Stephen Simpson, CFA, Kratisto Investing
Summary
- Wright Medical Group announced a merger with Tornier to create a major player in the higher-growth extremities segment of orthopedics.
- Wright Medical also announced the receipt of an approvable letter from the FDA for its much-harried orthobiologic product Augment.
- With the potential for Wright Medical and Tornier to become a $2 billion company with leading share in upper and lower extremities, Wright Medical looks undervalued below the high $30s.
Four months ago, I fretted that Stryker‘s (NYSE:SYK) acquisition of SBi reduced the pool of eligible buyers to acquire Wright Medical Group(NASDAQ:WMGI) and/or Tornier (NASDAQ:TRNX). A lot of bullishness on these companies was based on their attractiveness as M&A targets for larger ortho companies, but the two companies have instead decided to come together to create a leading enterprise in the fast-growing extremities segment.
I have mixed feelings on this move as a Wright Medical Group shareholder. Wright Medical’s somewhat disappointing third quarter sales result suggests that there’s still more self-improvement to be done and Tornier has been working through sales restructuring efforts of its own. That said, Wright Medical CEO Bob Palmisano is a proven leader in the med-tech space and the prospects of a company with leading technology in both upper and lower extremities is appealing, not to mention the fact that the impending approval of Augment brings hundreds of millions of potential revenue into play.
A Busy Day
Investors were given a lot to digest on Monday, as Wright Medical not only gave investors an early look at third quarter revenue, but also announced that the FDA had issued an approvable letter for the Augment Bone Graft and that the company would be merging with rival extremities peer Tornier in an all-stock deal.
Taking the least significant item (from a long-term perspective) first, Wright Medical announced that third quarter revenue rose 24% to about $71 million, missing expectations by close to 7%. This is two straight revenue misses for Wright Medical, with management citing sales execution issues in the U.S. foot/ankle business and shortfalls in the international operations (related to inventory/sales channel mismatches) as the cause. While management did lower full-year expectations, the company’s growth is still solid in the wider context of the extremities market and orthopedics in general.
Success At Last For Augment?
I have written repeatedly on Wright Medical’s battles with the FDA to get the orthobiologic product Augment to market. While I can sympathize to some extent with the FDA’s concerns given its embarrassment over the Medtronic(NYSE:MDT) Infuse debacle, the reality is that Wright Medical has consistently demonstrated that Augment is safe and effective as a bone graft substitute.
It’s worth noting that what Wright Medical received from the FDA was an approvable letter, not an actual approval. Final approval will be contingent on a few additional steps, most significant being facility inspections, but these should be routine and Augment should be on the market in 2015.
