Owners of orthopedic-device stocks are starting to relax. Over the course of the past week, they have learned that a criminal probe of the industry could prove far narrower than they had previously feared. Zimmer ( ZMH) and, more recently, Biomet ( BMET) have now reported that a government inquiry into possible antitrust violations centers on actions by an unnamed competitor involving a single hospital. Both companies say they didn't engage in any questionable practices themselves. (On Monday, Smith & Nephew ( SNN) identified one of its independent sales representatives as the likely culprit. Smith & Nephew said that it has severed ties with the individual and believes that the company itself did nothing wrong.) Shares in the group have risen in relief. Zimmer, which hit a 52-week low of $52.20 earlier this month, climbed 3% Friday to $62.39. Similarly, Biomet has bounced 10% off a recent low of $30.22. It rose 2.2% Friday to $33.31. Some analysts have started feeling better about industry giant Zimmer in particular, as a result of the updates. "Considering Zimmer's belief that negotiations with only one hospital are the subject of the investigation, the dramatically narrowed scope likely limits the potential penalties," Thomas Weisel Partners analyst David Lebowitz wrote on Thursday. "This will reduce the overall pressure this investigation has placed on orthopedic company shares. In addition, specifically with respect to Zimmer, it seems that the company is not likely the primary focus of the investigation." Lebowitz went on to note that Zimmer reported that it had reached an agreement with the hospital in question -- without participating in any pricing schemes -- in early 2006. He acknowledged that the company had finalized a deal with a major customer, HCA ( HCA), during that same time frame. But he doubts that the HCA pact caused the antitrust probe, since only one hospital is apparently involved. Lebowitz has an outperform rating on Zimmer's stock, which he values at between $68 and $75 a share. His firm hopes to secure investment-banking business from the company over the next three months.
Zimmer CEO Raymond Elliott insisted last week that the company can do just that. "There seems to be some anticipation that Zimmer will reset the bar and lower sales expectations" for the second half of the year, Elliott said during a conference call Thursday with investors. "But the company has no intention -- or need -- to do so." Instead, Zimmer will rely on new products to significantly ramp up sales. The company expects a slew of new hip offerings in the third quarter and the rollout of its highly publicized gender-specific knee in the fourth to get the job done. But some people feel that a previous high-profile offering from Zimmer, called minimally invasive surgery, or MIS, fell short of expectations. Once a hot topic, Zimmer's patented two-incision hip-replacement surgery never even merited a mention by company officials in last week's conference call. Still, the company claims that its big push for MIS reshaped the industry. An analyst at JPMorgan recently asked Zimmer whether it now expects similar results from its gender-specific knee. "I think I just naturally draw a comparison between it and when you started pushing MIS a number of years ago," the analyst said during last week's conference call. "In hindsight, how much did MIS benefit you vs. the industry? And then, how much do you think we could expect the same or different for gender solutions?" Elliott drew clear distinctions between the two. He said that MIS involved surgical techniques and instrument changes rather than new implant sales. He said that it attracted "surgeons we couldn't talk to prior to that" and probably increased the company's market share as a result.
But Elliott seems to be banking on a more direct impact from the gender-specific knee. Indeed, he suggested signs of that already. Following a flood of media attention to the new offering he said, female patients have started putting off their operations as they wait for the specially tailored knee to become available. Zimmer clearly plans to dominate the market for female knees going forward. "This is going to be extremely tough for people to follow us, once we get in full motion," Elliott said. "I mean, we're not there yet -- we're not even close. We're getting a free ride right now on some great media coverage. We haven't even shown any of our marketing yet. So I think it's distinctly different
from MIS -- different in terms of where it's going to end up."