Just when it seemed like small-cap orthopedic company NuVasive (NUVA) had significantly quelled worries about competition (and/or market share), overall market growth, and its business model, an earnings warning for the third quarter has thrown it all back into doubt. Although the magnitude of the company's miss doesn't seem enormous, I already had my concerns about the valuation on these shares and it looks like NuVasive is going to have to sit in the penalty box for at least a little while.
It Doesn't Look Bad, But...
NuVasive's third-quarter earnings warning (released after the close on Wednesday) may not look like a huge miss on first blush. Whereas analysts had been projecting about $154 million in revenue, the company reported that results look to be on the order of $147 million. That's a roughly 5% miss in a quarter that isn't historically an especially strong one for the medical device industry.
… The Details Matter
There are many reasons, though, that this apparently modest miss is a bigger deal for NuVasive and a real worry to investors.
For starters, it represents a material deceleration in growth. It looks like NuVasive's core spine business grew about 2-4%, down from double-digits in the first quarter and 8-9% in the second quarter. Along the same lines, unless we see material misses in the spine businesses of companies like Johnson & Johnson (JNJ) or Stryker (SYK), this could mark the first time NuVasive failed to gain share in the spine market.
In fact, NuVasive management acknowledged the share loss, and the details here are troubling. About half of the loss went to physician-owned distributors (PODs) and the other half went to smaller competitors, one of which apparently bid away multiple NuVasive reps (including a few high-value reps). As far as the competition goes, it may be Globus Medical (GMED) that's taking the bulk of that business, though Alphatec (ATEC) has also slowly been gaining some overall spine share.
Are The Spine Market's Glory Days Over?
While small competitors may have been a problem this quarter, I'm not sure that's NuVasive's biggest worry over a longer horizon.
The company mentioned that surgeons were seeing increasing pushback from insurers, and my ortho contacts have been saying that as well. That's likely to strengthen the argument/incentives for PODs even more, and that's not going to be a helpful development for NuVasive or the spine market as a whole. In fact, there are ample concerns out there now that changes to reimbursement policies are going to significantly crimp the long hoped for recovery in spine market growth.
I also have some concern that the bigger players like Johnson & Johnson and Medtronic (MDT) have stabilized. In fact, Medtronic's last quarter suggests just that. If so, that puts NuVasive in a tougher spot - investors have been clamoring for better margins, but it's tough to fight the biggest names in the industry for market share while also looking to save money on marketing expenses.
The Bottom Line
NuVasive is neither beyond hope nor helpless. As I wrote in that earlier piece, the company has high-potential growth drivers like the entry into the Japanese market and new products on the way. It's also worth noting that the aging boomer population (a thesis that is pretty much a cliché at this point) is a real thing and these people will need spinal care in the future.
While the market's severely negative reaction to this warning has pushed the stock to a much more attractive valuation, the risk has also increased. If NuVasive can steadily build its business to over $1 billion in revenue and $100 million in free cash flow by 2022, the shares are worth more than $20 today.
Those numbers are built on below-average free cash flow conversion (quality med-techs usually produce free cash flow margins in the mid to high teens), but market share of around 11-12%. If NuVasive can do that, these shares are worth a look today. But with growing worries about reimbursement and competitive products, that "if" just got a little bigger.