When I wrote on MAKO Surgical (MAKO) in the wake of disappointing first quarter results, I mentioned an old wives tale that says med-tech companies miss in threes. Based on management's warning that second quarter results would come up short of lowered expectation, it looks we may have one more yet to go.
Q2 Bad News That Sounds A Little Too Familiar
MAKO Surgical management announced after the close Monday that second quarter results were going to disappoint on most of the key metrics.
MAKO placed nine systems this quarter, down from last year's 12 and below the sell-side average estimate of 11. Including the miss and downward revision from the first quarter, management's system placement expectations have fallen about 25% so far year-to-date.
Just as troubling was the company's miss on procedures; management announced 2,590 RIO procedures during the second quarter, up 71% from last year, but about 3% short of estimates. Relatively speaking, the procedure count for hips was more disappointing as the miss was more on the order of 5%. Of course, MAKO is still seeing procedure growth vastly in excess of the underlying ortho market, but then MAKO's stock also enjoys substantially higher multiples than mainline ortho companies.
So How Bad Is It, Really?
Two quarters of year-on-year declines in system placements is a legitimate worry. There are ample questions as to whether the RIO system is really necessary and whether it can really produce better outcomes in the hands of skilled surgeons. At the same time, there are concerns among hospital administrators as to whether there is enough return on the investment to justify writing a large check for this particular piece of equipment.
Likewise, bears are going to jump on the decelerating procedure growth in uni, which has fallen from about 90% in the fourth quarter of 2011 to about 50% this quarter. With Biomet and Zimmer (ZMH) having recently launched new products for the uni market, the risk is that these established ortho giants are recapturing share with relatively simpler (and substantially cheaper) tools.
But, and this is a significant "but", utilization continues to increase. Monthly utilization was 7.2 for the second quarter, and though that was lower than sell-side analysts projected, it still marked a nearly 10% sequential increase and a nearly 13% annual increase. In other words, RIOs are not being abandoned to collect dust at the hospital, but are instead being used and used more often as the surgeons gain experience. Moreover, Biomet's recent earnings give reason to think that a second-half rebound could materialize in the ortho space.
Although bringing Intuitive Surgical (ISRG) and Hansen Medical (HNSN) into the discussion is not completely fair, investors can took some solace in the fact that utilization rates do seem to have a real bearing on the "structural" environment for a piece of capital equipment. As long as utilization rates are increasing, it is generally the case that doctors are satisfied and giving relatively positive recommendations to other physicians.
Competition Still A Worry
That said, MAKO Surgical investors shouldn't ignore the threats presented by the company's competitors. I'm not talking so much about Stanmore Implants' Sculptor system, nor Curexco's ROBODOC, but rather the threat of new tools and cutting guides from Biomet, Zimmer, Stryker (SYK), and so on. Orthos I've spoken to aren't necessarily sold on these new tools and guides, but they seem inclined to give them a try, and administrators are likely to feel much better about a "try it out and see" approach with tools that are much, much cheaper than a RIO system.
What's more, I continue to believe that Stryker is going to get into robotics business at some point - maybe not in the form of a $1 million piece of capital machinery, but perhaps in a lower-cost platform that leverages its expertise in surgical navigation.
The Bottom Line
My objections around MAKO have largely centered around what I think is a mistaken belief that the RIO adds the same sort of value as Intuitive Surgical's daVinci and the idea that MAKO was going to capture basically 100% of its addressable market. With these two straight disappointments, though, valuation no longer demands such a lofty market share.
Assuming that utilization rates don't start to drop, I think the wash-out valuation for these shares could be somewhere in the vicinity of $10. I will not be surprised if there's a third straight downward revision around the third quarter, but that could be a very interesting place in time to reconsider these shares (again, assuming no sharp fall in utilization). Even with more rational (or conservative, if you prefer) growth expectations, MAKO could still be a winning stock, but the burden is now back on management to prove that the RIO is an in-demand system that hospitals and orthopedic surgeons really do need.