Within biotechnology and the broader healthcare sector, investor sentiment often reaches extremes. A company might be heralded as a revolution in medicine and see its stock price soar, only to have it fall as reality fails to match lofty expectations; sentiment swings to the other extreme. That’s exactly what occurred with MAKO Surgical (MAKO). After climbing to well above $40 in March 2012, shares began to collapse as the company failed to meet high consensus estimates. And since then, shares have continued to slide to their current $10.65, and with over 26% of the company’s float sold short, it’s clear that there is ample skepticism about MAKO’s ability to reach profitability. With Q1 2013 earnings to be released on May 7, traders and investors will have a fresh opportunity to see if MAKO’s efforts to turn itself around are bearing fruit.
2012: What Went Wrong?
Much of MAKO’s slide over the last 12 months can be attributed to 2 events: 1) A Q1 2012 miss and lowered guidance, and 2) guidance that was lowered again in Q2 2012. MAKO’s original guidance for 2012 called for 56-62 RIO surgical system sales, and in Q1, the company revised that guidance downward to 52-58 system sales. Alongside a Q1 miss, that sent shares falling well over 20%, and in July 2012, MAKO provided new guidance ahead of its Q2 2012 results, which sent the stock into a 43% plunge.
In July, MAKO lowered its forecasts for growth in both sales of RIO systems and surgical procedures. The company called for 42-48 RIO system sales in 2012, versus prior guidance of 52-58, and lowered its procedure guidance to 11,000-12,000, versus prior guidance of 11,000-13,000. MAKO’s forecasts implied an 18.18% cut to RIO system sales at the midpoint of guidance, and a 4.17% cut to procedures at the midpoint of guidance. On its Q2 call, MAKO spoke at length about the challenges it faced during the first half of the year, and it is important that investors understand the underlying drivers of weak performance at MAKO, and what the company has done (and is doing) to address these issues.
In the first 6 months of 2012, MAKO noticed that hospital administrators had begun to scrutinize RIO purchases more closely (and by extension, MAKOplasty hip and knee procedures as well), as well as garner more surgeon support for the systems. MAKO reiterated on its Q2 call that while it has been successful in securing surgeon support for RIO systems, in hindsight it was unprepared for the increased efforts needed to actually overcome initial hesitations about its products. To that end, MAKO announced several initiatives, including a restructuring of its salesforce to increase the levels of scientific and technical knowledge regarding clinical data for MAKO’s products as well efforts to deepen relationships with surgeons across the United States, and continued to make enhancements to its product line, both in terms of hardware and software.
Framing the Quarter: 4 Key Elements
MAKO’s Q1 will be a pivotal quarter for the company, not only in terms of preserving/repairing management’s credibility, but in terms of competition and capital as well. To that end, there are 4 key elements to this quarter that investors need to pay attention to.
- Consensus estimates: Ahead of MAKO’s Q1 results, consensus estimates call for a loss of 19 cents/share on revenue of $24.82 million. MAKO must, at a minimum, meet these estimates, or provide clear and convincing arguments as to why a miss should not be interpreted as a sign of structural weakness.
- Reaffirming guidance: MAKO provided guidance for the year ahead during alongside its year-end 2012 earnings, and for 2013, MAKO expects to sell 45-48 RIO systems (flat to +6.67% Y/Y), and perform 13,500-14,500 MAKOplasty procedures. Given that MAKO has revised guidance downward several times in 2012, this is perhaps the most important element to this quarter. Expectations have fallen sharply, with Mizuho noting that over the past 7 months, consensus estimates have fallen by nearly 50% as sentiment regarding MAKO has soured. Another cut to guidance would further damage the credibility of MAKO’s management team, despite the multiple steps taken to turn the company around.
- Competition: Historically, MAKO’s primary competition has come from traditional surgical companies, such as Stryker (SYK), Zimmer Holdings (ZMH), and Johnson & Johnson (JNJ) [Intuitive Surgical (ISRG) is more of peer than a competitor, given that its da Vinci systems are designed for different indications than those of MAKO]. However, in recent months, a new competitor has emerged: privately held Blue Belt Technologies. For the time being, it does not seem that Blue Belt has weakened MAKO’s market position. However, the threat remains, and MAKO is likely to come under pressure in addressing how it plans to defend itself against stronger competition, particularly if the company’s Q1 results come in below consensus or guidance is lowered.
- Capital resources: MAKO ended 2012 with $73.266 million in cash & investments, and although MAKO is debt free, it continues to burn capital, with $27.303 and $30.292 million of cash burn in 2011 and 2010 respectively. MAKO forecast that it will see operating cash burn of $22 to $27 million in 2013, which will bring MAKO’s balance of cash & investments below $50 million at the midpoint. And, should MAKO’s Q1 results come in below expectations, or if guidance is yet again lowered, the company may see cash burn reach the upper end of its forecasted range. With sustained profitability currently estimated to begin only in 2015, the possibility exists that MAKO will need to raise capital before that occurs, and the company’s Q1 performance and updated guidance for 2013 should clue in investors as to whether or not the company will need fortify the balance sheet in the near- to medium-term.
We believe that it’s best to remain on the sidelines until MAKO reports its Q1 results. While we’re always interested in picking up a turn-around story while it’s still on the cheap, there remains a major element of risk coming into the Q1 results. If MAKO disappoints, the stock will tumble yet again as confidence in managements’ foresight and ability to improve its competitive position erodes. But given the stock’s high short interest and low expectations, if the quarter exceeds — or even meets — expectations, we expect a significant rally from MAKO. In that case, the company will see a near-term overhang removed with guidance finally set appropriately. The potential for short positions to unwind rapidly following an earnings meet (or beat) will serve as a tailwind and squeeze, we suspect, MAKO back to the high-$12 range.
MAKO’s May puts present an attractive hedging opportunity for investors with a bullish bias and a desire to hedge against downside risk. MAKO’s May $12.50 puts are currently trading at $2.10 per contract, and when combined with MAKO’s closing price of $10.65 on May 3, the net cost to enter the position is $12.75. At that level, losses are capped at less than 2%, creating an inexpensive hedging opportunity. Although MAKO would need to rally nearly 20% for the trade to break even, such a move is not outside the realm of possibility given prevailing expectations and sentiment for the last few months.