Biomet ( BMET) has often looked downright nimble compared with its older and heftier peers. While rival orthopedic device makers have been pinched by belt-tightening at big customers like hospitals, Warsaw, Ind.-based Biomet has continued to secure premium prices. Many credit the company's innovative edge and the drive of founding CEO Dane Miller for that success. But now a test is emerging that may challenge even fleet-footed Biomet's mettle. Observers say the economics of the implant business are getting even tougher for these manufacturers, owing to deepening cutbacks at hospitals. More surprising, perhpas, is the identity of one emerging skeptic of the industry's growth prospects: Ray Elliott, chief of Biomet rival Zimmer ( ZMH). Over the past month or so, Elliott has alarmed investors on at least three separate occasions with his comments about pricing for orthopedic implants. Higher prices for both existing and newer products have always helped fuel the industry's explosive growth in the past, and Zimmer has often trumpeted its own share of that expansion. But lately Elliott has been sounding a much less upbeat note about the industry's prospects. "There's a lot of bell-and-whistle stuff in this industry over the last five or six years where you got pretty good money for stuff that was pretty fluffy, I think, at times," Elliott said Sept. 20 at a breakout session at a Bank of America conference. "Mix, I believe, continues to be strong and will be -- as long as you're bringing out technology that has proven clinical benefit. ...
But if you're going to take this and spray it red and add $1,000 to it and say, 'This is still the good old days,' it's not going to happen anymore." For his part, Miller has stood by Biomet's earnings forecasts. "Bottom line is we expect to be able to improve pricing going forward," Miller said a day after Elliott's comments. "I don't know what our competitors are doing price-wise. They've made some negative comments ... some of them have, as it relates to reconstructive pricing. But I guess only time will tell."
Biomet failed to return a telephone call from TheStreet.com on Monday seeking input for this story. But after peaking near $50 late last year, the stock has lost 30% of its value and now hovers within 50 cents of a 52-week low. The question that confronts Biomet investors is whether to listen to still-bullish Miller -- or to the growing ranks of orthopedic industry skeptics.
profit and loss, so orthopedic manufacturers have historically been able to raise prices beyond the point where orthopedic reconstructive procedures become unprofitable to the hospital," Faulkner wrote. "Only once the hospital as a whole comes under price pressure do we see hospitals begin to push back against orthopedic pricing. This is where hips and knees are currently."
But the stock has drifted lower since. Indeed, some investors heard plenty to worry about. Notably, they pointed out, Biomet seemed befuddled by a drop in the gross margin number that investors watch so much. Gross margin, a particularly strong metric in the orthopedic space, tracks revenue minus the cost of goods sold. "I don't think any of us has any explanation at this point as to why gross margins are down a little bit," Miller confessed when questioned about the decline. But "we're looking into it." Miller did suggest that higher-priced supplies could be cutting into those margins. However, some investors have noted that lower-priced implants could be hurting that metric as well. Whatever the case, Faulkner felt cautious enough to recommend avoiding Biomet -- along with Zimmer -- after the company's call. As a result of pricing pressures, he predicted, Biomet's reconstructive sales growth could slow from 19% in 2005 to just 5% three years down the road. By now, he noted, Biomet has already seen its hip sales slide even earlier than most. Nevertheless, he added, that downturn could very well continue. "There is nothing inherently inferior in Biomet's long-term hip business, we believe, but unit volume is tracking at zero in the United States, and the company's high growth is entirely comprised of price and mix," Faulkner wrote. "These are the components of industry growth that are at risk, in our view." Faulkner went on to predict a hit to Biomet's booming knee business as well. Looking ahead, in fact, he suggested that the entire industry faces a "prolonged deceleration" in reconstructive sales. Thus, he suggested that investors steer clear of the group for the time being. "We observe that orthopedic stocks are great long-term stocks that should be owned eight out of 10 years," he said. "We are perhaps halfway through the two-year period not to own them. ... All of the signs we can identify seem to be pointing in the same direction: These stocks have more room to come down."