MAKO Surgical Battles Back into the Ring

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’s (NASDAQ: MAKO) fourth-quarter results answered the mail on all three of the Market’s concerns: Strong sales of RIO surgical robots; Record number of surgical procedures; Pricing holds firm while the expense ratio continues to decline. It is a prize fighter back in the ring, yet the Market yawned. So what is it this time?

In a nutshell: “Show me.” The market wants to see a sustained turnaround, a recovery of the growth momentum it had in 2011; and this will take time. When a high-growth company falters for any reason, the momentum investors flee en masse; yet no matter how low the stock falls, value investors are loathe to touch a young tech darling. That leaves only the tech enthusiasts buying the stock, but that will likely change. Here's why:

“Show Me” has Begun

Let’s take a close look at MAKO’s fourth-quarter and full-year 2012 results in light of the Market’s three primary concerns. These very legitimate concerns were:

  • Loss of momentum in sales of RIO surgical robots
  • Loss of momentum in the number of surgical procedures performed
  • Fear that price reductions may be required to recover sales

RIO Surgical Robot Sales

RIO sales fell off a cliff in the first and second quarters of 2012. Since then MAKO has taken fruitful steps to put this concern to rest. While very encouraging, the resurging sales trend must continue before anyone can declare victory. Let’s look at the numbers in the table below.

<img alt="" src="" />

While sales in the first two quarters of last year pulled a serious vacuum, sales in the second half of 2012 successfully pulled above those of a year ago. This is significant progress, but there is still more “show me” to go.

Number of Surgical Procedures

Just as MAKO was proving it could still sell RIOs, the number of procedures declined in the third quarter for the first time ever. The Market’s concern was that surgeons were wandering away from the new technology in favor of their traditional surgical methods. If true, this would strongly imply that the new robots didn’t provide a compelling value proposition to the surgeons or their patients. Fortunately for shareholders and tech enthusiasts, this proved to be a single-quarter blip. As can be seen in the next table below, procedures surged to a new high-water mark the very next quarter.

<img alt="" src="" />

MAKO’s Pricing Power

When MAKO pre-announced its sales quantities, many shareholders breathed a sigh of relief. On the surface of it, the numbers looked good: 15 robots sold and record procedures. Without mention of the dollars, however, the stock didn’t respond. I believe an unease prevailed as everyone began to wonder if the new sales vice president had achieved these remarkable results by slashing prices. I certainly did. The quarterly earnings report, however, resoundingly put that concern to rest. Prices were rock solid as you can see in the next table.

<img alt="" src="" />

MAKO’s Cost Structure

The news gets better. High growth companies do so by spending prodigiously – enough to drive their earnings negative. The promise is that rapidly increasing sales and market penetration will outstrip the rise in costs until the company is profitable, and ultimately wildly profitable. That’s the promise, anyways.

Even through the sales debacle of 2012, MAKO still continued along that promised path of an ever declining cost structure relative to sales. This wasn’t immediately obvious in their earnings report because they didn’t include their 2 international RIO sales in the revenue. They didn’t include them because the customers are both new and overseas, so they won’t book the sales until they have cashed the check. Now that’s my kind of management! Honest, forthright, and not trying to pump up the numbers with accounting chicanery (ahem, CRM or GMCR anyone?).

Adjusting for those two as-yet-unbooked sales, their improving profitability can readily be seen in the costs as a percentage of sales, as illustrated in the table below.

<img alt="" src="" />

All values are costs as a percentage of revenues.

The Competition

In their latest conference call, MAKO’s CEO, Maurice Ferré, reinforced the ever increasing reports of head-to-head competition in robotic orthopedic surgery, specifically naming “Optics Fitness.” He takes this as a significant positive: “We believe attempts to develop and commercialize competing robotics systems validate our foundational thesis on the benefit of robotics in orthopedics” [emphasis mine]. Ferré is very confident in his “top dog and first mover” status in this surgical field, and that it is merely customer hesitancy that is holding him back; a hesitancy that the increasing competition indicates is fast fading.

MAKO’s most relevant competitor, Intuitive Surgical (NASDAQ: ISRG), doesn’t even operate in the orthopedic industry. They instead specialize in robotic surgery of organs; but as the premier surgical robot provider in the world, they certainly have the medical expertise and business acumen to enter this business if they choose to. This steadily rising customer enthusiasm for robotic orthopedics may be the catalyst they are looking for to enter the orthopedic market, just as Intel waited patiently for the mobile computing industry to mature sufficiently before diving in with its strength and expertise.

The increasing enthusiasm for robotic surgery could also spur the traditional non-robotic product suppliers into building a robotic business around one or more surgeons who are already developing nascent robotic capabilities to support their own practices. Smith & Nephew (NYSE: SNN), Stryker (NYSE: SYK), Zimmer Holdings (NYSE: ZMH), and DePuy Orthopedics - a subsidery of Johnson & Johnson (NYSE: JNJ), are all substantially larger and profitable companies that design, fabricate, and distribute medical implants and surgical devices for a wide variety of traditional medical procedures. Their financial prowess comes from a broad suite of products supporting orthopedics of the spine, skull, jaw, hips, knees, shoulders, feet; and further afield into trauma, neurology, and endoscopy.

More specifically, 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. Any one of these companies could decide the writing is on the wall for orthopedic surgery, that it is going robotic and they need to get onboard to give MAKO a run for its money. But thus far, none has done so. All the rumblings are coming from small startups who are several years behind MAKO and thus have far to go just to pull even.

As for the future, if MAKO keeps putting up numbers like it did in the latter half of 2012, with sales reaccelerating and cost ratios continuing to fall, then I see a very bright future for them.

Erik Eason has a position in MAKO Surgical and Intuitive Surgical, and a bullish options position in Johnson & Johnson. The Motley Fool recommends Intel, Intuitive Surgical, Johnson & Johnson, and MAKO Surgical. The Motley Fool owns shares of Intel, Intuitive Surgical, Johnson & Johnson, 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!

blog comments powered by Disqus