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Wednesday, September 20, 2006

Why Biomet Needs to Find a Buyer

Biomet (BMET) finds itself in a bit of a predicament after it latest earnings. The stock is trading down again by about 3% at the open to under $33.50, and longer-term investors who probably were seeking the safety and predictable cash flows out of this sort of company are probably getting antsy. The company was supposed to post EPS at $0.43, but posted EPS of $0.42 after stock options ($0.44 before options). The revenues were expected to be $519.95, but they came in at $508.2 million. This report year-over-year was compared to EPS of $0.40 and R$484.9 million.

The company said that while sales of orthopedic reconstructive devices and dental reconstructive implants were strong, sales at its Biomet trauma and spine subsidiary were below expectations and the $12 miss in that area was to blame for the revenue shortfall. Biomet is implementing a new computer system and sales support systems and has in-sourced manufacturing, in an effort to improve performance.

The company gave next quarter guidance of $0.44 to $0.46 EPS (street is $0.45) and revenue between $519 million and $540 million ($535.25 million is estimate). For a company that has been stuck in a rut, this one report isn’t that bad in and of itself; but it is the steady shortfall and the slight miss of the bar that is irritating to traders and investors.

The company will host a conference call at 10:00 AM EST, but it makes you really wonder what is going on inside the minds of management. BMET stock has been dead money for some time after enjoying a meteoric rise from under $5.00 to almost $20 from 1995 to 2000 and from $17+ to over $45.00 by 2005. It hasn't seen the light of day since then. It closed at $34.47 yesterday, right in the middle of the $30.22 to $39.45 52-week trading range. The market was not expecting an earnings AND revenue miss again.

Biomet is part of the "replaceable you" field. They manufacture reconstructive products, which include knee, hip, and extremity joint replacement systems, as well as dental reconstructive implants, bone cements, and accessories; the GPS system; and the procedure-specific instrumentation required to implant the company's reconstructive systems.

The market cap is $8.4 Billion, and with $1.86 expected for May 2007's fiscal year-end from the street (that we will take down by $0.07 for an exponential continued miss expectation) we will pretend that the street should expect $1.79. At $33.50 pre-market this derives a forward P/E of 18.7. The street is still giving this a 13% earnings growth, but we are only going to give it a 10% based on reduced expectations. Please understand that this is pre-conference call data and we are only using the empirical data to make reduced expectations. Wall Street has a neutral/hold bias on the stock, and that is hard to blame them for.

What is becoming painfully obvious is that the company isn't cutting it. Its products have suffered from reimbursement rate issues just like other orthopedic and implant companies on and off, but the company is missing the bar outside of that too. They need to find a buyer. It is small compared to J&J' (JNJ) Dupuy unit, smaller than Zimmer Holdings (ZMH), and about the same size as Smith & Nephew (SNN). It is also smaller than Medtronic (MDT) by far, much smaller than Boston Scientific (BSX) after the Guidant buyout;and smaller than Stryker (SYK). The WSJ was just commenting yesterday that J&J was struggling to perk up its medical device business.

Unfortunately the company is under an interim-CEO & President. They need to do something, and that is obvious. If they aren't going to go seek a buyer, then they need to seek divestitures of slower groups or even go out and look at strategic smaller deals that could pay off in two years. The company posted global constant currency growth of knee replacement of 10%, hip replacement growth of 7%, extremity sales 11%, dental reconstructive growth 10%. Its fixation sales and bone cements were negative growth; and its spinal growth was red too.

Biomet carries $257.5 million in cash and investments, claims $493 million in accounts receivable, has 560 million inventories, and it lists $106 million in other current assets and $363 million fixed assets. They are top heavy in "goodwill" and "other" assets at $442 million and $93 million respectively. If we butchered out the fluff of the balance sheet we would issue a raw $1.75 Billion in total assets. It only claims about $570 million in liabilities, so there is quite a bit of tangible book value here even after you use a butchering of the "goodwill and other" assets.

We will be on the conference call this morning at 10:00 AM EST, but the end game for Biomet is becoming quite clear. The real question to ask is how the company will be able to make a larger acquirer see value.

Jon C. Ogg
September 20, 2006

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