Torn ACL? Rotator Cuff? It's Not Just NFL Pros Driving Sports Medicine Demand

St. Louis Rams quarterback Sam Bradford tore his ACL, requiring season-ending surgery. Arian Foster, the Houston Texans runningback, broke his leg and tore his LCL, and prolific wide receiver Reggie Wayne is also now out for the rest of the season with a torn ACL. And, that was just in week 7 of the 2013 NFL season.

But, sports injuries aren't limited to the National Football League, Major League Baseball, or the National Basketball Association. All across America, student athletes are increasingly injuring shoulders, elbows, and knees, leading to orthopedic surgery to repair their torn ligaments.

The U.S. Centers for Disease Control and Prevention estimates 30 million kids participate in youth sports, resulting in an estimated 2 million injuries, 500,000 doctor visits, and 30,000 hospitalizations for high-school athletes each year, according to a 1999 study. And, it's not just professional and high-school students visiting sports-medicine practices.

Some 3.5 million kids under the age of 14 receive sports-related medical treatment, accounting for 40% of all sports-related injuries treated in hospitals, according to the American Orthopaedic Society for Sports Medicine.

A shift in paying for sports injuries 
Unfortunately, many of those injuries occur in urban settings with large uninsured populations. As a result, the Affordable Care Act, or ACA, could drive the biggest increase in orthopedic demand in a generation.

These orthopedic practices already provide services to thousands of uninsured trauma patients in hospitals and clinics in compliance with Emergency Medical Treatment and Active Labor Act, or EMTALA. However, in these situations, practitioners receive little or no compensation for the treatment. While the launch of the ACA portal has been disappointing, Massachusetts' success at increasing enrollment suggests the ACA will eventually drive demand for health care procedures, creating a larger revenue stream for health care providers.

The industry is also set to benefit from an older, more active population. As baby boomers retire, they're increasingly embracing more active lifestyles, and with joints weakened by a lifetime of activity, these boomers are likely to require more surgeries, too.

As the patient pool climbs and more guaranteed money is paid out to orthopedic surgeons by the Centers for Medicare and Medicaid Services, or CMS, surgeons may find they're spending more on next-generation orthopedic equipment, providing an opportunity for medical equipment makers like ArthroCare (NASDAQ: ARTC  ) , Smith & Nephew (NYSE: SNN  ) and Stryker  (NYSE: SYK  ) over the coming decade.

It won't happen in a straight line
In order for ArthroCare, Smith & Nephew, and Stryker to sell more equipment, the ACA will need to create enough demand to strengthen sports medicine provider balance sheets.

The adoption of high deductible plans means providers will still have to track down some payments from individuals. And, it's considerably harder to collect payments from patients than from the CMS or commercial insurers. Even in cases where lower deductible plans are chosen, the CMS could pressure doctor margins as regulatory mandates -- such as sequestration -- limit annual increases.

However, offsetting that risk is a far more predictable payment stream from the CMS. Unlike commercial insurers, CMS doesn't require pre-certification and referrals for services such as MRIs and surgery. For those with price-conscious private insurance, it still means a consistent and reliable stream of income for a patient population that previously didn't pay.

Couple predictable payments with a potentially larger, younger, and more active patient pool and you get an opportunity for rising demand for meniscectomies, ACL reconstructions, and instability repairs. That's leading some industry experts to predict orthopaedic practices may see business climb by 10% to 15% a year, thanks to the ACA.

Medical device and instrument companies likely to benefit
To make sure more patients are choosing reconstruction -- medical device and instrument innovation from ArthroCare, Smith & Nephew, and Stryker is designed to reduce post-op pain and improve recovery time. That type of innovation eases patient anxiety and helps with confidence, which may convince patients to embrace treatment.

Of the three companies, ArthroCare may see a greater benefit than larger competitors Smith & Nephew and Stryker.  ArthroCare generated 68% of its revenue from sports medicine sales in the second quarter of 2013. That works out to $118 million of the company's $175 million in quarterly revenue.

Source: ArthroCare Jefferies conference presentation.

The company's products include branded and private label surgical devices, instruments, and implants, with a growing focus on minimally invasive procedures built around ArthroCare's Coblation technology. That technology limits damage to surrounding healthy tissue by dissolving targeted tissue, reducing pain and recovery time for common sports surgeries.

ArthroCare is also increasingly migrating this technology into its ear, nose, and throat business, too. That slower growth market should benefit from rising insurance enrollment -- particularly in states where Medicaid is expanding.

Across all three companies, ArthroCare, Smith & Nephew, and Stryker may also see rising provider demand for equipment as procedures like spine surgery, which are typically conducted in hospitals, shift to outpatient surgery centers. Currently, a few of those procedures are done in ambulatory surgical centers, but as many as 50% of them could be, according to the Ambulatory Surgical Centers of America. Total joint replacements may also shift to outpatient centers, too, as commercial insurers seek to move more care out of expensive hospitals.

And, ArthroCare, Smith & Nephew, and Stryker are likely to sell more equipment as their technologies are embraced abroad. According to the Department of Commerce, exports of medical technology increased 7.2% year over year in 2012 to $44 billion.

The Foolish final take
The sports medicine market offers an opportunity for growth for medical device and instrument makers ArthroCare, Smith & Nephew, and Stryker. But that opportunity comes with risk. It's a competitive industry, which could mean lower margins as the three compete for sales.

That competition could put ArthroCare at a disadvantage, as its larger competitors are arguably better able to withstand short-term hiccups tied to demand, pricing, and technology.  ArthroCare is also dealing with its own self-inflicted troubles stemming from a former executive who pleaded guilty this past June to inflating the company's prior earnings. As a result, ArthroCare paid $74 million last year to settle a class action lawsuit and set aside $30 million this year in insurance dispute reserves. 

ArthroCare, Smith & Nephew, and Stryker will also have to navigate regulatory headwinds tied the ACA's 2.3% medical device tax, which ended up on the cutting room floor during the latest impasse in Washington.

However, despite the risks, it appears the tide is turning. At ArthroCare, sales climbed to $368 million last year from $354 million in 2011. And, in the second quarter, ArthroCare's sales grew slightly to $92.1 million from $91.7 million last year, as sports medicine revenue rose 2.1%. Smith & Nephew sales grew 3% to just under $1.1 billion, led by international markets, and a 6% growth in its sports medicine joint repair business. Stryker sales grew 4.8% in the third quarter to $2.2 billion, led by a 6.5% lift in reconstructive sales. As a result, you may want to keep a close eye on these companies.

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