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Shares of NuVasive (NUVA), the medical company focused on surgical products and procedures for the spine, fell more than 36% last week. The company warned for a weak third quarter.

Preliminary Third Quarter Results

NuVasive reported preliminary third quarter revenues of $147.0 million. Earlier, NuVasive guided for flat to small sequential revenue growth compared to second quarter revenues of $154.4 million.

The company is set to report the complete third quarter earnings report on October 29, 2012. At the third quarter earning release, NuVasive will also update the full year 2012 guidance.

Chairman and CEO Alex Lukianov commented on the warning, "We experienced an unexpected sequential decline in the third quarter due to unusually high account churn related primarily to the growth of surgeon participation in physician-owned distributionships and to increasingly aggressive competitive tactics. As well, we heard from many surgeon customers of increased delays and denials from insurance payers. We believe our ability to take market share with innovative procedural solutions and services remains strong. We are focused on addressing the new challenges and will provide revised full year guidance on our October 29th earnings conference call."

Valuation

NuVasive ended its second quarter with $242 million in cash, equivalents and short term investments. The company operates with $400 million in short and long term debt, for a net debt position of roughly $158 million.

For the first six months of 2012, NuVasive generated revenues of $306.1 million. The company net earned $3.1 million, or $0.08 per diluted share. At its second quarter earnings release, the company guided for annual revenues of $625 million. Annual GAAP earnings per share are expected to come in at $0.16 for 2012. Most certainly, the annual outlook will be revised downwards on the 29th of October.

The market currently values NuVasive at $633 million. This values the company at 1.0 times annual revenues. The price-earnings ratio is pretty meaningless as full year earnings are most likely revised downwards towards zero.

Currently, NuVasive does not pay a dividend.

Investment Thesis

Year to date, shares of NuVasive have risen some 15%. Shares started the year at $12 per share, and rose to highs of $26 in July on the back of an upward revised full year guidance. Shares fell from $24 last week to merely $14 at the moment, on the back of the warning.

Over the past five years, shares have fallen some 60%. Shares traded as high as $58 in 2008, and gradually fell to lows of $11 at the end of 2011 and the beginning of 2012. While shares have fallen 60% over the past five years, the company has aggressively expanded its business. Annual revenues rose from $250 million in 2008, to an expected $625 million in 2012. In reality, revenues will likely come in a bit lower. The company net lost $28 million in 2008, and is likely to report a very small profit in 2012.

The company's warnings are quite severe. NuVasive sees a higher churn rate as an important sales representative moved towards a competitor. Furthermore, defections from surgeons to physician owned distributionships could impact revenues between $15-$25 million per annum.

Despite the significant pullback, I do not see any triggers for an upside movement in the short term. For those investors considering taking an opportunistic long position at the moment, I would wait until the actual earnings report on October 29th. At that date, the company will release its third quarter results and give an update for the full year of 2012.

While the revenue warning is not that severe, revenues are adjusted downwards by some 5%, investors are scared that the company's business model is impacted on the long term. NuVasive's representatives might leave for competitors and surgeons defect from the distribution partnerships, possibly creating a lasting impact. If these concerns materialize, future revenues might come under even more pressure. The nature of the warnings, implies that the revenue generating capabilities might be under structural pressure, rather than imply just a weak quarter.

Source: NuVasive - Investors Are Running For The Exit On Fears The Business Model Is Impacted