Exactech: Value Play in Orthopedics

11/22/2013 7:00 am EST

Focus: STOCKS

James Fink

Editor, Jim Fink's Options for Income and Stocks to Watch

Orthopedic surgery and implant stocks are hot, and it is becoming attractive for large firms to buy the successful technology of smaller companies rather than try to develop the technology itself, suggests Jim Fink, editor of Roadrunner Stocks.

In September, Stryker Corp. (SYK) agreed to acquire MAKO Surgical (MAKO) for $1.65 billion in cash. The buyout price represented a huge 89% premium to the stock.

Wall Street analysts believe the MAKO acquisition is just the beginning of an industry-wide consolidation. Within this market, we believe Exactech (EXAC) is growing fastest and is priced cheapest.

Exactech was founded in 1985 by orthopedic surgeon Bill Petty, who, at the time, was Chairman of the Department of Orthopedic Surgery at the University of Florida's medical school. He believed that orthopedic surgeons would appreciate orthopedic implants designed by a fellow orthopedic surgeon.

Exactech's strong growth since its founding is proof Dr. Petty was right. Annual sales have grown 120-fold since 1990—from $2 million to $239 million.

Over the past ten years, revenue has grown at an annualized double-digit rate of 14.2% and earnings have grown at a 7.18% clip. Earnings growth appears to be accelerating, with the most-recent third-quarter financials showing a 21.1% growth rate.

Exactech is focused heavily on extremity devices, which orthopedic implants other than hips, knees, and spines. This is the industry's fastest-growing segment, which explains why the company is forecast to grow much faster than the industry and why it could be a takeover target.

Its market capitalization is only $306 million, which would be easily affordable to any would-be acquirer—less than one-fifth the $1.65 billion Stryker paid for MAKO.

Other aspects of Exactech that I like are its low debt level, high insider ownership, and founder CEO. The debt-to-capital ratio is a very-reasonable 19.38% and insider ownership stands at 33.6%.

CEO and co-founder Bill Petty loves his company and is focused on its long-term success. When Dr. Petty retires (he is 70 years of age, after all!), the company will remain in the founding family, since his son David is Exactech's president. Exactech is a buy up to $26; I'm also adding the stock to my Value Portfolio.

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