(Seekingalpha.com)–Not a lot has really changed for NuVasive (NASDAQ:NUVA). The third-largest spine company in the U.S. by market share, NuVasive continues to take share from larger players on the back of innovative products that offer meaningful advantages in terms of patient outcomes and surgeon convenience. On the other hand, concerns remain about the company’s weaker share and lower profits outside the U.S., the company’s position in biologics, and the real prospects for meaningful margin improvement in the coming years.
While LDR Holding (NASDAQ:LDRH) looks like a higher risk/reward option, NuVasive and Globus Medical (NYSE:GMED) seem similarly priced in a market that has turned more hostile toward growth med-tech. I don’t necessarily think that NuVasive will hit its margin targets (or at least not quickly), but I do believe the company has a solid plan for growing its spine business and using opportunistic M&A to supplement internal innovation. It’s not uncommon for the market to run hot and cold on growth med-tech, and I don’t know how long this apparent cold cycle will last, but NuVasive is at least worth a spot on a watch list.
IGA May Not Be XLIF, But Innovation Is Still Significant
NuVasive’s eXtreme Lateral Interbody Fusion (XLIF) platform has been a significant driver for the company, as lateral access has shown to lead to less trauma and blood loss and faster recovery times. With that (but not only that), NuVasive established itself as a major player in minimally invasive spine surgery, a key growth market within the $10 billion global spine market where NuVasive enjoys a roughly 10% share. What’s more, NuVasive’s rivals have found it difficult to compete with XLIF, with only Medtronic (NYSE:MDT), Globus, Zimmer Biomet (NYSE:ZBH), and K2M (NASDAQ:KTWO) gaining real competitive traction in my view.
Now NuVasive is looking to its Integrated Global Alignment (or “iGA”) platform as its next new growth platform. This is a comprehensive platform, including planning software, monitoring, and tools like ReLine pedicle screws and new interbody spacers. The idea here is that proper spinal alignment has a meaningful impact on long-term outcomes, and getting the alignment right helps reduce adjacent level disease. Considering that gold-standard spinal procedure success rates are still in the 70% range, there’s definitely room for improvement and iGA could be a player on that basis.
Whether iGA is “the next XLIF” or not, NuVasive continues to prioritize innovation. That’s wise, as I believe innovation (particularly in the minimally invasive space) is a key driver of market share in the spine surgery space, as many large companies like Johnson & Johnson (NYSE:JNJ) and Medtronic are tied to older products were price erosion has been more severe. As of the company’s December analyst day, management laid out a target for higher R&D spending (targeting 7% of sales over time versus 4% recently). Management has also apparently taken a page out of Globus’s playbook, mentioning a target of 10 product launches a year and an interest in robotic systems.
The early 2016 acquisition of Ellipse also reflects this interest in innovative disruptive products. NuVasive paid over $400 million (including the milestone) and over 10 times sales to acquire a fast-growing platform of procedural solutions for skeletal deformities. Ellipse’s MAGEC technology uses gear-based transmission systems powered by magnets to allow for implants to be adjusted via remote control and without follow-up surgeries. These products are already in use in scoliosis and limb length discrepancies, and this looks like a high-potential technology. I’d also note that there could be revenue synergies, as MAGEC rods are used with screws and those screws are usually sourced from Johnson & Johnson, Medtronic, or Stryker (NYSE:SYK) – substituting with NuVasive’s screws (at $750 a pop) could add $7,500 in sales per procedure for NuVasive.
Will The Margin Gap Shrink?
NuVasive generates attractive gross margins, but the company spends very large amounts of money on SG&A. Some of this is at least partly unavoidable – there are expenses with instrumentation and whatnot that are just impossible to ignore. What’s more, NuVasive continues to spend money supporting sub-scale foreign operations that just aren’t generating enough revenue unit to produce attractive leverage.
Management has laid out some ambitious plans to get operating margins into the mid-20%’s (after a 17% GAAP result for 2015). Driving four points from further insourcing of manufacturing seems ambitious but not impossible. Likewise with better international scale – four points of margin leverage is a steep target, but NuVasive’s 4% OUS share is certainly a number that can be improved. Another seven points are to come from various sales force efficiency efforts, improved inventory management, reduced instrumention costs, and so on. Time will tell; I think NuVasive can and will improve its margins, but I see a risk that it takes longer and the results are less impressive than these goals.
Other Risks Seem Manageable
Companies like NuVasive and Globus have done well for themselves by taking share from larger players like Johnson & Johnson and Medtronic in recent years. Whether they can sustain that is a key factor in their outlooks. Some of the share growth has come from these companies focusing on innovative new products (particularly NuVasive’s focus on minimally invasive procedures), as Johnson & Johnson and others have seen significant price pressure on traditional fixation products. Given the imperfections of current procedures, I do believe there is still plenty of room for innovative products. That said, the instrumentation and inventory demands of large product launches can be significant and that acts as something of a headwind as companies grow.
NuVasive also needs to improve its positioning in the biologics space. Biologic products are used in more than two-thirds of cases, but NuVasive’s share in biologics has historically been a few points behind its overall share. New products like Osteocel Pro and AttraX should help, but Stryker has apparently been pretty aggressive with Bio4 (which it has through a partnership with Osiris (NASDAQ:OSIR)) pricing in an effort to establish the product.
I also expect NuVasive to continue to be an acquirer in the spine space. The Ellipse transaction likely means a large deal is less likely in the near term, but there are a lot of small companies in the instrument, monitoring, and biologics spaces that could make sense. I also wouldn’t be surprised if NuVasive looked to acquire more international distributors (it acquired its Brazilian distributor recently) to accelerate the process of achieving scale outside the U.S. and lifting that OUS market share.