Wrong time for Wright Medical
Don't invest now, but bone up on Wright Medical's breakthrough potential.
By Richard Saintvilus
Wright Medical (WMGI) investors continue to be unsure about what to do with the stock. Although Wright shares are up more than 28 percent year to date, the stock has been range-bound since mid-June. While the stagnant share price has frustrated investors, the Street's "wait-and-see" attitude should have come as no surprise.
Not only did the company's management just sell its OrthoRecon business to Chinese med-tech company MicroPort for $290 million in cash, but only a couple of months later, the Food and Drug Administration (FDA) rejected Wright's application for the company's Augment bone graph product, which is used as an alternative in foot and ankle fusion procedures.
Augment facilitated the process of taking bone from one part of the patient's body to use it in another area, a market dominated by the likes of Medtronic (MDT). Upon the FDA's rejection, shares of Wright Medical plummeted as much as 11 percent. While the stock has recovered some of those losses, I believe the FDA's rejection of Augment negated a key advantage the company achieved with the sale of its OrthoRecon business to MicroPort.
Although the sale to MicroPort was not a popular decision, I felt the move allowed Wright's management to focus on the orthopedic extremities and biologics businesses, which were growing at a much faster rate. Not to mention, the sale (then) alleviated the sort of execution risk that kept would-be investors at bay.
Essentially, in what seems like overnight, Wright Medical became a much easier company to understand. And following the company's better-than-expected third-quarter earnings report, investors now want to hop back onboard the bandwagon. I won't deny the impressive performance in the results, especially from a revenue and margin perspective. But given the stock's expensive valuation, not to mention the risk that Augment's approval may never come, I don't believe now is the right time to buy this stock.
Now, given Wright's unusual circumstances, I won't go so far as to evaluate its results with better-management companies like Johnson & Johnson (JNJ), which also has a strong orthopedics business. But Wright's performance, which includes revenue growth of 13 percent year-over-year, is on par with the likes of Zimmer (ZMH) and to a lesser extent Stryker (SYK), which posted growth of 18 percent.
One of my concerns with Augment's rejection by the FDA was that the company's core lower extremity business (foot and ankle) would have been adversely impacted, especially given that Wright had just sold off a business that was generating strong cash flows. But in impressive fashion, management was able to still grow the lower extremity business by 21 percent year-over-year, which strongly suggests that the company has begun to steal market share.
Biologics business, however, which produced year-over-year growth of only 4 percent, didn't quite measure up. This is while revenue the upper-extremities business declined 4 percent. Likewise, while it was indeed encouraging that management was able to advance gross margin to nearly 78 percent, I still can't generate a warm-and-fuzzy feeling for a company that is still operating at a loss (adjusted basis).
All of that said, I do see the appeal with Wright Medical, given the breakthrough that's possible in Augment. After all, getting a rejection letter from the FDA is sort of like a rite of passage in this industry - every company gets one at some point or another. The question, though, is if/when Augment gets approved, can management make a dent in the market already established by the likes of Medtronic?
Essentially, while Augment has been the main factor to this story over the past couple of quarters, the reality is that, it guarantees nothing for Wright other than market entry. In that regard, I can't recommend this stock yet -- now's just not the right time.
At the time of publication, the author held no position in any of the stocks mentioned.
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