Skip to main content

Pricing pressures continue to aggravate the pain being felt by orthopedic device makers.

Take the situation at


(SYK) - Get Free Report

, for example. One of the more flexible players in the group, Stryker suffered a big fall this week due to weakness in its joint reconstruction business. Challenges in the crucial U.S. market, where hospitals have stepped up demands for cheaper artificial joints, obviously hurt.

During the latest quarter, analysts noted, Stryker saw domestic knee sales grow by just 11% -- and domestic hip sales actually dip -- for the first time in recent memory. The company still managed to hit its own profit target, if not Wall Street's, because of exceptionally strong results outside its orthopedic division. Even so, many investors have started to question whether Stryker can keep turning the cartwheels necessary to deliver the 20% earnings growth the market has come to expect.

If anything, however, some investors have grown even more concerned about other big players -- such as


( BMET) and



-- in the orthopedic space.

"We believe the orthopedic reconstructive market (i.e., hips and knees) is set for a long slowdown due to pricing pressure from hospitals, which are being squeezed by insurers," JMP Securities analyst Robert Faulkner wrote this week after reviewing Stryker's results. "We rate Stryker a market-perform because it is less dependant on its orthopedic reconstructive franchise for growth than others in the group, which we rate market-underperform."

Nevertheless, Stryker took the biggest hit on Wednesday. The company's stock tumbled 9.1% to $42.27 on news of its disappointing quarter. Meanwhile, shares of Zimmer -- which ranks as the largest orthopedic device maker in the world -- fell 6.9% to $63.25. And smaller Biomet slid 1.7% to $33.47.

All three stocks, which have been stellar performers in recent years, are now trading near their 52-week lows.


To be sure, investors heard plenty to worry them this week. Even

Johnson & Johnson

(JNJ) - Get Free Report

, which posted strong results for medical devices in general, offered some clear words of caution about the orthopedic business.

"My views are going to be in line with quite a few others in the sense that we see the growth rate for orthopedics slowing down, in part because of the ability to take less price," Mike Dormer, president of the company's DePuy orthopedics division, told analysts on Tuesday. "And that is true both in the United States and also some other countries around the world."

The news got even worse later in the day, when Stryker followed up with an earnings release and conference call of its own. After news of its disappointing results, Stryker found itself repeatedly questioned about pricing pressures on the company's orthopedic business.

Stryker's responses proved grim. Prices for joint implants will no longer climb by 2% or so, as they have in recent years. Instead, the company indicated, they will remain flat or even fall by "a point or two" in 2006. Moreover, Japan -- one of the largest joint implant markets in the world -- could slash reimbursements even more than some, like Zimmer, have bleakly projected.

"We are doing a lot to try to bring some more reasonableness to the table there," Stryker CEO Stephen MacMillan told analysts Tuesday afternoon. But "we're probably in the minus-6 to minus-10 range" in modeling for prices in Japan.

Widespread Pain

Meanwhile, back at home, Stryker has faced challenges inside large and small hospital systems alike. Stryker fielded many questions about its deal with hospital giant


(HCA) - Get Free Report

in particular. The company, along with DePuy and Zimmer, previously agreed to give HCA price cuts on joint implants with expectations of more business volume in return. But Stryker, like Zimmer, has now indicated that the arrangement has not worked out as planned.

Originally, the companies had suggested that they would return to higher prices if HCA failed to deliver on its side of the bargain. However, some now question whether that will really happen.

"If you don't get volume, can you claw back the price?" William Blair analyst Ben Andrew asked during Tuesday's conference call. "Or have you set a new benchmark that you cannot come back with your original price ever again?"

Stryker CFO Dean Bergy said the company clearly intends to get its old prices back and would "sure hope that the other side will live up" to its promises. Even so, some investors now doubt whether Stryker can in fact reverse the current situation.

Indeed, Stryker has apparently endured tough negotiations with hospital systems that lack HCA's muscle as well.

"Clearly, the big guys -- the HCAs of the world -- have pressure," MacMillan said. "But even some of the smaller hospitals, they are out there trying to manage their supply chain a little tighter than probably we've seen. ... So we don't want to say it's just the large customers."

That statement could trouble some who are looking for Biomet, at least, to get a break. Just last week, Baird analyst Suey Wong suggested that Biomet could suffer less pricing pressure than some because it tends to conduct business with small hospital operators that lack the negotiating power of larger hospital chains.

For its part, Biomet continues to stand out with its promises of price increases going forward. However, Stryker's recent comments suggest that Biomet could face unexpected challenges ahead.

After this week's updates by Johnson & Johnson and Stryker, Faulkner clearly feels more cautious about the orthopedic group as a whole.

"These two

companies together represent just under 50% of the worldwide reconstructive market, indicating that the industry may be decelerating even faster than our bearish outlook would suggest," Faulkner wrote. "Commentary on pricing and mix confirmed that the slowdown is real and accelerating."