What Now for Mako?

By Mohamed Mounir - July 25, 2012 | Tickers: ISRG, MAKO | 0 Comments

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It must hurt to be a MAKO Surgical (NASDAQ: MAKO) shareholder right now. The stock just got hit with a double dip whammy losing over 40% of it's value each time. The first haircut came in May when the company released Q1 results showing that less RIO Systems were sold compared to Q1 2011, the second came just 2 weeks ago when it lowered its full year guidance for RIO system sales from 52-58 to 42-48.

MAKO was expected to be the next Intuitive Surgical (NASDAQ: ISRG) who's da Vinci systems right now are the latest hit in the medical world. However we can't expect that every burger shop will be a McDonald's, and Hansen Medical offers an example of how a medical robots company can struggle.  

MAKO like ISRG offers a medical robot system which allows doctors to translate their hand movements through robotic arms and instruments on a patient using a vision console. ISRG's da Vinci system is used mainly for Prostatectomy and Hysterectomy operations while MAKO's RIO systems is used for Knee and Hip replacement. Both companies also employ the same razor/blade business model in which each installed machine generates a stream of recurring revenues throughout its lifetime.

MAKO has a leg up on the razor/blade part as each procedure that's performed by a RIO brings in more than double the revenue of a procedure performed by a da Vinci.                                                                                                 

MAKO 2011 procedures

$34,600,000 procedure revenue/ 6,900 MAKOplasty procedures = $5,000 per procedure

ISRG 2011 procedures

$700,000,000 procedure revenue/360,000 da Vinci Procedures= $1,950 per procedure

There is one major difference that sets them apart and which represents a weakness for MAKO. Da Vincis are used for a lot of life saving operations such as in treating prostate cancer. Knee and Hip replacements are a lot of times elective operations and hospitals are reluctant in acquiring an expensive RIO system to replace cheaper tools from Zimmer, Stryker, and J&J that could be used for the same procedure.

That's where the trouble for MAKO lays. As pointed above MAKO's steep share price declines came right after news of lower than expected RIO systems sales hit. In order for MAKO to move into profitability it has to rapidly increase its base of RIO systems installed in hospitals and it has to do it at a faster rate. 

The company showed strength in 2011 especially in the last quarter where 18 RIO systems were sold. However that was followed by an incredible and unexpected amount of weakness in the first half of 2012.

At a pace of 10 units sold per quarter it would take MAKO 221 quarters or 54 years to reach ISRG's current worldwide installed base of 2,341 da Vincis!!!

The company's vice president of sales Steven Nunes just resigned and the CEO Maurice Ferre took his place until they can appoint a new and permanent SVP of sales. 

For hospitals to be convinced to acquire the RIO system they have to be convinced that MAKOplasty offers a better procedure effectiveness/ procedure invasiveness ratio than traditional knee and hip replacement procedures. Hospitals also need to see a good return on investment from acquiring the RIO system. Keep in mind that a da Vinci system costs on average about $1.5 million while a RIO system costs only about $800,000. That means hospitals don't mind acquiring a large number of da Vinci systems per year which cost about twice as much, while they are more reluctant with the cheaper RIO.

There are some positive indicators though. The number of MAKOplasty operations performed increased by 71% in the first half of 2012 and the utilization rate of RIOs in hospitals is at 7.2 per month compared to 6.4 per month in the same quarter of last year which is very positive because it indicates that the hospitals who purchased the system are not just letting them collect dust in the corner. Doctors are actually using the RIO and they may recommend them to other doctors. An increase in the utilization rate and number of procedures could be considered a leading indicator of sorts for RIO system sales.

What should you do

MAKO is not out of the game just yet, but if and when you decide to buy the stock depends upon your risk tolerance.

Evel Knievel: There is no better time than now.The stock is ultra cheap compared to a few months ago and the low number of shares makes a short squeeze a likely event in the event of positive news and the company usually posts the strongest results in the second half. If you are really in the Vegas Spirit and believe MAKO will be recover quickly you can use LEAPS for leverage.

What the Heck: Enter after the company proves that it can grow its RIO systems sales. wait for a great increase in the number of RIO system sales Q on Q over 2 consecutive quarters. The company should also be able to cross its previous high of 18 RIOs sold in Q4 2011. In my opinion this is the best entry point. You will get a lot of the long term appreciation with less risk. 

Retirement Money: Wait until the company turns profitable and cash flow positive. It would have proven to have a business model that works and that it is able to control costs effectively and even though you might miss some of the initial price appreciation, you would still be getting early in the uptrend if MAKO can follow in the footsteps of ISRG. Use the 2 consecutive quarters rule, in order to rule out a one time event.  

Widows and Orphans: Forget Mako, Buy ISRG

Conclusion

What: MAKO who was an all star performer last year and earlier this year turned out to be a huge disappointment and took a nosedive not once, but twice in the last 3 months caused by lower than expected RIO sales

So What: MAKO needs to grow its base of installed RIO systems in order to move out of the red and into the black and truly capitalize on its Razor/blade business model. It has the potential to be much more profitable than ISRG if it reaches the same size and controls its costs and expenses effectively.  

Now What: Invest according to your risk tolerance. I suggest waiting for the company to actually prove that its RIO system is desirable by hospitals, doctors, and patients alike and can compete with traditional knee and hip replacement operations.

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