Spine Market Share Changes This Year

Sales reports for the first nine months of this year confirm that, with but two key exceptions – Stryker and Synthes, larger spine companies are continuing to give market share to smaller players.  Can larger suppliers reverse these trends?  Will their eventual solutions become acquisition and consolidation strategies? Given the challenging macro-economic environment and the hypercompetitive marketplace in spine, both acquirers and aquirees appear to be in a position to uniquely benefit from acquisitions.

Certainly, smaller companies, starved for capital, face a quasi-frozen credit market and increasing hesitance on the part of venture capital firms to invest. By investing in smaller technology driven spinal implant firms, larger spine companies will provide the much needed working capital to fledgling spine companies while, at the same time ensuring a inflow of differentiated technology for themselves.

Reviewing the results so far this year, we are lowering our fourth quarter industry revenue estimates primarily as a result of revenue shortfalls as reported by the larger spine companies.

Spine: Third-Quarter Revenue Growth

Table 1 displays our summary of third-quarter spine revenues and fourth-quarter estimates. We estimate that the global spine market grew 12.6% in 3Q2008, (vs. 14% in 2Q2008). The third and fourth quarters are critical for spine companies for several reasons. One is that the annual North American Spine Society (NASS) meeting takes place in the third quarter, and the conference is often used by companies as a launching pad for new products. Another reason is that NASS is the site for numerous analyst meetings during which companies give financial guidance for the fourth quarter.

Seasonality tends to be a factor in the fourth quarter. From 2005-2007, on average, spine companies realized 26.2% of their revenues in the fourth quarter. This ratio tends to be more pronounced in smaller, faster growing companies. For example, Trans1, Inc. and NuVasive, Inc. recorded 30.1% and 30.4%, respectively, of their revenues in the fourth quarter of 2007. Small cap spine companies often grow revenues at an increasing rate quarter over quarter. The most common explanation for proportionately higher fourth quarter earnings is that by the end of the year many potential patients have met their deductibles, and are hence opting for surgery.  

Looking ahead, we forecast a 10%–12% (or $2.062 billion) overall revenue growth for the global spine and related biologics market for 4Q2008. This is down from our previous estimates of 12%–14% growth, or $2.241 billion.

We have ratcheted down our annual industry revenue growth estimates for the following reasons:

• Overall, there has been a lack of revenue growth from major players such as Medtronic (Sofamor-Danek), Biomet, JNJ (DePuy), and Orthofix, which together comprise a market share close to 60%
• Near anemic core spine and biologics growth at Medtronic (spine revenues came in nearly $45 million short of consensus)
• A probable slowdown in hospital CAPEX
• Uncertainty regarding how increasing unemployment may impact elective spine procedures. Analysts estimate that 40% of spine procedures are elective and are therefore economically sensitive
• The impact that a strengthening dollar (FX) may have on international operations
• A difficult credit environment and its impact on working capital requirements at smaller spine companies.

Table 1: Spine Market Revenue Model

Below Market Revenue Growth From Spine Leaders

Table 2 displays annual revenue growth for public spine companies. While smaller spine companies are growing faster, the majority of the revenues are still derived from the largest companies. Any slowdown in revenue growth from these companies will negatively impact overall industry revenue growth.

Table 2: Spine Market Annual Revenue Growth

Medtronic Sofamor-Danek

Overall spine revenues rose to $829 million in the third quarter (vs. $660 million in 3Q2007), up 25%. Core spinal implants and biologics, excluding Kyphon, grew 3.4% in the third quarter (vs. 5% in 2Q2008), to $485 million, lagging overall industry growth of 12.6%. The Kyphon business registered $198 million for the quarter, declining 10%. Third quarter biologics revenue growth was flat year-over-year coming in at $198 million for the quarter (vs. $221 million in 2Q2008) declining 10.4% in the third quarter. Growth in biologics was flat due to issues surrounding the off-label use of Infuse® and a recent subpoena from the Department of Justice.

Medtronic is taking steps to return to market growth rates in both its Kyphon and biologics businesses. At NASS in Toronto, Canada, this past October, the company released the X-Stop® PEEK® IPD system and plans to build on clinical data regarding the device. Medtronic stated that U.S. X-Stop revenues grew at 14% sequentially. Also, Medtronic is marketing Infuse for other applications such as maxillofacial. On November 17th, Medtronic announced that it had purchased the assets and intellectual property of Pabban Development, Inc. This adds a bone cement delivery system to Medtronic’s spine portfolio that will allow surgeons treating vertebral compression fractures to be farther from the fluoroscope.

Table 3: Medtronic Quarterly Revenue Growth

DePuy Spine

Overall spine revenues rose to $221 million in the third quarter (vs. $204 million in 3Q2007), up 8.3% this year. Growth has been modest for the spine division of DePuy, and sales of the Charité disc have not exploded as was anticipated. However, we see a bright future for DePuy Spine driven by a myriad of new product launches. A focus on MIS should also aid DePuy in growth. At American Academy of Orthopaedic Surgeons (AAOS) in March 2008, Gary Fischetti, President of DePuy Spine stated that, "Since the beginning of last year we've introduced eight new products and we are on track to bring an even larger number to the marketplace this year."

Listed below are key DePuy product introductions that have taken place in 2008.

• April 2008: Launches Concorde™ Bullet VBR
• April 2008: Launches new Expedium™ 4.5 spine system for deformity treatment
• April 2008:  Launches new VIPER™ 2 Pedicle Screw Fixation System at AANS (American Association of Neurological Surgeons)
• May 2008: Launches EXPEDIUM™ PEEK rod system
• May 2008: Launches Confidence™ system to treat VCF fractures at Spineweek
• June 2008: Launches Eagle and Swift ACP systems
• September 2008: Resolves patent litigation with Allez Spine

By gaining exposure to the VCF market through the Confidence system (acquired in 2007), the MIS market via the VIPER, and the niche deformity market via Expedium, DePuy is laying the groundwork for renewed growth in 2009.

We forecast 4Q revenues to grow 6% at DePuy Spine, rising to $224 million. We expect annual revenues to be $924 million in 2008, up 6.2% from the prior year.

Synthes Spine

Synthes Spine is quiet. However, the company is growing revenues and may become the number two spine company in terms of annual revenues by 2010. Synthes is not obligated to report quarterly revenues, so these are estimates. On October 23rd, Synthes reported third quarter 2008 sales of $807.7 million—a 17.2% growth over last year. The release was laden with comments referring to strong growth in its spine unit. The company even sited growth in its lumbar and artificial discs, which have faced reimbursement challenges. Below are listed key points made in the release signaling strong spine growth.

• Synapse, Pangea, Zero-P and SynFix-LR systems were the key contributors to Synthes’ encouraging performance.
• “Synapse is a comprehensive set of instruments and implants designed for posterior stabilization of the upper spine. The implants provide the flexibility required to accommodate variations in patient anatomy, therefore satisfying the preferences of numerous surgeons while simplifying the procedure.”
• “Pangea is a pedicle screw system used to stabilize degenerated lumbar spine segments. Zero-P is designed as a zero-profile plate/spacer combination with screws to provide similar stability to a traditional cervical plate and inter-body spacer.”
• “Additionally, the ProDisc®-Total Disc Replacement systems (both lumbar and cervical) continued to gain traction in the U.S. market.”

Zimmer, Stryker, and Biomet Spine

On September 4th, Zimmer acquired Abbott Spine for 3.3x 2007 revenues or $360 million in cash. This could contribute an additional $100 million in annual revenues to Zimmer. However, we view this as primarily an acquisition of scale. The company reported third quarter revenues of $50 million (vs. $46.1 million in 3Q2007) up 8.5% this year. During the third quarter earnings conference call, held on October 23rd, the company stated that spine sales in the Americas were up 2.2%, Europe increased 19.1%, and Asia Pacific was up over 100% on a small base. The company did not provide fourth quarter guidance in spine. We estimate fourth quarter spine revenues will rise 42% this year to $78.8 million. Spine revenues excluding Abbott will rise 7% this year to $58.8 million.

Stryker Spine continues to grow above the industry average and gain market share. Spine revenues grew 21% last year (31% domestically) to $100.1 million. Growth was lead by inter-body and lumbar products. The company also stated that international growth returned to double digits. In the company’s third quarter earnings conference call, held on October 16th, Dean Bergy, Vice President and Chief Financial Officer, stated: “On the geographic basis, Pacific, Canada, Japan, and Latin America all posted strong levels of operational growth and Europe was solid.” Stryker may be the best-positioned orthopedic company and we believe that momentum in spine will continue into the fourth quarter. We estimate fourth quarter revenues will rise 18% over last year to $144 million. We estimate full-year spine revenues to rise 20.7%, equating to $512 million (vs. $424 million in 2007).

Biomet Spine reported third quarter revenues of $51.3 million (vs. $53.5 million in 3Q2007), down 4.1% annually. Biomet Spine has struggled after being acquired by private equity, in part due to declining market share in its spinal stimulation business. We forecast fourth quarter revenues of $52 million, or a 5% growth this year on a seasonally strong fourth quarter.

Orthofix/Blackstone

Change is on the way at Orthofix. During the third quarter, Brad Mason was named president of the spine division. Orthofix and Biomet compete in the spine stimulation business. Biomet has been on the loosing end recently. In the Orthofix third quarter earnings conference call held November 6th, the company stated that spinal stimulation revenues grew 12%, while Blackstone’s implant and biologic sales decreased 13%. The issue is returning to growth at Blackstone. The company has taken the following steps to accelerate growth in the spine implants and biologics division.

1. Brad Mason is taking steps to stabilize the spine distribution network
2. Restructuring activities focused on strengthening leadership in the spine division
3. The company announced an agreement with the Musculoskeletal Transplant Foundation (MFT) initially focusing on the final development and commercialization of a new stem cell-based allograft to be released in 2Q2009.
4. The company will be relocating its Massachusetts operations to the McKinney, Texas, facility, and moving Blackstone into the Orthofix Oracle ERP system. The new facility will also include a new world class national training center as well as a state of the art innovation and custom surgical instrument shop for use by both the spine and orthopedic engineering and marketing teams.
5. The company anticipates new product launches in 2009 and a sufficient inventory of Trinity.

NuVasive’s third quarter revenues grew to $67 million, up 73.8% from last year. NuVasive continues to gain market share and is well on its way to its goal of $500 million in annual revenues. Osteocel, which contributed $4.4 million in revenues for the quarter, is poised to be a key contributor to NuVasive’s goal of $100 million in biologics related revenues.

Alphatec’s third quarter revenues grew to $25.8 million (vs. $20.3 million in 3Q2007), up 27% over last year. Alphatec has made a remarkable recovery in 2008 under CEO Dirk Kuyper, and is targeting its business toward the aging spine, which we believe is currently being overlooked by the spine industry. We remain bullish regarding prospects for continued growth at Alphatec. We forecast fourth quarter revenues of $27 million, growing 24.2% per year. We estimate fiscal year 2008 revenues at $99 million–$100 million (+24.1% per year).

Trans1’s third quarter revenues grew to $6 million, up 39.1% annually. The company reported that 671 AxiLIF™ procedures were performed in the quarter (vs. 469 in 3Q2007). AxiLIF procedure growth rose 43% last year. The company also had a limited market release of its AxiaLIF™ 2L, which enables Trans1’s unique approach to be used in two-level fusions. Management gave a fourth quarter revenue estimate of $6.1 million-$6.5 million. We estimate fourth quarter revenues of $6.3 (+27%) and fiscal 2008 revenues of $24.2 million (+47%).

Globus Medical is the largest, private spine company. On February 4, 2008, in a company press release Globus announced that the company recorded $123 million in revenues during 2007, up 50% from last year. While we caution that these are estimates, we believe that this momentum has continued through 2008. We forecast 45% growth in 2008, with annual revenues rising to $178 million.

 Globus is focused on high-growth markets—motion preservation for example. The company is developing the Secure®-C cervical artificial disc, but is not entering into the more questionable lumbar disc market. It is developing the FLEXUS™ interspinous process spacer, focusing on the growing stenosis market. On May 8th, the company announced it had completed enrollment in its Secure-C clinical trial. On August 15th, the company announced that the first surgeries were performed in the FLEXUS IDE clinical trial.

Thesis Revisited

Our industry thesis is based on the larger players in spine losing market share and being forced into growth through acquisition strategies. Alternatively, their smaller counterparts, who have developed disruptive, high growth technologies, face a shortage of capital. This helps to create an environment ripe for consolidation and is mutually beneficial for all parties involved.

Market Share Analysis

Our analysis by company shows continued market share losses by major spine players excluding acquisitions. Consider third quarter revenue growth at the fastest growing spine companies displayed in Table 4. With this revenue growth, comes market share gains.

Table 4: Third Quarter Revenue Growth/Market Share Comparison

Companies best positioned to complete an acquisition are those with strong balance sheets laden with cash. We may see a decline in the use of equity in acquisitions throughout the first half of 2009 due to the significant multiple contraction that has taken place. Given the current economic environment, we turn to companies with solid balance sheets. Stryker is perhaps the top candidate for making an acquisition. In its most recent 10-Q, the company reported $668 million in cash and equivalents on the balance sheet along with $1.539 billion marketable securities. NuVasive reported $104.3 million in cash on the balance sheet according to its most recent 10-Q. We would expect NuVasive to be acquisitive should the right opportunity present itself.

Spine as It Stands