Rl - Zacks Investment Research
October 05, 2007
Research Associate: Sweta Gupta, MBA
Editor: Kinjel Shah, C.A.
Sr. Ed.: Ian Madsen, CFA; imadsen@; 1-800-767-3771, x9417
111 N. Canal Street, Suite 1101 ( Chicago, IL 60606
|Kyphon Inc. |(KYPH-NASDAQ) |$70.27 |
Note to Readers: All changes since the last report are highlighted.
Reason for Report: Rating Downgraded by One Broker (1/15 brkrs w. cvrg.) Prev. Ed.: September 19, 2007
Brokers’ Recommendations: Neutral: 100% (11 firms); Positive: 0 %(0); Negative: 0%(0) Prev. Ed.: 10:1:0
Brokers’ Target Price: $68.83 (↔ to last edition; 15 firms) Brokers’ Avg. Expected Return: 2.09%
Recent Events
On July 27, 2007, KYPH announced its 2Q07 earnings. Highlights are as follows:
• Revenue was $144.3 million versus $101.1 million in 2Q06, up 43 % yoy (41% in constant currency).
• GAAP net income was $11.0 million versus $9.5 million in 2Q06.
• GAAP EPS was $0.23 versus $0.21 in 2Q06.
During the earnings release, KYPH also announced that it has signed a definitive agreement with Medtronic (MDT) under which MDT will acquire KYPH shares for $71 per share in cash. The total value of the transaction is $3.9 billion, which also includes $350 million in net debt representing a 35% premium to the closing price as on July 31, 2007. The acquisition is expected to close in 1Q08.
Overview
Analysts have identified the following issues as critical for considering for investment in KYPH:
|Key Positive Arguments |Key Negative Arguments |
|Analysts believe KYPH’s technology is the best in the field, and the |The company operates in a highly competitive market. |
|competition from Medtronic is coming from a device with no significant |Litigation may be filed against the company on issues of unlawful marketing |
|technical advantages. |of kyphoplasty. |
|With strong fundamentals, analysts expect strong EPS growth, going forward. |An unfavorable Medicare reimbursement change can be a possible threat to |
|A strong balance sheet provides opportunity for further acquisitions. |KYPH. |
|Overseas results continue to post strong momentum for the company. |Kyphon's legal entanglement with Medtronic is a major concern for investors,|
|The company has taken several initiatives to boost its long-term prospects. |as is the potential launch of Medtronic's Equestra device as well as other |
|Historically, the company has shown strong operating leverage, and is |future competitors. |
|expected to perform even better with the acquisition of St. Francis Medical.|The most important risk is the potential for the Federal Trade Corporation |
|Brokerage firms believe that St. Francis Medical’s X-STOP reinvigorates |(FTC) to disallow MDT’s acquisition of KYPH. |
|KYPH’s top and bottomline growth. | |
|The Disc-O-Tech deal seems favorable for KYPH. | |
Based in Sunnyvale, California, Kyphon, Inc. (KYPH) is a medical device company, engaged in the design, manufacture, and marketing of medical devices to treat and restore spinal anatomy using minimally invasive technology. The company’s products include KyphX Bone Access Systems, KyphX Inflatable Bone Tamps, KyphX Xpander Inflation Syringe, and KyphX Bone Filler Device. Its products also comprise KyphX Bone Biopsy Device, KyphX HV-R polymethylmethacrylate bone cement and KyphOs calcium phosphate. Primarily spine specialists, orthopedic surgeons, neurosurgeons, interventional radiologists, and interventional neuro-radiologists use KYPH’s devices. More information on the company can be found online at .
Note: KYPH’s fiscal year references coincide with the calendar year.
Revenue
The company reported net sales of $144.3 million in 2Q07, an increase of 43% (41% on a constant currency basis) over $101.1 million in 2Q06. The Zacks Digest average revenue was $144.1 million in 2Q07 versus $101.1 million in 2Q06, up 42.5% yoy.
KYPH’s core spinal fracture management and repair product revenue grew 19% yoy to $120.6 million. Net sales in the U.S. increased 13% yoy to $92.2 million in 2Q07, while total international revenue increased 46% to $28.4 million in 2Q07. Revenue from Kyphon's spinal motion preservation and disc disease diagnosis and therapies businesses, which includes the X-STOP IPD, Aperius, Percutaneous Lumbar Interspinous Decompression (PercLID) and Functional Anaesthetic Discography (F.A.D.) technologies, were $18.4 million in the U.S. and $5.3 million in international markets.
Provided below is a summary of revenue as compiled by Zacks Digest:
|($ in million) |
|Positive |0% |
|Neutral |100% |
|Negative |0% |
|Avg. Target Price |$68.83 |
Please refer to Zacks Research Digest spreadsheet for more details on valuation.
Capital Structure/Solvency/Cash Flow/Governance/Other
As of the end of 2Q07, Kyphon had over $51.87 million in cash and cash equivalents. Inventories at the end of 2Q07 were $18.6 million, up from $11.9 million at the end of 4Q06. The increase in the inventory level reflects the combination of Kyphon and SFMT.
The company markets its products through sales representatives in the United States (U.S.), and through a combination of sales representatives, distributors, and agents in its international markets. Kyphon competes against larger, well-capitalized companies in the orthopedics space. However, within the kyphoplasty/vertebroplasty spine niche, Kyphon has a leading market share, approximately double versus its nearest competitor. KYPH appears to be favorably positioned in Europe for both the X-Stop (B-Twin) and Aperius inter spinous spacers for the treatment of LSS
The company made solid progress on key initiatives designed to fuel future growth including the introduction of new marketing programs to supplement expansion of the global sales channel, training of new spine specialists in performing balloon kyphoplasty and the X-STOP IPD procedure, as well as the increased enrollments for the clinical trial programs.
Acquisition Update
On September 17, 2007, Kyphon announced that it has obtained clearance from the Federal Trade Commission (FTC) and U.S. Department of Justice with respect to its acquisition of the non-vertebroplasty spine-related assets and associated intellectual property rights of Disc-O-Tech Medical Technologies, Ltd., a privately-held Israeli company, and its U.S. subsidiary. This clearance relates to one of two definitive agreements entered into with Disc-O-Tech in December 2006. Further, on September 19, 2007, Kyphon announced clearance for the merger from the German Federal Cartel Office.
Most of the analysts in the Digest group believe the two acquisitions will provide new platforms for the treatment of lumbar spinal stenosis and minimally invasive fusion. These acquisitions are strategic in advancing KYPH’s mission to become the recognized global leader in restoring spinal function through minimally invasive therapies.
Medtronic (MDT) proposes to acquire KYPH $3.9 billion excluding the $320 million in payments associated with the St. Francis Medical and Disc-O-Tech transactions. Both Boards have unanimously approved the deal. One firm (Bear Stearns) believes that MDT is a logical fit, given the companies’ existing relationship and significant revenue and cost synergies resulting from the transaction. KYPH’s product mix, treating both vertebral compression fractures and mild/moderate lumbar spinal stenosis fills voids in MDT’s current platform.
On September 20, 2007, KYPH announced that Institutional Shareholder Services (ISS), a leading independent proxy advisory firm, will urge Kyphon stockholders to vote "for" the merger agreement between Kyphon and MDT at the special meeting of Kyphon stockholders to be held on October 16, 2007.
Potentially Severe Problems
There are none other than those discussed in other sections of this report.
Long-Term Growth
Of the brokerage firms covering the company, four have published three to five year EPS growth rates. The average Zacks Digest long-term growth rate is 35.9%. The low-end projection is 32.7% (Bear Stearns) and the high-end projection is 39% (Lazard).
Analysts believe Kyphon’s long-term strategy of focusing on management information system solutions to access and treat disorders of spine exposes the company to one of the fastest-growing segments in orthopedics, which is expanding 20%–25% annually. While the company continues to serve the under-penetrated vertebral compression fractures (VCFs) market with its 300-plus person worldwide sales force, it should be able to leverage the infrastructure in the U.S. to provide instrumentation for a variety of ailments treated by spine surgeons. Having trained 5,560 U.S. surgeons to date, the company’s efforts to expand internationally are beginning to bear fruit, with the establishment of direct-selling efforts and reimbursement in select countries, such as Germany, according to analysts.
KYPH expects continued growth to be driven by: (1) deeper penetration into the expanding VCF market, particularly with the additional marketing clearance; (2) high revenue per procedure as Kyphon’s bone cement is incorporated in an increasing percentage of procedures; (3) product pipeline expansion addressing additional indications; and (4) regional expansion.
Further, firms in the Digest group state that the acquisition of St. Francis Medical is strategically a perfect fit to KYPH’s line of business, and believes the X-STOP device will produce a classic case of product and sales force synergy. They also believe the positives from the acquisition will be greater than the potential negative effects of the MDT litigation.
Upcoming Events
On October 25, 2007, the company expects to release its 3Q07 earnings results.
|Date |Event |
|2H07 |Complete enrollment for the CAFE trial |
|2H07 |Commence new product launch in select European countries |
|2H07 |Initiate randomized controlled U.S. trial comparing X-STOP with laminectomy |
|2H07/2008 |Initiate larger, randomized trial evaluating predictive value of F.A.D. following the SODA trial |
|2008 |Publish interim data in leading medical journals for products |
|March '08 |Tennessee trial against MDT begins |
|2H08/2009 |Potential Japanese regulatory approval for different products |
|2H08/2009 |Complete enrollment in KAVIAR trial |
Individual Analyst Opinions
POSITIVE RATINGS
None
NEUTRAL RATINGS
BMO – Market Perform ($71 price target) – 07/27/2007: The firm initiated coverage on KYPH with a Market Perform rating and a price target of $71.
Citigroup – Hold ($71 price target) – 07/27/2007. The firm downgraded the stock from Buy to Hold and increased the target price from $54 to $71. INVESTMENT SUMMARY: The firm believes (1) kyphoplasty continues to penetrate the worldwide VCF markets, (2) data from the ongoing clinical trials, if positive, could promote increased kyphoplasty adoption for treating newer indications such as cancer and trauma, and (3) management has built a corporate operating infrastructure that can be leveraged into other therapeutic areas besides kyphoplasty.
Lazard – Hold (no price target) – 09/17/2007: The firm maintained the target price and rating.
SIG – Neutral (no price target) – 07/27/2007. INVESTMENT SUMMARY: Given the deal metrics, the financial strength of Medtronic, and the likely synergies implied from a strategic standpoint, the firm believes this combination as a very compelling one and the other players could have a tough time trumping this bid.
ThinkEquity − Hold ($71 price target) – 07/30/2007: The firm downgraded the stock from Buy to Hold and increased the target price from $58 to $71. INVESTMENT SUMMARY: The firm believes that there will be significant synergies, which will make KYPH more profitable as a division of MDT than it would have been as a standalone.
Bear Stearns − Peer Perform (no price target) – 07/30/2007: The firm downgraded the stock from Outperform to Peer Perform. INVESTMENT SUMMARY: The firm continues to have a positive outlook on KYPH given superior technology platform and market share lead in an under-penetrated vertebral compression fracture market and two-year US head start in the treatment of lumbar spinal stenosis with the X-Stop interspinous spacer.
B. of America − Neutral ($71 price target) – 09/20/2007: The firm downgraded the stock from Buy to Neutral. INVESTMENT SUMMARY: The firm believes the spread on the proposed acquisition by MDT has now narrowed as the companies continue to make progress on the regulatory front. The deal however appears well on its way to being completed; hence the stock is rated as neutral.
MorganStanley – Equal Weight (no price target) – 08/20/2007. INVESTMENT SUMMARY: The firm remains concerned about (1) the continued softening in the core U.S. kyphoplasty market, and (2) potential sales risks associated with the pending acquisition of Disc-O-Tech. The firm expects the stock to trade in line with the acquisition price subject to the timing and risk associated with the deal.
Piper Jaffray – Market Perform ($58 price target) – 09/21/2007: The firm downgraded the stock from Outperform to Market Perform but maintained a target price of $58.
Wachovia − Market Perform (no price target) – 09/16/2007: The firm maintained the rating.
Research Associate: Sweta Gupta
Copy Editor: Joyoti D
Content Ed.: Kinjel Shah
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Zacks Research Digest
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