Stanmore's Sculptor and Savile Row system has shown some encouraging data and the ASPs could be challenging.
Destined For A Take-Out?
If MAKO really can carve out a niche in partial knee replacement and hip MAKOplasty, it stands to reason that other major ortho companies will consider making a bid. After all, proprietary/defensible products in orthopedics can be worth a lot.
Stryker has publicly talked about developing a competing system, but it stands to reason that Stryker, JNJ, and Zimmer would all be interested, and perhaps Biomet or Smith & Nephew (SNN) as well. Intuitive Surgical could also be a potential suitor as they arguably have more cash than they can reinvest in the present business and certainly understand marketing medical robotic systems. Medtronic (MDT) could be a dark-horse candidate as well, though investors would likely be livid at seeing the company enter what looks like another slow-growth market.
The Bottom Line
For MAKO to be undervalued today, an investor has to be willing to assume that the company can capture over $1 billion in revenue by 2020 with strong free cash flow conversion. From a similar revenue starting point, Intuitive did that in five years, but these are different companies and different markets, so be careful about drawing straight lines between them. Nevertheless, even a generally cynical and pessimistic med-tech guy like myself cannot completely rule that out.
The stock looks like it has petered out a bit for now, and it may be the case that pessimism about the orthopedic market pushes the shares down again. If that happens and there's a real pullback in the shares, aggressive growth investors should be ready and waiting to add this name.