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Wright Medical Doesn't Have the Right Answer

The stock licks its wounds after a profit shortfall and CEO departure stoke a 20% drop.


Wright Medical

(WMGI) - Get Free Report

, a niche player in the joint reconstruction business, things have gone terribly wrong.

The company's CEO, Laurence Fairey, has flown off to "pursue other interests" after warning of a huge profit shortfall on Tuesday. He lasted just 15 months on the job.

Fairey's exit comes at a time when even much larger orthopedic device makers, including industry giant



, have found themselves struggling to obtain the price increases that boosted their profitability in the past. But Fairey wound up doomed by other problems -- outside the domestic reconstructive business -- in the end.

"In what is becoming a familiar theme at Wright, the biologics and international divisions led the shortfall," noted Piper Jaffray analyst Raj Denhoy when downgrading Wright from outperform to market-perform on Wednesday. "The company believes the overall business tone is improving in these divisions, but the quarter was the fourth in a row of lackluster results, and we have little confidence in a quick turnaround."

In one of his last public comments as CEO, Fairey said that the company would fall short of its expectations due to a 10% dive in domestic biologics sales and ongoing challenges in both Italy and southern France. As a result, the company said it would post third-quarter revenue of $73.4 million -- up just 6% from a year ago -- and a profit of between 10 cents and 11 cents a share instead of the 17 cents Wall Street was anticipating.

After plunging 20% Wednesday, Wright gave up 6 cents Thursday to $19.14.

From the Hip

Still, Wright tried to serve up some good news along with the bad. Notably, the company said that its domestic reconstructive joint business -- a major focus for most industry investors -- continues to perform quite well. Specifically, it said that third-quarter sales of hips and knees rose by 15% and 13%, respectively.

Even so, some experts had expected better from the hip division in particular. Indeed, Banc of America analyst Steven Lichtman had predicted that hip sales would grow at twice the rate that they actually did.

"Despite outpacing the market in its U.S. hip business with 15% growth, the segment did come in below our estimate and management expectations and fell below 20% growth for the first time in 10 quarters," Lichtman wrote when downgrading Wright from buy to neutral on Wednesday. "We expect to learn more about the reason for the shortfall on the 3Q call."

No doubt, many investors will be listening then for signs of pricing pressures at the company. By now, in fact, some have already started betting on a downturn for even stronger players in the group.


(SYK) - Get Free Report

, a major seller of artificial joints, slid 35 cents to $47.14 on Thursday. Meanwhile, powerhouse Zimmer tumbled 76 cents to $66.07 -- setting its second new 52-week low of the week.

"Dead Money"

Baird analyst Suey Wong upgraded Wright from neutral to outperform in anticipation of better times down the road. To be sure, Wong admits that investors could be sitting on "dead money" for a while. However, he believes they could be rewarded for their patience in the end.

He suggests two possible catalysts that could send the stock higher. First, he says, Wright could become a takeover target just as DePuy and Howmedica were in the past. (Those two companies were acquired by

Johnson & Johnson

(JNJ) - Get Free Report

and Stryker, respectively.) Or, he says, Wright could finally start improving its performance on its own in the second half of 2006 and beyond.

In the meantime, Wong highlights some unique strengths that could make the company look attractive.

"Wright focuses on the smaller, higher-growth sectors of the orthopedic market that the bigger players tend to overlook," he notes. For example, he adds, "we estimate that Wright is the leader in finger and toe implants, with an estimated 75% share of the worldwide market."

Moreover, Wong says, Wright has managed to roll out some innovative products -- including one of the first-ever ceramic-on-ceramic artificial hips -- and has several others still in the pipeline. Going forward, he adds, the company should continue to benefit from favorable industry trends.

Still, Wong admits that Wright could encounter serious challenges. For starters, he says, Wright faces "formidable" competition from the larger companies that dominate the industry. For another, he adds, it could find itself hurting along with the sector as a whole.

Wong then goes on to warn about the very risk that, some believe, has already started to surface.

"A slowdown or reversal of the positive pricing trends in the U.S. reconstructive market that have helped rejuvenate the industry over the last couple of years would likely reduce company share valuations," he concedes. And "if this favorable pricing environment were to deteriorate, sales trends would likely be negatively impacted across the industry."