The growth story in the orthopedic-device sector is sounding a little creaky. Outfits like Biomet ( BMET) and Zimmer ( ZMH) have been counting on aging, deep-pocketed baby boomers to drive huge earnings growth. But setbacks including a criminal probe of industry business practices have left investors feeling achy. For years, joint makers have leaned on regular price increases, lucrative product upgrades and rising surgery volume. But the price hikes and upgrades have slowed, in part because hospitals have grown more demanding as their own finances have tightened. And some observers believe that even surgery growth could ebb, increasing the pressure on the group's already flailing shares. More than a year ago, Bernstein analyst Bruce Nudell launched coverage with a cautious stance. Nudell was the rare analyst to question the staying power of the routine price increases that long boosted results. Now, his concerns are coming home to roost. "From my point of view, this is just a tough space to invest in," says Nudell, who rates Biomet as underperform. "It will be interesting to see how all of this plays out." (Bernstein makes a market in Biomet.) Biomet trades near the bottom of its 52-week range, while Zimmer -- the biggest pure-play orthopedics-device maker -- hovers near a three-year low. Even more diversified Stryker ( SYK) has been pounded.
For now, at least, product pricing remains the biggest threat to the group. Many blame an escalating government probe of the industry. In the spring of 2005, the Justice Department subpoenaed several big orthopedic-device makers about their financial arrangements with physicians. For years, device makers had relied on notoriously brand-loyal surgeons -- including some with financial conflicts -- to insist on using their implants regardless of their costs. But government prosecutors, sniffing for possible fraud, have been investigating the financial arrangements between the makers and the surgeons who use their products.