Investors in the orthopedics space are probably well acquainted with the travails of the spinal care sector. Once a growth darling in the space, growth has evaporated in the face of serious pricing pressure, pushback from insurance companies, and a relative lack of innovation. What’s curious is that this malaise hasn’t necessarily been universal. In fact, some of the smaller players in the space have continued to post solid results and take share from the 800-lb gorillas. With seemingly contradictory premiums being placed on both innovative and margin efficiency, it will be interesting to see how this next-level companies fare in the coming years, and/or whether larger players decide to go the M&A route to improve their spine businesses.
A familiar story, with familiar consequences
Demand for devices and instruments used in spinal surgery fueled strong growth for leading companies like Medtronic (NYSE:MDT) and Synthes (now owned by Johnson & Johnson (NYSE:JNJ)) for several years, and spinal care became a major growth driver for orthopedic companies that found it harder to grow revenue in the traditional hip/knee recon space.
Like most good things, this didn’t last. At the risk of over-simplification, surgeons and companies got too aggressive in pushing these procedures, and when the long-term outcomes for patients and insurers didn’t match the promises, a pushback started. The end result has been a very challenging time in the sector, with insurance companies leading the way due to their refusal to approve/reimburse for procedures as before. At the same time, hospitals have started fighting back on pricing, leading to a one-two punch of weak volume and pricing.
But the pain has not been shared equally
While the three largest spine care companies (JNJ, Medtronic, and Stryker (NYSE:SYK)) have seen revenue growth slow dramatically (or decline), that hasn’t been the case for everybody. In particular, next-tier rivals NuVasive Inc. (NSDQ:NUVA) and Globus Medical (NYSE:GMED) have continued to deliver solid growth rates through this downturn.
NuVasive has succeeded with a familiar plan in med-tech – focusing on tools and devices that allow for procedures to be done on a minimally invasive basis instead of with traditional open procedures. NUVA has emerged as a leader in minimally invasive (MIS) procedures, and though MIS penetration is only about 25% overall, it has been enough to make NuVasive the fourth-largest spine care company by market share at around 8% (just below Stryker).
NUVA has built itself around what it calls the Maximum Access Surgery (MAS) platform, which includes an array of tools, biologics, implants, and visualization tools designed to allow safe and effective spinal procedures that also minimize blood loss, hospital stays, and post-op pain/complications. Keys to the platform include the eXtreme Lateral Interbody Fusion (XLIF) procedure and MaXcess line of instruments.
Globus has followed a different path. Globus is not as focused on minimally invasive procedures as NuVasive, but the company has a rather remarkable focus on product innovation. The company targets 12-month development times and aims for as many as 10 new product introductions per year. As a result, Globus has launched a series of innovative and/or niche products that have not only helped the company avoid capitation (as many products fall outside of capitation rules), but build share with surgeons. Globus has been aggressively expanding its sales efforts (it has roughly as many reps as NuVasive) and holds approximately 5% market share (5th in the market, behind NuVasive) despite a minimal overseas presence.
A host of small spine companies are hoping to step up
Given the resistance from insurance companies and the price pressures in the market, current conditions in the spine sector have placed a premium on price-based competition and innovation. The former is something that large companies like Johnson & Johnson, Medtronic, and Stryker can arguably handle, as they have the advantages of scale and bundling working for them. As smaller companies historically tend to struggle to compete in med-tech on the basis of price, innovation is the avenue left open to a host of smaller companies that want to become players in the spine space.
While Integra LifeSciences (NSDQ:IART) is not a small company on the whole (it produced more than $800 million in revenue in 2012), it’s a sub-5% share player in spine care. Integra gets a lot of attention for its biologics products, but two-thirds of the spine business is built around more traditional tools, instruments, and devices. Unfortunately, outside of biologics Integra hasn’t really invested in establishing a clearly innovative product line-up. I would expect Integra to get some benefit from its strong position in extremities and seemingly limitless appetite for acquisitions, but as is Integra does not look like a disruptive force in the market.
On the other hand, Alphatec (NSDQ:ATEC) is looking for new products to help drive its industry share beyond the 2% level. The company has gotten some attention for its NEXoss nanostructured synthetic biologic, and initial reports have suggested very attractive fusion rates – perhaps giving it a shot to be adopted by former users of Medtronic’s InFuse. It’s not just biologics that could drive Alphatec forward, though. The company’s re-introduced Solus anchored ALIF device has an interesting (and unique) fixation mechanism that some surgeons I’ve talked to believe is easier, faster, and safer to deploy. Alphatec is also looking to products like the Illico MIS fixation system and Pegasus cervical anchor cage to help drive share gains against the larger players.
Even more speculative is Banaxo Surgical (NSDQ:BAXS), once known as TranS1. This company is essentially built around MIS technologies and products. The company has been selling its AxiaLIF product for lower lumbar fusion for a few years now, but has struggled to gain adoption. In addition to AxiaLIF, the company has the VEO lateral fusion platform and the iO-Flex line of disposable tools for decompression. The decompression tools could be particularly interesting, given that the carry a per-procedure ASP of less than one-third of single-level AxiaLIF and that certainly fits in with what insurers want to see these days.
It’s important to keep a few things in mind about these smaller rivals. First, hospitals are increasingly looking to winnow down the number of suppliers they deal with, and it’s a great deal easier to close the door on a company that holds less than 5% of market share. Second, the quality of the sales reps really do matter in driving sales, and smaller companies have more limited resources when it comes to attractive and retaining top-level reps.
It’s also well worth remembering that IP is important in this space. Medtronic and NuVasive have been wrangling over patent infringement for some time now, with NuVasive losing a meaningful judgement and looking at paying higher-than-expected royalties to Medtronic.
Will the quality companies get snatched up?
Med-tech is almost always an active M&A space, and it’s not unreasonable to think that there could be further consolidation in the spine space. Together, Medtronic and JNJ account for nearly two-thirds of the spine market, and that’s a formidable level of scale for even the likes of Stryker, Zimmer (NYSE:ZMH), or Biomet to challenge. As NuVasive and Globus have amply demonstrated, though, innovation can drive share growth and that could provide the incentive to do deals in an otherwise challenging market.
Stryker is seemingly tied to M&A rumors in almost every part of med-tech these days, so it feels a little too convenient to tie them to a company like NuVasive (or, much less likely, Banaxo). That said, with some degree of resolution now on the Medtronic litigation (though NUVA is appealing), I would expect that an acquisition of NuVasive is a “when, not if” proposition and both Stryker and Zimmer would make sense. Globus would also be an interesting acquisition target, though I wonder how the company’s culture of constant innovation would mesh within a larger organization – in my mind, buying Globus is actually a risky proposition for most companies, as the odds of screwing up that culture and ruining the source of its value creation is very real.
The bottom line
As is generally the case in the med-tech space today, there really aren’t obvious bargains lying around in spine care. Both Alphatec and Banaxo could conceivably be worth a lot more in the future, but buying either stock is a risky bet ahead of real signs of revenue growth and business momentum. NuVasive is more of a borderline prospect – the chances are better than average that the company will continue to gain share and post above-market growth, but the shares have already double off their late 2012 lows.
Last and not least is Globus, probably the cheapest of the spine-centric companies mentioned, and the most likely to generate double-digit growth over the next few years. Even here, though, the stock is probably no better than 10% undervalued, so investors may need to temper their expectations for above-average capital appreciation.