Somewhere near the bottom of the valuation pile lays Carlsbad, California, spinal implant manufacturer Alphatec Spine, Inc.. By nearly every measure of a company’s value, Alphatec is a dusty bargain bin asset that has been so cheap for so long, buyers can’t imagine that it would ever be anything else.
Sales this year will come in somewhere around $192 million. The products that generate those sales include the Trestle Luxe anterior cervical plate, MIS products like the ILLICO fusion system and a pretty full line of biologic products like PureGen, AlphaGRAFT and Alphatec NEXoss.
Other public spine companies, NuVasive, Inc. or Globus Medical, Inc. for example, report profit margins of between 2% and 17% of sales. Alphatec, on the other hand, lost $2.5 million on $47 million in sales last quarter for a minus 5.3% of sales profit margin.
The stock market could not be any clearer in its assessment of Alphatec. At a market capitalization of $156 million, the company is valued at around 0.79 times revenues. Stock market buyers, in other words, are only offering 79 cents for every dollar of Alphatec sales.
By contrast, the average orthopedic company is attracting $2.79 for every sales dollar. Why the difference? Earnings. One Alphatec sales dollar loses about 5 cents. One average orthopedic company sales dollar makes 20 cents. Without earnings, Alphatec’s sales are just not that valuable.
The Silk Sow
There is an old saying. If you want to make a silk purse out of a sow’s ear, start with a silk sow. Les Cross, the fellow who is largely credited with taking DJ Orthopedics, a bracing company, from stock market obscurity as a division of Smith & Nephew to the darling of Wall Street in two years, decided to take over day-to-day operations of Alphatec Spine.
When Les looked at Alphatec, did he see a silk sow? “Alphatec has always been an innovation expert and when I looked at the company I saw several key products that can drive revenue, ” said Cross.
Les Cross
Les is now 61years old. For 40 years he has labored in the orthopedic trenches and has certainly earned the privilege of enjoying his boat off the San Diego coast or wherever breezes are soft and the putting greens well manicured. “It’s true.I was happy sailing my boat in Cabo after my retirement from DJO.” So why jump in at Alphatec? “The similarities between DJO and Alphatec convinced me that I could change the direction of the company by applying lessons learned from my DJO days, ” said Cross.
A Snake-Bit Company
Since entering the public market, Alphatec Spine has been at the receiving end of a string of unfortunate events. Its June 2006 IPO, for example, was snake bit from the start. Originally HealthpointCapital, the private equity firm which owned Alphatec, hoped to sell shares for $13 to $15 each. Then the company’s underwriters, Deustche Bank Securities and First Albany Capital, strong armed Healthpoint to lower the price to $11 to $12 per share. Literally on the effective date, the final price was set at $9. Even that price didn’t hold.
At the closing bell on its first day of trading, June 12, 2006, Alphatec’s stock landed uncertainly at $8.60 per share. For the next two and half years sellers dominated ATEC’s trading and the stock slid to a previously unimaginable $1.25 per share. Bottom for Alphatec came in early 2009.
With a kind of morbid fascination, analysts who weren’t in the underwriting group watched ATEC try to find purchase on that slippery slope. By early 2009, most investors had given up on ATEC. For Alphatec’s employees, who got up every day to do the essential work of a spinal implant supplier, those two years were gut-wrenching. Two CEOs came and went.
It seemed at the time as if the orthopedic market was witnessing a particularly rare event in ATEC’s collapse. But, point in fact, one other orthopedic company had endured an equally remarkable and ignominious birth as a public stock.
That company was DJO. And its CEO was Les Cross.
Déjà Vu All Over Again
DJO (formerly Smith & Nephew’s Don Joy Orthopedics) came public four years before Alphatec’s own stumbling attempt. DJO’s IPO price was $17 per share—remarkably close to Alphatec’s proposed price of $15 per share. DJO’s sales that year (2002) were $183 million (Alphatec’s sales this year will be about $190 million). DJO lost $15 million that year (Alphatec is expected to lose between $10 to $15 million this year).
While Alphatec’s post-IPO swan dive was larger in dollar terms—$490 million in lost shareholder value that first year as a public company versus DJO’s $250 million—the pain index for shareholders and employees was at the same level of public company hell.
For Les Cross, Alphatec has an eerie sense of déjà vu.
“Both Alphatec and DJO have always had competitive product lines that are capable of driving consistent growth. That is one similarity. But another similarity is that both companies have faced challenging times when they were not executing on all cylinders and their growth waned as a result, ” comments Cross today.
At DJO of 2002, Cross used a two pronged strategy to turn the company around:
- Squeeze costs out of the operations and turn a profit as soon as possible
- Bolt on interesting and accretive technology companies.
Roughly two quarters after Cross and his team went to work, the company reported a profit and Wall Street buyers began returning to DJO. Twelve months after Cross took on DJO’s CEO job, his company’s stock hit the stratosphere—$29.00 per share—which represented a 10-fold increase in a single year.
In 2002 Cross reported a $15 million loss on $183 million in revenues. In 2003 he reported a profit of $12 million on sales of $198 million. Three years after that, private equity powerhouse Blackstone Capital paid $1.6 billion or $50.25 per share for his company.
$1.6 billion for a bracing company…whose average medical device product sells for $70. “Compared to DJO, Alphatec’s products are much more expensive. We can ring the cash register a lot easier here, ” say Cross.
Les Cross’s Reboot of Alphatec
To Cross, Alphatec has more innovative products which sell at higher profit margins than DJO during his tenure there. He specifically points to Alphatec’s commitment to biologics products and such creative implants as the Osseo-screw and the ILLICO MIS system. Cross also notes that Alphatec’s product gross profit margins are 60% of sales versus DJO’s 56%.
“I believe Wall Street gets excited about consistent growth regardless of the business that drives that growth. When I joined Alphatec as CEO, the company was in the middle of a very difficult spine market that is well characterized today. The first thing we needed to do was to ensure that everyone operated with a sense of urgency and felt accountable for their performance contributions, ” remembers Cross. “We made several changes in this regard and I think we have a much more aligned culture today.”
Pulling a page from his DJO experience, Cross said “At Alphatec we’ve looked at the company’s processes across the organization, starting with our process for developing new products internally. It was clear that we have a very talented R&D group, but that they were working on too many projects simultaneously. So we focused the R&D resourcing to those few projects that would have greater chances for near-term commercial success.”
Within one year of taking DJO public in 2002, Cross bought his first company—Orthologic, a supplier of bone stimulation products. Over the next four years Cross and his team at DJO would bolt on another four companies—all of which were accretive to earnings.
Similarly at Alphatec, within months of taking over as CEO, Cross purchased Phygen, LLC, a small spinal implant manufacturer in southern California. “It’s no secret that if you want to grow your spine business, we need to add more spine surgeon customers and the Phygen acquisition fits this strategy nicely, ” said Cross when asked about Phygen.
But, at the end of the day, Cross’s legacy at DJO was finding that delicate balance between aggressive streamlining operations/driving efficiencies and accelerating sales.
Already, Cross is pointing to some changes at Alphatec. “On the operational side of our business, we made significant progress in 2012 to drive lean practices throughout our U.S. supply chain and in doing so achieved our $2 million annualized savings goal that we set at the beginning of the year.”
The Future
“Our focus, as it was at DJO, is on lean operations. The secret to our success at DJO was the experts we brought into the company. Like our CFO, Vicki Capps. And Luke Faulstick, our VP of Operations at DJO. I put Luke on Alphatec’s board.”
By his second public year at DJO, Cross and his team posted a 6% profit margin. If he pulls the same rabbit out of a hat at Alphatec, his company will be the second most profitable public spinal implant company.
And if Wall Street responds to Cross’s efforts at Alphatec as it did to the very same plan at DJO nearly a decade ago, then Alphatec is no longer a bargain bin asset. It is a diamond in the rough.
