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Morningstar | Zimmer Biomet Receives Important Robot Clearance; No Change to Our Fair Value Estimate

Zimmer Biomet reported fourth-quarter performance that, again, demonstrated consistent, incremental progress toward addressing the supply, regulatory, and cultural issues that have hampered the firm over the last two years. Our fair value estimate is unchanged, as full-year performance generally met our expectations. We continue to anticipate a gradual return to growth and improved profitability in the longer term, though we still think large joint growth will lag the market in 2019. Nonetheless, we think new management has methodically addressed key weakness and dysfunction since CEO Bryan Hanson joined the firm one year ago. Hanson’s attention at shoring up fundamental operations leave the firm well positioned to take advantage of its wide economic moat stemming from surgeon switching costs.

Two issues caught our attention coming off the earnings call. First, the firm indicated it was working on its remediation plan for the legacy Biomet plant and should be ready for reinspection by end of the year. Considering the FDA first raised issues with the facility in late 2016, the time necessary to resolve this issue has now moved beyond our original expectation of two years. However, we’re considerably more optimistic about this situation than we were last spring following the FDA reinspection that repeated a number of its original observations. The longer time frame for remediation suggests that Zimmer Biomet is devoting more time and resources to fully address regulatory concerns.

Second, last week Zimmer Biomet received FDA approval for its total knee replacement indication on the Rosa robot. As we’ve discussed before, the Mako robot has been instrumental to Stryker’s impressive knee growth over the last two years, and we expect the addition of Rosa to Zimmer Biomet’s arsenal should help the firm boost growth in its own knee franchise. The first six months of soft launch should be muted but should grow in strength as we head into 2020.

Since Stryker ramped up its placement of the Mako robot, both Zimmer Biomet and Johnson & Johnson have borne the brunt of anemic knee sales that trailed market growth. As we’ve pointed out before, market share shift in the orthopedic market tends to be glacial, at best, due to the high switching costs for surgeons. On a global basis, we estimate Zimmer Biomet has lost roughly 100-200 basis points in market share (on a dollar basis), though it still owns the largest share of knee implants by dollar. We surmise the shift may be more acute in the U.S. market where most of the Mako placements are. Thus, we were particularly intrigued by management’s comments that suggest Zimmer Biomet’s share loss by volume appears to be less than the dollar share loss. This implies the number of procedures using Zimmer Biomet knees may be holding up relatively well and that Stryker has been able to grow its knee revenue by selling the more expensive implants in its portfolio. If this is the case, then Zimmer Biomet is in a strong position to roll out its Rosa robot to its base of surgeons already favorable about the firm’s products and to pivot to robot-driven opportunities to increase revenue per knee replacement procedure.

Finally, we look forward to seeing the initial clinical data on the Mako robot at the upcoming orthopedic conference. If findings are positive, Zimmer Biomet could see acceleration in its placement of Rosa robots through this year.