Why I Am Buying MAKO Surgical

Last week, in "5 Stocks With Explosive Potential," I quoted venture capitalist Peter Thiel, who believes that "swinging for the fences is probably less risky than people think."

I think he's right. And now it's time to take the first of several swings for my Trends and Trades portfolio. But before I give you the name of my first purchase, I want to remind you that I am looking for TNT companies -- ones with:

• Tranformational technologies.
• Nascent performance.
• Talented management.

Making lives better
MAKO Surgical (Nasdaq: MAKO) has been called "the next Intuitive Surgical (Nasdaq: ISRG)" -- and that's a compliment. Both companies developed robotic surgery systems that focus on minimally invasive cuts and promote shorter recovery times. They also generate revenue by selling systems as well as the accessories needed for the procedures. But that's where the comparison ends.

Intuitive's da Vinci systems serve the markets for prostatectomies and hysterectomies. MAKO's RIO system focuses on arthroplasty, the surgical repair of a joint. MAKO started with knees and launched a hip-replacement application in September.

Nearly 800,000 knee replacements and more than 600,000 hip replacements were done in the U.S. in 2009 -- and those numbers will continue to grow. By 2030, the National Institutes of Health projects there will be 72 million Americans over 65 and at high risk of developing osteoarthritis. The rising trend of obesity also makes Americans more likely to develop joint problems. A lot of knees and hips will need help over the next 10 to 20 years, and that could bode well for MAKO.

Rather than replacing the entire knee joint, an incredibly invasive surgery, the RIO removes diseased sections of the knee and replaces them with implants. RIO helps doctors make more precise cuts, ensuring accurate placement and alignment of the implants. The system also sets a "safety zone" for each patient, preventing the surgeon from cutting outside the intended area. The company believes MAKOplasty, its joint-repair method, is a better alternative to total knee replacement, one that can help patients get back on their feet faster.

More robots and more procedures
The market agrees. MAKO has come a long way since 2006, when its first robot hit the market: There are now 97 RIO systems helping improve patients' lives, and those robots have never been busier. MAKO robots assisted in a record 1,813 procedures in the third quarter and 4,674 year to date. Yet MAKO is barely scratching the surface of the total market. And the trends for robots and procedures continue to rise. That's good news for shareholders.

Source: MAKO Surgical SEC filings.

As MAKO sells more systems and doctors perform more procedures, financial performance continues to improve. The gross margin increased from 56.7% at the end of 2010 to 66% for the 12 months ended September 2011. MAKO still has a way to go until it generates a profit. But if things continue to progress as they have, I expect MAKO to reach breakeven by the end of 2012 or the beginning of 2013.

Hip-replacement MAKOplasty couldn't have come at a better time. MAKO installed 12 applications during the quarter, and surgeons completed 88 procedures. That's a great start to an important growth driver going forward. By serving both the knee and hip markets, MAKO will continue to gain ground on the competition -- which is a formidable group.

Source: S&P Capital IQ.

All the right moves
MAKO continues to gain traction in the marketplace because management is making all the right moves.

Every procedure using the RIO system generates revenue for the hospital, which it needs to justify the investment. That's why management invests heavily in sales and marketingL If hospitals don't know about the benefits RIO systems bring, they aren't likely to buy one. Management also holds information and training sessions for doctors, as well as seminars for potential patients, to learn how MAKOplasty offers a less traumatic option than total knee replacement and can improve patients' lives.

If Intuitive Surgical's history is a guide, all of this work should create a reinforcing feedback loop. As the number of systems sold increases, hospitals have a big incentive to use them. As hospitals perform more procedures and deliver favorable outcomes, more people will be open to the procedure, which means more hospitals will want to use the RIO system. Promoting this feedback loop is marketing's best option for long-term growth.

An ideal TNT company
Right now, MAKO is still a small fish in a big pond. But the company isn't playing the game the same way as the competition. Rather than simply selling products, MAKO is selling hospitals a solution -- one that can generate revenue for them over time. And as more hospitals do more knee and hip procedures, demand for its RIO system should continue to rise, creating more revenue along the way.

It's impossible to say for certain how fast MAKO can grow its system sales or how quickly procedures per machine per month can accelerate. But management is taking all the right steps to promote the benefits of its RIO system. If the trends persist, in five years, MAKO can be 3 to 4 times the size it is now. That would prove very rewarding for shareholders, which is why I am taking a 3% position in my Trends and Trades portfolio.

MAKO Surgical is the first of a series of purchases that I will be taking to build a home-run portfolio. The easiest way to stay on top of all the action is to follow me on Twitter, @trendsandtrades.