Will MAKO Get Back on its Feet?

Erik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

MAKO Surgical (NASDAQ: MAKO) recently pre-released sales quantities to assuage the Market's anxiety, after a rough year of poor sales, over whether it would make its 2012 targets. The sales of RIO surgical robots (15 RIOs) was spot on the middle of their forecast range, and the number of procedures surged back up to an all-time high (2,904), which returned them close to their average number of procedures per month on each robot.

<img src="/media/images/user_13510/rio-sales-procedures-graph-2012q4_large.png" />

Yet the Market was unimpressed, sending the stock down 14% that day. It has recovered somewhat, now at 8% down while the S&P is up 2% during those two weeks. Last summer the Market was unhappy about a sharp fall in RIO sales. When autumn came the sales had recovered but the Market was unhappy about a decline in the rate of surgical procedures. This quarter, both sales and procedures have recovered; so what is the Market unhappy about now?

In a nutshell, margins. The pre-release informed us on quantities sold, not on revenue received. The concern is, with their new vice president of marketing and sales hired from Intuitive Surgical (NASDAQ: ISRG) to meet the sales targets, did MAKO reduce sales prices to ship product? If they did, then gross margins, which have been steadily rising for years, will take the next big hit.

That would be a problem because MAKO's ultimate profitability, and its ability to become "the next Intuitive Surgical" for its shareholders, requires a continued rise in gross margins. There is no room for falling margins.

I'll speak in a moment about why prices could be falling, but first let's take a look at some numbers to prepare ourselves for their earnings release on Feb. 26. MAKO earns money through sales of RIO surgical robots, sales of products and services for each surgical procedure, and maintenance support of the robots.  Last quarter they sold each RIO robot for $961,000; earned $5,000 for each procedure; and pocketed $21,600 to maintain each RIO previously sold.

If prices have not been reduced to make the target sales numbers, they should make the income shown in this table,

<img src="/media/images/user_13510/anticipated-revenue-graphic_large.png" />

Now back to the pricing pressure. Two forces could drive MAKO toward lowering their prices. The first is continuing struggles to sell to a new customer base, the large number of "early majority" customers, those big pragmatic hospital chains that want much more than new technology. They want operating and training support, logistical support, effectively implemented upgrade cycles, and the confidence that the company will still be around in 10 years. Even though MAKO provides all but the last point, a young company must overhaul its marketing to successfully convey that capability to a prospective customer. This is no simple task as it also requires the re-alignment of sales and engineering to the new marketing priorities.

The second force is the increasing counter-marketing from the competition who have been selling products for the traditional methods of knee and hip surgery for years.

These traditional competitors include privately held Biomet, DePuy Orthopedics (a subsidiary of Johnson & Johnson), Smith & Nephew (NYSE: SNN), Stryker (NYSE: SYK), and Zimmer Holdings (NYSE: ZMH). All five of them design, fabricate, and distribute medical implants and surgical devices for a wide variety of traditional medical procedures. These are large companies whose products collectively span far beyond MAKO's current scope, supporting orthopedics of the spine, skull, jaw, hips, knees, shoulders, feet; and further afield into trauma, neurology, and endoscopy. Individually, each company's products only partially overlap its competitors. For example, in addition to supporting the traditional orthopedic knee and hip markets, Smith & Nephew supports the spine, bone repair, wound, trauma, and endoscopy; Stryker supports the spine, neurology, trauma, and endoscopy; and Zimmer supports the spine, dental, and trauma. This illustrates just how fragmented the competitive landscape is, which I believe works to MAKO’s advantage.

These companies are the entrenched industry MAKO is attempting to overturn, but who in turn are actively working to bar MAKO's continued intrusion. They have long-standing relationships with MAKO's customers, both hospitals and doctors, through which they can put pressure to forestall RIO sales in favor of traditional surgical products. This could force MAKO to reduce prices to continue gaining market share.

The largest and most successful robotic surgical company is Intuitive Surgical. Their specialty is robotic surgery of organs, which sets them in a different sub-market from MAKO, which specializes in robotic surgery of bones. If MAKO continues to struggle with the marketing and sales, do not be surprised if Intuitive Surgical, or Johnson & Johnson via DePuy, buys them to expand or claim new domain in the robotic future of surgery. Their well developed marketing, sales, and customer relationships could easily propel MAKO's orthopedic robotic surgery products rapidly forward. At the right price, such might actually be a benefit to MAKO shareholders if they continue struggling.

But before we cavalierly sell them off, let's first see if MAKO can make it on their own. We'll have our next important insight with the Feb. 26 earnings release, which we can directly compare to our numbers above.

FoolishErik owns shares of MAKO, ISRG, and bullish options on JNJ. The Motley Fool recommends Intuitive Surgical and MAKO Surgical. The Motley Fool owns shares of Intuitive Surgical, MAKO Surgical, and Zimmer Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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