dj Orthopedics Announces Redemption of Senior Subordinated Notes
BY JOHN MCCORMICK, MAY 17, 2004
Last week dj Orthopedics (NYSE: DJO) made the call analysts have been expecting: the redemption of their punitively expensive Senior Subordinated notes. This lingering artifact from the Company's 1999 LBO was costing the company nearly $10 million in interest costs per year, or roughly double its current R&D budget. DJO will make the redemption on June 15 of this year when the call premium (effectively a pre-payment penalty) becomes less onerous. The entire redemption is $75 million plus the $4.7 million call premium. This event is consistent with what management has been signaling over the last few months and comes on the heels of a hugely successful operational turnaround at the Company. The action was consistent with analyst expectations and earnings estimates have not been revised as a result.
Standard & Poor's gave DJO an upgrade, however, but noted concerns about how the newly acquired bone growth stimulation business, Regentek, is competing with larger companies in the industry while facing 'ongoing pricing pressures as its products and devices become more mature." Stating that DJO competes in markets which are facing ongoing pricing pressures is obvious, but it is clearly for the wrong reason. The pricing pressures in DJO's core market, bracing, originate more from sometimes reluctant insurers and cutthroat price competition than the 'maturity' of the industry - whatever that means.
Nevertheless, bracing is a 5% revenue growth industry (that is slow for orthopedics), so it is stating the obvious that DJO made a fundamentally good move by buying the higher growth bone stim business given the Company's distribution relationships and new contracts with the likes of Broadlane and Premier Purchasing Partners. Standard & Poor's estimate for the bone growth stimulation market sees an overall growth rate of 15% to 20%. Our immediate reactions to that are (i) 15% growth is probably a better estimate for the bone growth stimulation market given that unit volume is more dependant on spine than on longbone while prices are expected to remain flat and (ii) DJO's Regentek grew 17.2% on a year over year pro forma basis for the fist quarter of 2004. That 17.2% is actually closer to 19% if one adjusts for shipping days. So prices may be flat, but this market is growing and DJO is growing even faster. This suggests that DJO is gaining market share and we were not surprised to learn from management that this is the case. While it is too early to tell who is losing share to DJO's newly acquired Regentek, there is only a shortlist of candidates: Biomet, Smith & Nephew and Orthofix.
Although equity analysts have not increased their earnings expectations for DJO as a result of this announcement, the operational dynamics for DJO should start to look all the more interesting when the reality of an extra $10 million per year becomes available for R&D, sales & marketing, improved manufacturing and/or simply an increase in the bottom line.
