Globus Medical Has The Growth, But What About Value?

On first glance, Globus Medical (GMED) looks like it could be one of the unicorns of the med-tech space – a legit growth story that the market hasn’t already pushed up to a red-hot valuation. Globus has what seems to be a sustainable culture built around product innovation, and that steady stream of innovative products could be just the ticket for success in a price-constrained implant world. That said, valuation isn’t quite the slam-dunk that value investors may hope to see.
As We Knew, Globus Did Well At The End Of 2012
Between the earlier release of Q4 revenue numbers and the results we’ve seen from other major spine companies like Johnson & Johnson (JNJ), Medtronic (MDT), NuVasive (NUVA), and Stryker (SYK), it was already clear that Globus had a very good quarter in a period where it looks like the spine market has found some stable footing.Revenue rose 14% this quarter, which was just slightly better than the sell-side had predicted prior to the early release. By product segment, “Innovative Fusion” saw 3% growth (58% of the total), while “Disruptive Technologies” revenue rose 35% and made up the remainder.Globus has made a name for itself with uncommonly good margins, and that continued this quarter. Gross margin improved more than two and a half points (to a better-than-Medtronic level of 80.5%), while operating income rose 23% despite ongoing spending increases in marketing and R&D.
Still Winning In The Spine Market
While the spine market as a whole probably just barely grew in the fourth quarter, Globus continues to gain share. Nobody topped the 14% growth rate that the company saw this quarter – NuVasive was strong at 10%, while Stryker was the best of the big boys at roughly 5% growth. Johnson & Johnson and Medtronic, which together account for more than half of the market, both saw revenue declines this quarter.Keep in mind, though, that we’re still talking about a relative small fish in a big pond. Estimates of the size of the spine market vary (in part on what is included/excluded), but Globus likely has about 5% to 6% share right now – suggesting ample opportunity for growth and expansion.
New Mousetraps Drive Sales
Globus is led by a former executive of Synthes, a company whose strong position in spine (and trauma) was a significant factor in why JNJ bought the company. Under his leadership, Globus has been a company focused on innovation and product development, with a target of 12-month development times and multiple (10 or more) product introductions each year. Curiously, though, the company is pretty efficient with its R&D spending relative to its deep pipeline – routinely spending less than 10% of revenue on R&D.As time goes on, I believe the importance of innovation is only going to increase in orthopedics (and, specific to Globus, in spinal care). While hospitals used to try to control costs by dealing exclusively with one or two vendors, it looks like capitation has come back into vogue. Under capitation, hospitals set a fixed amount that they are willing to pay for various implants, devices, and so on – if you are willing to sell for that price (or less), you can do business. If not, you’re left on the outside.Oddly enough, this can favor a small company like Globus. Under capitation, it’s pretty common to have different prices for different kinds of implants and new/innovative and niche products often fall outside of those categories – giving the innovative company an “in” it can exploit to win business. It’s also true that larger companies tend to be more sluggish with new product development and tend to have a larger cost basis – making it tougher to compete in that sort of environment.At the same time, while physician-owned distributors (PODs) have created price pressure in the market, I don’t think it will last. Simply put, the potential conflicts of interest seem too large for this approach to last indefinitely.What this all means for Globus is that the spine market is a pretty attractive place to be. If nothing else, Globus can still prosper by being innovative with the “small stuff” – products that generate $20 million or $40 million may not be seen as mission-critical at Medtronic or JNJ, but still matter a lot to Globus. At the same time, though, the orthopedic market can be a very challenging place for the smaller players – capitation may not last forever and if hospitals go back to bundling in a big way, Globus may find itself struggling to compete due to its smaller product line.
Can Globus’s Margin Advantage Last?
The margins at Globus Medical certainly stand out, particularly when compared to those of NuVasive. The question is whether they can be sustained for the long-term.The very high gross margins could be explained, in part, by the company’s focus on rapid launches of innovative products that capture premium prices – simply put, their sales are worth more. But it’s also true that Globus relies on an outside manufacturer owned by the CEO’s family for about 25% or so of its COGS. The company’s filings talk about an “arms-length basis” for negotiations between the company and this supplier, but I have to wonder if this company takes lower than normal margins for the products it supplies to the company. At any rate, it will be hard to maintain that elevated margin tied to new product launches as the company grows and matures, as the “installed base” will continued to grow over time and pricing will likely decline.On the marketing side, Globus is still pretty tiny, with about 20% of the U.S. sales reps as Medtronic. While the company hasn’t been adding sales reps willy-nilly, it does need more to keep growing. Likewise, the company is looking to increase its foreign sales over time, and that is a more expensive proposition – more than worthwhile in terms of long-term cash flow and returns on capital, mind you, but still negative for margins.
Good Growth Potential, But Beware The Waking Giant
Growth in the spine market has all but crashed in recent years, but I’m optimistic that we will see growth improve into the low single digits moving forward. Pricing pressure is not going to let up any time soon, but demographics favor ongoing procedure volume growth.I believe that Globus can grow its top line at a long-term rate of 10%, and perhaps higher if new products like artificial discs and a sacroiliac fusion product really take off and if Globus can maintain this particular culture as it becomes a larger player in the industry. By the same token, Globus’s very size makes it vulnerable for the meantime, as does the fact that a meaningful (approximately 15%) amount of sales come from doctors with financial/investment relationships with the company.The path of Globus’s margins will be very interesting. I think the company will be hard-pressed to maintain such high margins, and I would note that free cash flow margin has declined for the three years for which we have numbers. Still, I think the company will benefit from scale as it grows, and I think the pluses and negatives will largely cancel out at the free cash flow line – in other words, operating margins might weaken a bit, but the free cash flow margin will likely stay in the mid-teens. As such, I think free cash flow can grow at a long-term rate around 11% to 12%.It’s also important to note that Globus is in litigation with both Synthes and NuVasive regarding patent infringement. The downside in the Synthes case is likely limited (maybe sub-$10 million), as the company quickly swapped out infringing inventory. The NuVasive case will be more interesting. While it was only a component of a retractor that infringed, NuVasive is pushing for damages on a “convoy sales” basis – arguing that all products sold/used in a procedure with that retractor should be included in the total. While this could potentially be expensive, neither of this cases would seem to bear on future sales/profits.
Source:Stephen Simpson