The past two years have been bumpy for medical-device maker Stryker (NYSE:SYK). Hip implant recalls weighed heavily on its bottom line, but it won a key patent settlement against Zimmer Holdings (UNKNOWN:ZMH.DL), entered China by acquiring Trauson Holdings, and expanded into robot-assisted surgery by picking up MAKO Surgical. Despite those positive developments, Stryker's stock has underperformed Zimmer and barely outpaced Medtronic (NYSE:MDT) over the past 12 months.
Nonetheless, investors should pay attention to three unique opportunities that could eventually unlock long-term growth for Stryker.
Many analysts believed that Stryker's $1.65 billion acquisition of MAKO Surgical last year was a steep price to pay for an unprofitable company that only reported $103 million in 2012 revenue.
Stryker expected the deal, excluding acquisition expenses, to become earnings accretive after three years. For some investors, that wait wasn't worth the price.
Yet the deal made sense for two reasons: it allowed Stryker to expand into the growth market of robot-assisted procedures and naturally expanded its hips and knees business. MAKO's primary two products are the RIO Robotic Arm, which allows surgeons to conduct minimally invasive partial knee surgery, and a new application for total hip replacements.
Over the past year, the efficacy and safety of robot-assisted surgery has been questioned, mainly due to an FDA probe of market leader Intuitive Surgical's (NASDAQ: ISRG) flagship da Vinci devices. However, demand for robot-assisted minimally invasive procedures continues to rise: robot-assisted procedures across the world surged from 1,000 in 2000 to 450,000 in 2012.
Stryker recently started its first clinical trial for a total knee application for MAKO, which it hopes to launch in 2015. Stryker's knee business could clearly benefit from the boost, as the segment's sales only rose 1.1% year over year, to $348 million, in the last quarter. By comparison, Zimmer's knee segment sales climbed 4% to $488 million in that period.
Expansion into China
Stryker's acquisition of Chinese company Trauson for $746 million last year represents a promising way to grow its spine business overseas.
The spine business has been tough for all the major players. Last quarter, sales at Stryker's spine business only rose 0.7% to $177 million. Medtronic's spine revenue fell 3% to $786 million, while Zimmer's rose 1% to $48 million.
Nine percent of China's population,123 million people, is currently over the age of 65. By 2050, the government expects that number to surge to 25%. As a result, the Chinese orthopedics market is expected to grow from $1.6 billion in 2012 to $2.7 billion by 2015. The U.S. orthopedics market, by comparison, is only expected to grow 2% to 3% annually.
Stryker's purchase of Trauson, which sells cheaper implants, enables the company to reach both the higher-end and lower-end Chinese markets. That's a smart strategy because China's income gap is now the largest in the world.
Stryker isn't the only orthopedics business to expand into China, however. Medtronic bought Kanghui Holdings for $816 million in late 2012 for the exact same purpose.
Inorganic growth and market consolidation
Stryker's acquisitions of MAKO and Trauson point to a new strategy of inorganic growth. Earlier this year, Stryker also acquired German surgical equipment maker Berchtold Holding for $172 million. During the first quarter conference call, Stryker CEO Kevin Lobo told analysts that the company was also "open to acquisitions within spine."
That shouldn't come as a surprise, especially since Zimmer's recent $13.35 billion acquisition of rival Biomet made it the second-largest orthopedics company in the world after Johnson & Johnson (NYSE: JNJ). Johnson & Johnson claimed that top spot through inorganic growth as well, by acquiring DePuy in 1998 and then merging it with Synthes in 2011.
Considering the rapid pace of market consolidation, Stryker is faced with two options -- either keep pace with additional acquisitions or be bought out by a larger rival. With a market cap of $30 billion, the former seems more likely than the latter, but bigger acquisitions have happened.
The Foolish takeaway
Stryker now has footholds in robot-assisted surgery and China -- two markets that could grow considerably over the next decade. Moreover, robot-assisted surgery could increase the accuracy of hip and knee implants, greatly decreasing the risk of future recalls. Lastly, continued inorganic growth could lead to new sources of revenue growth.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of Medtronic and Zimmer Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.