MAKO Structural or Temporary Problem?

With these business models it is important to decipher whether the problem is structural or temporary, thereby providing an opportunity. I believe the current issues to be temporary due to the positive following trends. 1. Consumer MindShare- from what I hear consumers are actually requesting robots for knee surgeries. This is especially true if they are younger patients that dont need full replacements. This is important because consumer mindshare will drive both hospitals and docs to get on board with a robot. Even if the surgery is not ultimately done with a robot, if a doc/hospital has a program it can drive volumes from a consumer who comes in to discuss the procedure but eventually decides on a traditional procedure. 2. Marketing- this is somewhat related to the above point, but hospitals do see robotic programs as a marketing tool to drive volumes and potentially take market share 3. Standard of Care- makoplasty for uni knees is not the standard of care, but it is becoming more notable. Young surgeons in training know about the procedure and are taught about it even if they are not directly trained. Eventual training in residency is crucial to staying power 4. Robot Utilization in Procedures- utilization continues to show positive trends. The launch of the hip product should only help. The chart below compares utilization rates of MAKO with ISRG (success) and HNSN (failure). The ISRG rates for the early years are estimates but the trends are similar. Ultimately, increased utilization will drive more robot placements. *Please see last page for other robot model comparisons

5. Optionality- I believe the ability for the company to get into other extremity procedures is very real. This optionality should support a premium valuation relative to other companies. Longer term, robotic surgery is simply the path of least resistance as technology continues to improve. Its a rather simple statement but it shouldnt be underestimated. Shorter Term Issues 1. Placements- I believe that the company is undergoing a transition period as it moves from early adopters to the mainstream. This has a tendency to lengthen sales cycles, sometimes meaningfully, as new customers demand more hand holding and an increased focus on ROI. The companys guidance is 42-48 placements for 2012. This implies 30 robots in the back half which may be hard to accomplish. Based on estimates, the company only closed 60% of expected deals in Q1 and 65% in Q2 (see table below). Back half guidance implies the company can close 85% of the original deals they expected in these quarters. While its possible that robot purchases were merely pushed back this seems like a stretch. I would expect the company to continue to close 2/3 of its original expectations as the sales cycle lengthens and sell 40 or so for the year. Furthermore, the change in marketing personnel and focus on utilization will make placement guidance difficult to achieve. However, in 2013 the annualizing of a longer sales cycle will make robot comps easier. This combined with the hip launch should lead to impressive growth in 2013.
System Sales Original System Guidance Adj Ramp % Closed % Growth System Sales Original System Guidance Ramp Needed to Hit Guidance % Closed % Growth Q1 10 6
60.0% -14.3%

Q2 14 9
64.3% -25.0%

Q3 14 9
64.3% -18.2%

Q4 21 15
71.4% -6.3%

2012 59 39
66.1% -15.2%

2013 83 54
65.0% 39.0%

Q1 10 6
60.0%

Q2 14 9
64.3%

Q3 14 12
85.7%

Q4 21 18
85.7%

2012 59 45

2. Capital needs- while its possible that investors will look through anther guidance revision, I have my doubts as the technology is still fairly early. Additionally, the hip launch has caused a large increase in working capital. In nearly all scenarios it seems that the company will need to raise money. I think $30 million on the high side, leading to about 5% dilution.
Bear Sales Growth Op Margin Inventory Days Cash Drawdown

2013
25.0% (10.0%)

2014
30.0% (3.0%)

Base Sales Growth Op Margin Inventory Days Cash Drawdown

2013
40.0% (6.0%)

2014
40.0% 5.0%

Bull Sales Growth Op Margin Inventory Days Cash Drawdown

2013
50.0% (2.0%)

2014
50.0% 8.0%

Cash Needs Raise Price New Shares % Dilution

$10.0 $15.0 1
1.5%

$30.0 $15.0 2
4.6%

325 ($2.0)

325 ($20.0)

325 ($3.0)

300 ($13.0)

315 $0.0

280 ($7.0)

How to Play It?

I believe that $10-$15 is a good place to purchase the stock and would not buy it ahead of the quarter unless it was at the lower end of the range. I believe the stock will work its way back into the 20s next year on easier comps and utilization that I expect to increase. Any sign utilization is peaking would be a thesis break.
Valuation With 5% Dilution 2013 Bull 2013 Base 2013 Bear EV/Sales Sales Growth Implied Sales EV Sales Growth Multiple multiple factor EV/Share 10.0x
50.0%

5.5x
40.0%

3.0x
30.0%

$159.8 $1,597.9 0.200 50 $34.97

$149.1 $826.0 0.138 40 $18.08

$138.5 $415.5 0.100 30 $9.09

Penetration of Placement Opp (est)

0.5 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 1 2 3 4 5 6 7 8 9 10 11 12

ISRG MAKO HNSN

System Placements (US mostly)

300 250 200 150 100 50 0 1 2 3 4 5 6 7 8 9 10 11 ISRG MAKO HNSN

%SGA
400.00% 350.00% 300.00% 250.00% 200.00% 150.00% 100.00% 50.00% 0.00% 1 2 3 4 5 6 7 8 9 10 11 12 ISRG MAKO HNSN