Choose Medical Technology Stocks Carefully: William
Source: George S. Mack of
The Life Sciences Report
The dart board will not help in picking medical technology
stocks. Analyst and Managing Director William Plovanic of
Canaccord Genuity focuses on the musculoskeletal/orthopedic
sector, which is sensitive to factors beyond just the unmet needs
of patients. Economic and regulatory dynamics make it difficult
to predict growth in medtech, but in this exclusive interview
The Life Sciences Report,
veteran analyst Plovanic delivers both ideas and names that could
generate excellent returns for investors.
The Life Sciences Report:
What is the general feeling of institutional investors? Are they
positive on medtech? Are they seeing flows of funds come in from
I don't think investors are necessarily positive on medical
technology, but they are definitely looking for opportunities.
Medtech has been difficult from a macro perspective, and
therefore investors have not been focused on putting money to
work in this space. Over the last year or two it's been
challenging, to say the least.
We had a bit of a run-up in medtech between mid-December and end
of January. My assumption was that this was part of a general
Over the last 12 months, a lot of companies, especially the
growth names, have traded in a range after peaking at the end of
2010-early 2011. The stocks that did move in the sectors that I
cover were due to company-specific drivers. But as a whole, 2011
was probably more of a consolidation year.
So you have to be selective when you're choosing medtech stocks,
is that what you're saying?
I think you do, but I've also seen the risk trade in high-growth,
high-multiple stocks make advances. As money flows back into
medtech, it typically goes into that high-growth group.
On the outperformers, you think momentum has been the issue
On the growth names, definitely.
What has been holding medtech back? Is it macroeconomic, larger
co-pays/annual deductibles, regulatory? What is the single
All of the above. Obviously, these have resulted in a slowdown in
procedure volumes, which have changed drastically, and that has
negatively impacted these companies. On top of that, we're
looking at negative pricing in orthopedics, which used to be a
sector that realized positive pricing power, and that's
macroeconomic driven as well. Two things have really impacted the
sector, volumes and pricing. All of these factors have impacted
the growth rates and the bottom line earnings of these companies
for the past couple of years and they will likely continue to do
so going forward as well.
The earth has really shifted under the feet of this sector.
Right. Also, new technologies are the lifeblood of any industry,
and one of the big issues, for med tech as a whole as well as
orthopedics, is the regulatory environment. It has become more
challenging and more stringent, resulting in fewer new
technologies being approved, and that has caused growth rates to
slow. That has also been one of the causes of lower pricing.
Typically, a new product allows you to gain a premium price. If
you don't have innovation and new technologies coming to market,
you can't drive price mix.
So, companies need to innovate, but the regulatory environment is
in the way?
Companies are trying to innovate, but with more stringent
requirements, it pushes out the timelines and increases the cost
of innovation. Companies have to become more selective on what
technologies they move forward with, based on what they believe
the regulatory process may or may not be for any given
Has the slowdown in regulatory approvals been a factor related to
the increasing complexity of the technology, or is there
something else going on at the U.S. Food and Drug Administration
That's a difficult question to answer. Has the complexity of the
devices changed drastically in the last four years? No, but it
has probably changed over time. Maybe the regulatory process did
not keep pace with technology advances over the past few decades,
and it's finally making the changes necessary. But we've
definitely seen a much more difficult regulatory environment.
Bill, do you expect to see consolidation in medtech during
We have already seen some consolidation, and given the balance
sheets of the larger companies and the lack of innovation, I
would expect to continue to see that consolidation in order to
drive the top line revenues for those larger companies.
I assume that investors want to play the boomer market, and that
would mean largely musculoskeletal. Of course it could also be
the cardiovascular realm as people live longer.
It could be orthopedics, cardiovascular, diabetes, obesity or
aesthetics. There are many different ways to play that
Are there decent margins to be had now in orthopedics?
In the orthopedic companies that I follow, the range of gross
margins is typically from 60-80%. There are always some outliers,
but that's the range. You don't start falling down to a 50% or
below gross margin until you get into truly commoditized product
What shifts are you seeing in the orthopedic/spine industry
For total joints, the discussion has shifted away from materials
and squarely onto fit and alignment. That could be achieved via
robotic surgery, custom implants or custom cutting guides, but
we've definitely moved away from materials as the solution.
There haven't been a lot of new technologies in the spine
area, but the one bright spot is artificial discs. I think we'll
see the approval of several cervical discs coming over the next
12-24 months. I think that can help drive that market.
With extremities/trauma, it's been the creation of
procedure-specific implants. Customization is really a very
fast-growing market, and that's driven an increased focus on this
segment. Surgeons and companies are coming up with new products
that are specifically kitted to solve a problem. If I need a
plate for a procedure, it's specifically made for that specific
anatomy rather than bending and cutting a standard plate to make
it fit. I think we've seen a lot of those types of technology
advancements helping to drive that market.
Bill, what companies are you talking to investors about
Growth names include MAKO Surgical Corp. (MAKO:NASDAQ) in
robotics; I also follow DexCom Inc. (DXCM:NASDAQ) in diabetes
with its continuous glucose monitoring sensor; Insulet Corp.
(PODD:NASDAQ) with its disposable insulin pumps; and NxStage
Medical Inc. (NXTM:NASDAQ) in the dialysis market. In terms of
value names, there's NuVasive Inc. (NUVA:NASDAQ) in spine;
ArthroCare Corp. (ARTC:NASDAQ) in sports medicine. And then there
is Solta Medical (SLTM: NASDAQ) in the aesthetics space with its
non-invasive fat ablation product that it has just started
commercializing in the beginning of this year. Of the 21 stocks I
cover, those seven names are probably the most discussed on my
coverage list today.
You have DexCom rated Buy with an $11.50 price target. It's
pretty close to that now. Do you expect to raise your target?
I believe the company is well positioned this year in terms of
the guidance it provided and the potential for it to outperform
those expectations. As companies beat and raise estimates, the
price targets can typically move up. I think the big value driver
for this company will be its Gen 4 sensor, which is not due out
until the end of this year/early next year. Again, I repeat that
stocks tend to perform well in beat-and-raise years.
You mentioned NxStage Medical, a growth story. It's about
portable home hemodialysis. You raised your target price from $24
to $26. This is the kind of technology that can reduce cost for
an insurer, can it not?
I think the key to NxStage's home hemodialysis is the fact that
it's a better therapy for the patient. The economic data showing
that it reduces costs to the system will be out the middle of
this year. We've seen data from frequent dialysis studies and it
tends to point in that direction, but I think what people need to
really understand is that when nephrologists and nurses are
polled, almost all, like 98-99% of them, would rather patients be
on home hemo or peritoneal dialysis rather than in-center. More
frequent dialysis allows for lower drug use, better quality of
life and quicker recovery times post treatment. It is the right
You say economic data are coming out mid-year. I'm just thinking
here, FDA is considering economics along with safety and efficacy
in medtech. Why doesn't FDA just defer this to Centers for
Medicare & Medicaid Services (
) and judge the product on its safety and efficacy?
So, do you have a comment on that?
Can NxStage improve predictability for reimbursement
That will come over time. CMS will need to do that. One other
thing about this industry is that the service providers, the
clinics such as DaVita Inc. (DVA:NYSE) and Fresenius Medical Care
AG & Co. (FMS:NYSE), are the gatekeepers. They're the ones
that get reimbursed and they basically control which therapy the
patient goes on. So at the end of the day, you get predictability
when payers know exactly what the economic model looks like for
each type of therapy, and adoption will likely increase. I would
say at this point, NxStage, which has more than 5,000 patients on
its therapy, has been mostly a word-of-mouth, grassroots
You mentioned the robotics company MAKO Surgical, another of your
growth names. This stock is up 35% in the past three months and
has almost doubled in the past 12 months. What makes it so
I believe it's also the most expensive stock in med tech from an
enterprise value:sales multiple. Robotics has been a big value
driver. Intuitive Surgical Inc. (ISRG:NASDAQ) was a great
success, and I think people point to that company a lot. MAKO has
done a phenomenal job in the unicompartmental knee replacement
market. Historically, the challenge was surgeons being able to
implant the replacements correctly. It was very
technique-sensitive. What MAKO did was to make this procedure
extremely reproducible in any surgeon's hands. Why replace the
whole joint when you can intervene earlier and replace only the
However, the value and the driver of this stock over the last
12 months have been the expectations for the hip market, which it
has been slowly launching. MAKO showed the product at the
American Academy of Orthopaedic Surgeons' big conference in the
spring of 2011, and it started commercializing it at the end of
2011. I think that's what really drove the stock over the last 12
months. I think the jury is still out on how quickly the adoption
and penetration rate will be for the hip application and
You also mentioned ArthroCare, which has had its issues with the
Department of Justice (DOJ). What do you have it rated?
We have a Buy rating on ArthroCare, and our target is $29.
What do you like about it?
The thesis on ArthroCare is it is a market leader in the two
markets where it competes. It started as a platform technology
company and created the market-leading position in sports
medicine for the use of energy for the cutting/ablating of soft
tissue rather than using mechanical tools. It now has 50% of that
energy market in sports medicine. It then utilized that beachhead
to backfill with other products that would be used in
arthroscopic procedures. It also took the technology and moved it
into the ear, nose and throat (ENT) market for tonsillectomies
where it now has 40% market share. It has also done some
backfilling with some other ENT products. It's a company that has
great market leadership in the subsegments where it competes. It
also has a very high free cash flow yield, floating around 10%
But it's had the legal issues.
The ongoing legal issues have been its biggest challenges over
the last three or four years. But it's been going through its
checklist one-by-one and ticking them off. It had almost
completed that, and then a new one popped up. We'll see how long
that one takes to get resolved. This is a company that has great
market position and great potential. In terms of acquisition, it
would fit well into somebody else's portfolio.
So it's a takeout candidate, but now it has the new issue with
the DOJ which could put more pressure on the stock.
It would delay the timing of anything, which therefore puts
pressure on the stock. That's why the stock moved from $30 down
to where it is.
Are the shareholder lawsuits nuisances, or are they material as
Actually it took a charge for the shareholder lawsuits and put
the money aside for that. So, that's one of the legal issues that
has been resolved.
I'm noting that you follow and have a Buy on Exactech Inc.
(EXAC:NASDAQ) with a target of $27. Could you speak to that
Exactech is actually the company I've had coverage on the
longest, since March 1998.
Your target price implies about 80% upside.
The company trades at a significant discount to the rest of small
cap medtech. When it gets some of its new product cycle moving
and growing its top line, it will be lifting to a valuation
that's closer in line with all of small cap.
The company appears diversified in its product lines, and I
thought that was interesting considering its small market
The challenge with these smaller companies is that orthopedics is
a capital-intensive business, and they tend to have very low free
cash flows. All their money needs to be reinvested into
instruments to help grow the business. So orthopedics is
definitely a business of scale, and scale could be $1 billion (
) in revenue, but it's difficult to get to that $1B because share
shifts very slowly.
You mentioned one of your value names, NuVasive, and you have it
Buy-rated with a $21 target.
NuVasive is a stock that we've covered for probably three or four
years. We went negative on it with a Hold rating about a year and
a half ago. We foresaw a lot of the challenges coming in the
spine market, including price and procedure-volume impact. At
current valuations, we recently upgraded it. Given the
acquisition of the neuromonitoring business, we felt that this
stock was finally positioned where it could meet or exceed
expectations. We felt that if approval of its cervical disc and
the cross-selling efforts with neuromonitoring could come to
fruition that it would be all upside to the numbers. Upside tends
to drive stock higher. Given the current valuation, which is
anywhere between 1-1.5x enterprise value:revenue, that tends to
be a bottom for these names. On top of that, NuVasive is the
category leader. It created the lateral procedure where it leads
the market. It is considered the best player with that
technology, and that is a great asset in my opinion.
Insulet is one of your growth names. Would you comment on
Insulet is an interesting technology. It is the first player to
market with a three-day, disposable insulin pump. It's another
company like DexCom that has had challenges with new products
coming through the FDA. Its next-generation disposable pump is a
very promising technology, and should help more from a profit and
loss standpoint than anything else. It's a little smaller, and it
might be a little more applicable to a broader patient population
as a smaller patient can wear it. But I think this is more of a
gross margin story, allowing it to increase from a 50% level to,
say a 65-70% gross margin. We have Insulet rated Buy, and the
target is $27.
You mentioned Solta Medical in the aesthetics space.
Solta really pioneered fractional laser technology, Fraxel, for
skin resurfacing and also the use of radiofrequency energy for
skin tightening under the Thermage brand. Solta is different from
the rest of the aesthetics pack in that a large component, more
than 50% of its business model, is disposables, which is
significantly higher than any of its energy device competitors.
Those disposables carry ~90% gross margins. The reason we like it
that it is literally in the first inning of a new product cycle
in a new market with a different technology to be sold to its
current customer base. It acquired Liposonix, a noninvasive fat
ablation product. It is second to market in this category, and it
just began commercializing the product at the end of 2011. We'll
see the first significant revenues from this product in Q112.
Non-invasive fat ablation is a very fast-growing segment of the
These procedures are largely non-reimbursable.
They're all cash out of pocket.
Bill, I enjoyed speaking with you.
Thank you very much.
William Plovanic joined Canaccord in 2007 as managing
director, medical technology equity research analyst. He has been
a publishing sell-side analyst with coverage of medical devices
for over 15 years. Mr. Plovanic's areas of coverage include
orthopedics, diabetes, obesity, neuro-technologies, dialysis,
aesthetics and general surgery. In 2009, Plovanic was ranked as
the #2 Earnings Estimator for Health Care Equipment &
Supplies by Starmine. Furthermore, in 2003 and 2004, Mr. Plovanic
was selected as a
Wall Street Journal
"All Star" Analyst in the medical device sector and in 2002
was named the #1 ranked analyst by Starmine for stock picking and
performance in the medical technology sector. Mr. Plovanic is a
frequent presenter at medical and industry meetings. Prior to
Canaccord, Plovanic was a managing director and senior research
analyst at First Albany (now Gleacher & Company). Previously,
he worked at PMG Capital covering medical devices and products.
He also worked as director of research for the capital markets
division of LaSalle St. Securities Inc., where he focused on the
small-cap healthcare, technology and biotechnology industries. He
graduated from Bradley University with a Bachelor of Science in
finance and is a chartered financial analyst.
1) George S. Mack of
The Life Sciences Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are
The Life Sciences Report:
3) Bill Plovanic: I personally and/or my family own shares of the
following companies mentioned in this interview: None. I
personally and/or my family am paid by the following companies
mentioned in this interview: DexCom, Insulet Corp. and TranS1 are
investment banking clients of Canaccord Genuity Inc. Additional
information, including disclosures regarding all securities under
research coverage, is available at Additional information,
including disclosures regarding all securities under research
coverage, is available at
was not paid by Streetwise for participating in this story.
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