MAKO Surgical Corporation (NASD: MAKO) is a maker of robotic surgical equipment and minimally invasive orthopedic implants for knee procedures. It was incorporated in 2004, had its initial public offering in 2008, and currently has a $369 million market capitalization.
MAKO’s robotic equipment is in competition with Intuitive Surgical’s (NASD: ISRG) da Vinci system. ISRG has a $10.8 billion market capitalization and a large head start, and there are high switching costs in this industry. In addition to ISRG, MAKO faces new entrants in this space from better funded firms such as Stryker ($20 Billion market cap), Smith and Nephew, and Zimmer.
In the past seven quarters, MAKO has lost a little over one dollar in operating profit for every dollar in sales. It reminds me of the old Dave Letterman joke: “How do they do it? Volume, volume, volume.” Actually, they do it the old fashioned way: They dilute their existing shareholders. There has not been a year since the day it incorporated in 2004 in which MAKO has failed to raise capital by issuing new shares.
It’s not that MAKO is uniquely expensive in this space, but it does trade at over eleven times sales (a 40% greater multiple than ISRG and almost 400% more than Stryker) and almost five times book value. And, of course, it has never made money. Its product and patent inventory may be impressive, but as we learned in the late 1990s, at some point a firm needs to generate positive free cash flow in order to justify Pets.com- and eToys.com-multiples, and it’s rarely good to be an undercapitalized, late entrant without something unique.
At these valuations, investors must believe that a buyout at even more ridiculous prices is just around the corner. It is the greater fool theory. Yes, buying MAKO’s patents and expertise would save startup costs, but it is not as if better funded firms that have greater bargaining power than MAKO are happy to throw money in the trash.
Yesterday, before the market opened, MAKO announced that once again they were going to issue more common shares. MAKO will increase the number of shares by over 16%, which is serious dilution. MAKO entered into an agreement with their underwriter, Piper Jaffray, in which both parties agreed that the price for the new shares would be $9.65. At that price, MAKO and Piper optimistically assumed that increasing the number of shares by 16% would only reduce the share price by 8%. The closing price on the day before the announcement was $10.49.
So, how has the market taken the news? The shares are UP over 10% since the announcement; they are trading at $11.54. Current shareholders are apparently willing to pay almost 20% more for the shares than new shareholders will have to pay.
I or one of my investment vehicles has a short position in MAKO.